THE WHITE HOUSE
Office of the Press Secretary
1999 ECONOMIC REPORT OF THE PRESIDENT February 4, 1999 Council of Economic Advisers
Chapter 1: Meeting Challenges and Building for the Future
Chapter 1 provides the customary overview of the entire report, details the President's economic agenda, and describes accomplishments of the past year. The chapter notes that our Nation is currently enjoying the longest peacetime expansion on record and describes important challenges for the next century, including preserving fiscal discipline and meeting the international challenge. The chapter also discusses the challenge of embracing change while promoting fairness.
Comparing three long expansions. The current expansion is only the third on record that has lasted at least 7 years. Compared with the long expansions of the 1960s and the 1980s, inflation has remained tame even as the unemployment rate has reached low levels. In addition, productivity growth has remained strong (relative to the post-1973 trend) rather than slowing down as is often the case in the mature stage of expansions. Finally, more than a third of the increase in real GDP has come from fixed investment - a substantially higher fraction than in the other two long expansions - while the contribution of government spending has been negligible. Preserving fiscal discipline. Reducing the Federal budget deficit has been a centerpiece of this Administration's economic policy and the budget balance has improved steadily since 1993. The chapter describes the longer term demographic challenge arising from the aging of the U.S. population and the President's plan to use much of the projected budget surpluses to help save Social Security and strengthen Medicare, while preserving the fiscal discipline that has been so hard won over the past 6 years. Meeting the International challenge. The chapter describes how the United States has led the international community's efforts to promote world economic growth, to stabilize international financial conditions, and to implement reforms to reduce the vulnerability of the international financial system to future crises. Embracing change while promoting fairness. Difficult choices must be made when confronting change that confers broadly distributed gains while imposing smaller but more concentrated costs. Increases in our standard of living over the longer term require that we embrace change, but considerations of fairness require that we ensure that no part of our society bears disproportionate losses. The general principle that it is desirable to address the disruption caused by positive change rather than block the change itself is illustrated with a discussion of three areas of current policy concern: agriculture, corporate mergers, and international trade.
Chapter 2: Macroeconomic Policy and Performance
Chapter 2 reviews macroeconomic developments over the past year, and describes the Administration's economic forecast and the near-term outlook for the economy. This year it also analyzes financial market volatility in 1998, the strength of business investment in this expansion, and the macroeconomic implications of the Y2K computer problem.
Another strong year. By a number of different measures, the U.S. economy performed very well last year. Robust growth in business investment and household spending, combined with vital contributions from fiscal and monetary policy, fueled strong growth and created 2.9 million jobs. The unemployment rate of 4.5 percent was the lowest since 1969; the 1.6 percent rise in the consumer price index was the second smallest increase since 1964, and other measures of inflation were even more muted. The turmoil in foreign economies showed up in the sharp decline in net exports, but the economic expansion maintained considerable momentum. Financial markets. Markets finished the year solidly up by most measures, after a worldwide flight to quality and liquidity in the late summer and early fall temporarily reduced some businesses' access to capital and raised the cost of borrowing for others. The near collapse of the hedge fund Long-Term Capital Management raised questions about the proper regulatory stance toward hedge funds and other institutions that actively trade securities and derivative instruments - institutions that are currently relatively lightly regulated. Robust business investment. Rapid output growth, strong corporate profits, plunging computer prices, and increased national saving due to improving Federal Government balances have all contributed to strong growth in investment during this expansion. Equipment investment has contributed more than twice as large a share of GDP growth during this expansion as during previous postwar expansions. Y2K. The chapter concludes that even if Y2K disruptions turn out to be on the serious side, they will most likely show up primarily as inconveniences and losses in some particular sectors not in substantial macroeconomic terms. The Administration forecast. The Administration projects GDP growth over the long term at roughly 2.4 percent per year, a figure consistent with the experience so far during this business cycle as well as with reasonable growth rates of the economy's supply-side components. A moderation in output growth to 2.0 percent is projected for the next 3 years, in line with private forecasts, but the outcome could be even better, as indeed it has been for the past 3 years.
Chapter 3: Benefits of a Strong Labor Market
Chapter 3 examines conditions in the labor market during this expansion and discusses the Administration's education and training initiatives. It finds that the Nation's labor market is performing at record levels: the number of workers employed is at an all-time high, the unemployment rate is at a 30-year low, and real (inflation-adjusted) wages are increasing after years of stagnation.
Progress for disadvantaged groups. Groups whose economic status has not improved in the past decades are now experiencing progress. The real wages of blacks and Hispanics have risen rapidly in the past 2-to-3 years, and their unemployment rates are at long-time lows; employment among male high school dropouts, single women with children, and immigrants, as well as among blacks and Hispanics, has increased; and the gap in earnings between immigrant and native workers is narrowing. A strong employment relationship. Job displacement - job losses due to layoffs, plant closures, and the like - has declined substantially since the 1993-95 period, and among those who have been displaced, the share that have found new work has increased. These reemployed workers still typically earn less on the new job than at the job they lost, but these wage losses are at record lows. Moreover, the popular assertion that secure lifetime jobs are disappearing appears to be overstated. This is not to suggest that the picture is entirely benign: some groups have experienced declines in job tenure since the 1980s, and the rate of job displacement remains relatively high given current labor market strength. Reduced welfare use and crime. Besides spreading the benefits of economic growth more widely, the robust labor market has generated other, less obvious benefits. It has contributed to a decrease in welfare caseloads, allowing States and localities to focus increased resources on designing and implementing welfare reform. In addition, low unemployment and, especially, the rise in average wages may have contributed to a reduction in crime. Several studies have demonstrated an inverse relationship between labor market opportunities and criminal behavior: the better the options in legal employment, the less likely are potential criminals to commit crimes.
