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
System
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.
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