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Clintonomics 101

And why it beats Bush-Reagan

From The Editors: In his State of the Union address Wednesday, President Obama outlined his vision for economic recovery--and many of his ideas bore striking resemblance those Bill Clinton proposed when he was running for president in 1992. In a TNR article penned that year, Robert Reich (who would eventually become Clinton’s labor secretary) described the Democratic nominee’s economic plan. “The centerpiece of the Clinton plan is a major increase in public investment in education, training, and infrastructure,” Reich wrote. Sound familiar? It’s a lot like Obama’s stimulus plan. But Obama’s announcement this week, less than a year after the stimulus passed, that he wants a budget spending freeze might place him closer to the “Perot-Tsongas-Rudman austerity school” of deficit reduction, as Reich termed it. So just how similar is Obama’s plan to Clinton’s, in both ambition and implementation?


The presidential campaigns contrast two opposing economic philosophies about how to get the American economy back on a path of high growth. Which is likely to work? I admit I'm not exactly a disinterested observer. I have known Bill Clinton for twenty-four years, since we were students at Oxford University, and I've been talking with him about public policy and economic growth for almost as long. I also helped draft his economic plan. On the other hand, I was making many of the following arguments long before he decided to run.

On June 23 Clinton unveiled his plan; on July 23 the president unveiled his, for the second time this year (the first was in his State of the Union address). The contrast could not be sharper. The centerpiece of the Clinton plan is a major increase in public investment in education, training, and infrastructure. The president's plan contains various tax credits and incentives, but its centerpiece, as before, is a cut in the capital gains tax.

To term either plan a "philosophy" risks grandiloquence. That term implies some degree of logical coherence, details that fit together and rest easily upon a set of first principles. At the least, it implies something more than the product of political balancing that characterizes election-year proposals. But both plans do represent philosophies of a sort. Each candidate has a worldview about the economy, about what makes it tick -- or, more precisely, what will restart its ticking.

Bush's plan rests firmly upon the same supply-side premises of his predecessor in the White House. Despite his tax increase two years ago, Bush's basic inclination is still to rely on tax incentives as the most direct means of fostering growth. That faith rests on a simple syllogism. Labor productivity -- the linchpin of growth -- depends on the amount of physical capital available to each worker. With more and newer factories and equipment, American workers can produce goods in greater volume, at lower costs per unit. How to get more capital per worker? Induce wealthy individuals to invest discretionary income. And how? Increase their return on such investments by cutting their taxes -- ideally, their income tax, but at least, the tax they'll owe when they sell their investments for a profit.

In political terms, it suggests a bargain between the best-off members of society, who possess most of its discretionary income, and everyone else. The nation should forgo the tax revenues that the best-off otherwise would contribute to the common good; in return, this elite will invest even greater sums in factories and machinery -- which will improve the productivity and real wages of workers lower down. America's egalitarian ethic, in other words, should accept a less progressive system of taxation for the sake of widespread gains.

The supply-side syllogism, however, runs into several inconvenient facts, the most obvious of which is that we already tried it and it didn't work. Beginning in 1981, the first half of the bargain was kept. The effective marginal tax rate of high-income Americans was cut. Preferences for investment income tipped the scales even further, since middle-class Americans don't have nearly the investment income of wealthy Americans. Were the federal income tax as progressive as it was in the late 1970s, the top 2 percent of American earners would have paid about $72 billion more in federal taxes on their 1991 incomes.

But the second half of the bargain hasn't been kept. Although disputes continue to simmer over precise measurements, there is little debate over the basics: the share of gnp saved or invested did not rise substantially in the 1980s. Nor did productivity. Measured over the entire decade, per person growth in gross domestic products was the slowest of any decade since World War II. The federal budget deficit ballooned. The average American was no better off than before; those at the bottom grew much poorer in absolute terms.

There is no reason to expect President Bush's new plan would have any different result. The problem, in essence, is that too many links are missing in the supposed chain of cause-and-effect -- between cutting taxes on the rich and increasing the productivity of everyone else. For one thing, rich Americans -- once relieved of some of their tax burden -- do not necessarily invest their extra wealth in factories, machinery, and equipment. They tend to consume and speculate. But not even the portion of their windfall that they do invest is likely to have much of an impact on American productivity, since it is concentrated on capital assets rather than people. And here is where the contrast with Clinton's approach becomes especially clear. In the emerging global economy, national productivity is uniquely related to the accumulation of human capital. High-tech factories and equipment are worthless without skilled workers. For fifteen years American firms have loaded on computers, for example, but haven't reaped the benefits because employees don't know how to use them to improve output and quality.

The rates of return on investments in people -- in their education and training -- are thus high, and appear to be accelerating. One piece of evidence is the growing wage gap between workers who have college degrees and those who don't. In 1980 graduates earned about 50 percent more than non-grads; ten years later they were pulling in twice the non-grad wage. New evidence suggests that every additional year of schooling increases future wages by 15 percent. Compounded over a working lifetime, we're talking big money.

What's more, every factor of production other than people and infrastructure is moving with ever greater ease across national boundaries. Rather than trickle down, the savings of rich Americans are as likely to trickle out to wherever in the world they get the highest return. Nor are new technologies -- in the form of plans and blueprints -- securely moored behind borders; these days they move from computers in one nation to computers in another at the speed of electric impulses. So too with modern factories and equipment, which are now erected in the remotest regions of the globe by corporations that are themselves losing their national identities.

Still rooted within a nation's borders, however, are most of its people -- and their collective capacities to think, innovate, and use critical judgment. Also rooted within borders are the roads, bridges, ports, toxic waste treatment facilities, and airports that support these people in their efforts to be productive. Upon these two assets the future standard of living of a nation's people uniquely depends.