Chapter 4: Work, Retirement, and the Economic Well-Being of the Elderly
Today, more than one out of every eight Americans are over 65. By the time the youngest baby-boomers hit age 65 in 2029, almost 20 percent of Americans will be elderly, according to projections. Chapter 4 assesses the work decisions and economic well-being of the current and the soon-to-be elderly as America anticipates this phenomenal demographic change.
Labor force participation -- long-term trends are changing. The century-long decline in male labor force participation at older ages has leveled off since 1985. More men aged 55-64 are continuing to work, often part time or in a different occupation, after retiring. Meanwhile the share of women aged 55-64 participating in the labor force has increased by almost 10 percentage points in the past 15 years. Pensions and health insurance -- also changing rapidly. The share of participants in defined-contribution pension plans, such as 401(k) plans, is growing and the share in defined-benefit plans shrinking. Employer-provided health insurance coverage for retirees has also become less widespread, less generous, and more expensive. These developments have many ramifications, both for retirement incentives and for the well-being of retirees. Less poverty. The economic status of the elderly as a group has improved remarkably during the past three decades. Their poverty rate has fallen to less than half what it was in 1970. In that year the elderly were more than twice as likely to live in poverty as the nonelderly, but today poverty is less prevalent among the elderly than it is among younger persons. Disparities in well-being. Although most elderly groups - men and women; blacks, whites, and Hispanics; older and younger elderly; single as well as married persons- have enjoyed economic progress, large disparities in well-being prevail among these groups. Just 4.6 percent of elderly married men, but 28.8 percent of elderly black women and 17.9 percent of elderly widows, live in poverty. And whereas Social Security benefits account for at least 80 percent of income for 38 percent of all elderly households, for another 9 percent Social Security contributes less than 20 percent of their income. Moreover, among those now approaching retirement age, over 10 percent have no financial savings whatsoever, and 30 percent have less than $1,200, whereas the top 10 percent have at least $200,000 in financial assets. Over half of all blacks and Hispanics aged 51-61 have no financial holdings.
More highlights (Administration proposals):
Long-term care. In 1994, an estimated 2.1 million elderly Americans living in the community needed assistance with 3 or more activities of daily living. About 65 percent of elderly persons living in the community and needing long term care assistance rely exclusively on unpaid sources, most often family and friends. The Administration has proposed 4 initiatives to help relieve the burdens of family members with long-term care needs: a tax credit of up to $1,000 for persons in need of long-term care or their family members who care for them; "one-stop shops" to assist families caring for elderly relatives with training, counseling, and arranging respite care; a national campaign to educate families about Medicare's limited long-term care coverage; and long-term care insurance for Federal employees at nonsubsidized but favorable group rates, thus making the Federal Government a model employer. Universal Savings Accounts. The President has promised to reserve 12 percent of the projected unified budget surpluses over the next 15 years - averaging about $35 billion a year - to establish Universal Savings Accounts (USAs). Under the proposed plan, the government would provide a flat tax credit for Americans to put into their USA accounts and additional tax credits to match a portion of each extra dollar that an individual voluntarily puts into his or her USA account. This plan would provide more help for low income workers. USA accounts will build on the current private sector pension system to enable working Americans to build wealth to meet their retirement needs.
Summary of Chapter 5: Regulation and Innovation
Because innovation - the development and adoption of new technology - is essential to U.S. economic performance over time, regulation that interferes with innovation, however justifiable on other grounds, comes at a cost. Chapter 5 examines Administration efforts in three areas to ensure that regulation not only does not interfere with innovation, but indeed fosters beneficial technological change and adapts itself to such change as well.
Competition policy. Antitrust policy in recent years has broadened its conventional focus on the price and output benefits of competition to incorporate consideration of the long-run benefits of innovation. New technologies often have significant consequences for markets and consumers, while market and industry characteristics can affect the incentive and ability to innovate. The antitrust authorities have met the resulting challenges through careful enforcement decisions. In evaluating mergers, they look not only at conventional effects on prices and competition but also, increasingly, at evidence of a merger's likely effects on research and development, as the FTC did in a recent biotechnology merger. Antitrust policy has also addressed the relationship between competition and innovation in "network industries." Enforcement actions in the credit card and software industries as well as consent decrees in the telecommunications sector have highlighted the challenges enforcement agencies face - and their ability to meet those challenges- of balancing long-run encouragement of innovation with short-run concerns about competition. The environment. Environmental regulation can reduce pollution and increase the net value of economic activity (the value of goods and services produced after deducting all costs of production, including the social costs of environmental damage). The design of environmental regulation can also have a significant impact on innovation, and the ultimate costs of efforts to address important environmental concerns, such as climate change, will depend importantly on the pace at which such innovation occurs. The use of incentive-based regulation, such as the recently introduced tradable permits system to reduce nitrogen oxides emissions, not only achieves environmental goals at lowest possible cost given existing technology, but also gives firms proper incentive to search for more environmentally friendly technology. Electric power restructuring. The electric power industry is in the midst of technological and profound regulatory change. The Administration's Comprehensive Electricity Competition Plan provides an excellent example of how an enlightened regulatory approach can remove barriers to private innovation, resulting in both economic and environmental benefits.
