Jewish World Review Feb. 14, 2003 / 12 Adar I, 5763
Needed: fast fiscal action
http://www.NewsAndOpinion.com | America is suffused with a sense of unease, uncertainty, and anxiety. It is confirmed in the polls. Substantially less than half the country now thinks we are heading in the right direction. The wellsprings of this public mood are twofold and connected. One is the anemic economy. Despite two years of highly stimulative monetary and fiscal policy, low inflation, and even a return to modest growth, we still do not have a sustainable recovery. The other concern is the political tension arising from the fear of terrorism and the likelihood of war after Secretary of State Colin Powell's devastating indictment of Iraq. Everyone is holding his or her breath--which in business terms means holding back on hiring and capital spending.
Most Americans gauge our well-being from watching that television soap opera, the daily stock market reports. They have waited and waited for the good news, and it has not come. For the past three years stocks have suffered annual double-digit declines, and many Americans instinctively think that if the stock market goes down, so, too, must the economy. The result is a growing pessimism.
The source of the malaise, and the puzzlement with it, is that this recession has not followed the post-WWII pattern. Until now, recessions have worked this way: Pressure on resources triggers rising prices, followed by monetary tightening by the Federal Reserve, a squeeze on interest-sensitive consumption in housing, autos, and durables, and finally rising unemployment until inflation is suppressed. Not this time. Inflation has been no problem, and the Fed began to lower interest rates even before it was clear we were in a recession in 2001. As a result, for the first time ever there has been no real consumer contraction during a recession.
Capital pain. Instead, the economic pain has been focused on the stock market and the corporate side. The $88 billion downturn in capital spending accounts for the entire GDP decline in the nine-month recession of 2001. The investment boom of the 1990s left the country with excess capacity and declining profitability, so firms slashed capital spending, inventories, and hiring, devoting their cash flow to repaying debt and focusing on cutting costs. Even record-low interest rates have barely stimulated capital spending, which finally eked out modest growth in the fourth quarter for the first time in over two years.
Businesses, lacking an increase in top-line revenue growth, just do not feel confident enough to invest and hire, so, despite the welcome drop in January unemployment reported last week, we still have a near-jobless recovery. Private payrolls dropped by over 200,000 in November and December alone, a critical marker because labor markets ultimately drive consumer spending, which alone produced last year's modest recovery. Fortunately, the principal asset of the American family, a home, has been rising in value, enhancing an equity worth four times the median value of stockholdings. Mortgage refinancing put as much as $250 billion into family budgets.
But refinancing is a nonrecurring event and not a sustainable basis for an economic recovery. Even with it, the recovery slowed dramatically in the fourth quarter of last year to a tepid 0.7 percent, supported primarily by an upsurge in federal spending. The economy is approaching stall speed, and there is scant hope that it will pick up by itself. Demand for cars, houses, and capital goods is petering out; inventory rebuilding is now largely complete; the bulk of past monetary and fiscal stimulus has been absorbed, and productivity growth permits business to expand without taking on more workers.
All of this points to the urgency of the fiscal policy agenda. We need a fiscal spur to public and private spending to stimulate demand now--not years ahead. Tax cuts should be primarily for the benefit of consumers.
This means we have to tolerate larger fiscal deficits in the short run--not just to stimulate the economy but to pay for the military action in Iraq. Alas, the president's plan to eliminate taxes on dividends, which focuses on stockholders rather than workers, suffers from two macroeconomic defects. First, it mostly benefits upper-income groups: About 6 percent of Americans with incomes of more than $100,000 would enjoy two thirds of the benefits, and their spending habits are not likely to be changed by this tax break. Second, dividend tax relief would be a far weaker stimulant to capital spending in the short run than a spike in consumer demand, given that we are still operating at a dismal 74 percent of capacity, compared with the 82 percent average of the past two decades.
The president's plan also suffers from one crucial political defect: In its current
form, it can't get through the Congress without prolonged partisan wrangling
risking continued economic deterioration in the meantime. Congress and the
administration should focus on the stimulus plan and defer the dividend tax
cut--and do it now.
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