This dynamic can be seen as readily in Malaysia as in Mississippi. Global capital in the form of personal savings, corporate earnings, technology, or plant and equipment will remain within, or be attracted to, a particular location around the world only if it can obtain a high financial return. On this point George Bush and Bill Clinton would find themselves in complete agreement. The two part company when it comes to deciding how to deliver that high return.

Developing nations and even some states and cities try to lure capital with the promise of low wages, low taxes, and negligible environmental and safety regulations. This supply-side strategy does indeed attract capital. Ford Motor will gladly build a modern engine plant in Mexico, hiring Mexican workers to toil for $100 a month and enjoying extremely low taxes and lax environmental and safety regulations. Ford can expect a healthy return on its investment, and Mexicans get jobs. But this strategy will not result in a high standard of living for the citizens of the nation that deploys it. To the contrary, it puts that nation in direct competition for the next Ford plant with regions of the world that are willing to accept even lower wages and fewer pollution and safety standards -- and it reduces tax revenues that might otherwise have been invested in education and infrastructure in order to reverse the process. (Clinton, like many other Southerners, learned this lesson the hard way when his state's low wages and low taxes attracted Northern textile manufacturers, who later moved to Southeast Asia.)

The only way to lure global capital while maintaining or increasing the standard of living (defined to include not only good wages but also a healthy environment and safe working conditions) is to offer a highly skilled work force and a world-class infrastructure. These two uniquely national assets, combined with global financial capital, will also be profitable for global investors -- and will profit the nation's citizens. This high living-standard route is being pursued aggressively by many nations, even those whose average wages, taxes, and regulations are now higher or more burdensome than those in the United States. Global capital is not attracted to the former West Germany by its low cost of doing business. It is attracted despite the high wages, taxes, and regulations because of Germany's excellent labor force and its superb infrastructure, which links it to the rest of Europe.

The Clinton economic strategy is built upon these new realities. It recognizes that the best way to spur productivity is by investing in people directly: ensuring that infants get adequate nutrition and health care, preschoolers have adequate day care and Head Start, kids have good schools, teenagers who don't go on to college get a chance to develop productive skills, those who are eligible for college can afford to go, workers can get good on-the-job training, and all who wish can upgrade their skills. It also recognizes the importance of roads, airports, toxic waste facilities, fiber-optic information networks, and high-speed trains -- the infrastructure that supports human capital.

The Clinton plan calls for more than $200 billion of new public investment in education and infrastructure, spread over four years. This sum is not enough to yield dramatic improvements in growth anytime soon, but it marks an important start. And it compensates for the decline in public investment since 1980. Starved of tax revenues and confronted with a growing budget deficit, the federal government has reduced support for child health, education, training, and infrastructure by a third. According to the Bush administration's own estimates, Washington will invest less than 7 percent of the budget in human capital and infrastructure in fiscal year 1992.

Although some wealthy suburban townships have been able to make up the difference, most American towns and cities have been left stranded. The largest cities have fared the worst. In 1980 the federal government provided almost 18 percent of the costs of running major cities -- and most of these funds went to human capital and infrastructure. Today, even as local tax bases shrivel, the federal contribution is barely over 6 percent. The result has been a growing disparity in the quality of schools, parks, public health care, job training, and roads available to Americans of different incomes. Wealthy Americans are taking less responsibility for the needs of their less affluent compatriots.

The Clinton plan would pay for this new public investment mainly by cutting defense expenditures and by increasing the marginal tax rate on the top 2 percent of American households (earning $200,000 and above). In other words, less than a quarter of the tax windfall granted America's highest earners by Reagan and Bush would be dedicated instead to ensuring that other Americans could become more productive members of society. In this respect, the two plans represent mirror images of one another: the first calls for tax cuts on the highest incomes, even if the accompanying revenue loss necessitates reductions in government's capacity to invest; the second calls for tax increases on the highest incomes, in order to finance such investments. The first assumes productivity trickles down; the second assumes productivity bubbles up.

I don't mean to overstate the contrast. The Clinton plan incorporates a few targeted tax incentives; the Bush plan would enlarge public research and development. More importantly, neither plan would substantially reduce the budget deficit directly. Both rely on economic growth as the primary means of cutting the deficit, in contrast to the Perot-Tsongas-Rudman austerity school, which holds that deficit reduction is the means to growth. Not surprisingly, I side with Bush and Clinton on this. An emphasis on growth rather than austerity is entirely appropriate now, given currently high levels of unemployment and underutilized industrial and office capacity. Too rapid and radical an attempt at reducing the deficit could transform the current recession into a full-blown depression. Perot-Tsongas-Rudman may be overemphasizing the deficit problem even over the longer term. In a global capital market, government deficits don't completely crowd out private savings, which move easily across borders. The real issue is whether the global savings create good jobs here.

Yet although they seem to treat the deficit similarly, here too lies an important difference: Clinton's anticipated deficits are matched by public investment; Bush's are applied to public spending. Borrowing from the future in order to invest in the future is entirely appropriate because it makes future Americans who will bear the cost of the additional borrowing that much more productive. Borrowing from the future to prop up current living standards, on the other hand, is indefensible, because it merely transfers burdens to the future. (In the late nineteenth century, the United States as a whole was far more indebted than today, relative to its national income. But because our great-grandparents borrowed to build canals, railways, schools, roads, and the other foundations of a modern economy, the debt was paid off with relative ease by the early years of this century.)

The real issue here, after all, is the living standards of future Americans -- their capacities for full and productive lives. Bill Clinton and George Bush represent two fundamentally different ideas about how to achieve that end. Election-year politics during a recession tends to obscure the choice. Yet it is crucial that in the coming months Americans grasp what is at stake.

By Robert B. Reich