Chapter 6: Capital Flows in the Global Economy
What began in the summer of 1997 as a regional currency crisis in Southeast Asia spread in 1998 to Russia, Brazil, and elsewhere. Coming as it did after years of increasing worldwide financial integration, the crisis shook the faith of some in globalization. Chapter 6 describes these issues and the policy steps that ensued.
Global integration and financial crises. Enhanced financial integration has allowed investors to tap the benefits of international diversification, while enabling borrowers to draw on a broad pool of world savings to finance investment and growth. But these trends have also been associated with recurrent financial crises, three in this decade: the European Monetary System crisis in 1992-93, the Mexican peso crisis of 1994-95, and now the 1997-98 Asian crisis. Origins of the Asian crisis. After years of breakneck growth, Asia might have been heading for a slowdown in any case. Adverse external developments (terms of trade shocks, recession in Japan and yen weakness) played a role. More important were structural weaknesses in the crisis countries' financial systems. Directed-lending, connected-lending, crony capitalism, and moral hazard led financial institutions to borrow too much abroad and to lend too much at home for investment projects that were not always profitable. The financing of large current account deficits led to a buildup of foreign debt that was largely short-term, in foreign currency, and unhedged. Capital account liberalization in an environment of lax supervision of the financial system also played a role. Contagion. While the crisis was triggered by such fundamental vulnerabilities, investors may have overreacted. Large capital reversals occurred; currencies and asset prices probably fell more than justified by fundamentals. The chapter also discusses the channels of contagion across countries, and the role Japan, with its own deteriorating economy, played in the crisis. The policy response. The chapter details the U.S. leadership role in addressing the crisis and discusses the IMF's approach, particularly its emphasis on financing that is conditional on countries' adjusting their policies. A relatively novel feature is that the policies on which the IMF programs are conditional are not solely macroeconomic, but also structural (dealing for example with banking regulation and corporate governance). The chapter also analyzes some of the criticisms that have been lodged against the IMF. Implications for the United States. The crisis has led to an expanding trade deficit, but the chapter refutes the view that this deficit has hurt the U.S. economy. Paradoxically, trade deficits are often associated with strong growth, and surpluses with recessions. The increased U.S. deficit has been driven by an investment boom. The crisis has heightened the need to embrace economic openness on a global scale; a retreat to protectionism would be dangerous.
Chapter 7: The Evolution and Reform of the International Financial
Chapter 7 describes how the recurrence of currency and financial crises in the world economy poses a challenge to policymakers and how the international financial architecture can be reformed so as to strengthen financial systems and make such crises less frequent and less severe in the future.
Consensus for reform. Some consensus now exists for reforming the global financial system to 1) increase "transparency," namely to improve the availability of information; 2) strengthen and reform banks and other domestic financial institutions; and 3) improve the mechanisms available to resolve crises that do occur. Three G-22 working group reports addressed these respective concerns. Proposals for reform. In its October 30 statement, the G7 committed to a number of reforms consistent with both the recommendations of the G22 working groups and other analysis and research. The G7 also stressed the need to widen efforts to strengthen the international financial system in the following areas: - Examining the scope for strengthened prudential regulation in industrial countries. - Further strengthening prudential regulation in emerging markets and promoting orderly capital account liberalization. Proposals to slow the fraction of capital inflows that take the form of short-term bank inflows merit further investigation. - Developing new ways to respond to crises, including new structures for official finance and new procedures for greater private sector involvement in crisis resolution (for example, "bailing in" investors). - Assessing proposals for further strengthening of the IMF. - Seeking to minimize the human cost of financial crises and encouraging the adoption of policies that better protect the most vulnerable in society. - Consideration of the elements necessary for the maintenance of sustainable exchange rate regimes in emerging markets.
The chapter discusses several key issues associated with these new areas of study.
The euro. The European Economic and Monetary Union represents an historic reform of the monetary system. The chapter outlines the history that led up to the January 1999 adoption of a common currency. It outlines criteria for an "optimal currency area" and argues that Europe currently has too little labor market flexibility and insufficient ability to transfer funds between regions. The prospects for the euro as an international currency are also considered. The introduction of the euro instantly created an international currency that potentially rivals the dollar. There may be some small associated costs for the United States. But there is no reason to expect the euro to surpass the dollar anytime soon, nor for the costs from the U.S. viewpoint to outweigh the political and economic advantages of a successful EMU. ###