A Quick Fix Is Not Enough

By Barbara Rudolph

This recession is different. That is the raw, uncomfortable reality that more and more Americans seem to know and feel, from university economists in Massachusetts to shipyard machinists on the Mississippi coast. Many Americans sense that the classic cures for a garden-variety recession -- tinkering with the tax code, boosting spending programs or simply waiting for the business cycle to run its course -- may not be enough to restore lasting prosperity this time around. In fact, the U.S. economy needs more than a quick fix. Substantial, structural changes may be required. It may even be time, some economists are suggesting, for a new version of the New Deal.

Few would advocate a literal reprise of Franklin D. Roosevelt's response to the Great Depression, which included strong gusts of government spending and massive public-works projects. Most economists shy away from any agenda that would increase federal bureaucracy or require more direct, activist government intervention in the marketplace.

Yet the U.S. economy stands at an important crossroads. "This is the time to take major steps and make major changes," says Allen Sinai, chief economist of Boston Co. Economic Advisors. "The economy is beset by structural, long-run problems that cry out for a systematic plan of attack. The time has come to create a new economic order." Robert Heilbroner, an economist at the New School for Social Research, argues that the 1990s should mark the start of a new era. The U.S. economy, he says, could be poised for a new "long wave" of growth, following the most recent wave that began after the World War II era and continued more or less through the 1980s.

Each economist carries his doctor's bag of pills and potions for the ailing economy, but there is a strong consensus on the need for one dose of medicine: a dramatically improved infrastructure and educational system. Capital investment for roads, bridges, highways and airports is essential for the long-term health of the American economy. Serious repairs of the nation's transportation system have been postponed, and the evidence can be seen in crumbling bridges and congested highways everywhere. During the past 30 years, infrastructure projects have declined from 3.2% of total U.S. spending to 1.6% today.

In a TIME/CNN poll conducted Jan. 2, a majority advocated such economic remedies as middle-class tax relief, favored by 78%, and a cut in the tax on capital gains, endorsed by 55%. But most also want long-term solutions, including greater spending on education, which 82% support, and increased spending on highways, roads and bridges, which 57% advocate. To finance such projects, 68% want an increase in taxes on households with incomes of $100,000 or more, and 67% favor an increase in taxes on alcohol and tobacco. Only 22% would accept a higher gasoline tax.

Since this is an election year, the quick and relatively easy economic fixes are bound to take precedence over the more worthwhile but cumbersome long-term reforms. When President Bush unveils some specific growth-stimulating proposals in his State of the Union address at the end of the month, the centerpiece will probably be a capital-gains tax cut. Such a cut would do the economy the most good if it were directly aimed at stimulating new investment. Democrats may accept a capital-gains cut in a compromise deal if it is joined with some sort of break for lower-and middle-income taxpayers, since it is the wealthy who benefit most from capital-gains relief. Congress may revive the investment tax credit in hopes of boosting spending on factories and equipment. Bush would probably sign on. Experts caution that the ITC would be truly helpful only if the credit is temporary (somehow temporary measures tend to become permanent by default) and targeted to productive investments.

Several Democrats and Republicans advocate a sharp cut in the payroll tax for Social Security and Medicare. This regressive tax has nearly doubled in the past decade to 15.3%, with the burden shared equally by employer and employee, and of all the taxes that the Treasury collects, it may be the strongest deterrent to the creation of new jobs.

If properly focused, these measures could be sensible and even effective. But they are little more than cosmetic surgery -- a nip here, a tuck there. What the U.S. economy desperately needs, many experts now argue, is the equivalent of open-heart surgery. The key to the economic transformation: basic investment in capital improvements and not in consumption. The notion would be to rebuild a public environment in which businesses could flourish. In this way, America's waning competitiveness in global markets might be restored.

To resurrect the American infrastructure, the government might help finance federal, state and local partnerships to build mass transit, opting for light rail more often than underground subway lines. These transit systems would easily pay back their start-up costs through reduced consumption of fossil fuels, diminished pollution and traffic congestion. The construction could be financed, at least in part, by new taxes on parking and gasoline. Similarly, high-speed railcars could be a new, more efficient means of transportation and could be paid for by imposing new taxes on diesel and jet fuel. Those levies would not be popular -- but that is what leadership is for.

This ambitious undertaking would certainly provide an immediate lift to the economy, no bad thing when the general prognosis is for anemic growth through the middle of the decade. In the long run, the economy's basic foundation would get a second life. "The economy needs a shot in the arm, and these things need to be done," says economic forecaster David Levy.

As part of any new boost to capital investment, the Federal Government will have to spend more to stimulate private research and development into new technologies. The President's proposed budget for basic research in fiscal 1992 was 8% greater than funds allocated in 1991, but is still paltry by comparison with defense R.-and-D. spending. As Americans have been skimping on R.-and-D. projects, their foreign rivals have been boosting outlays and reaping the rewards. U.S. spending on nondefense R. and D. has amounted to less than 2% of GNP, vs. nearly 3% in Japan.

The American public-education system gets equally dismal grades when compared with much of Europe's and Japan's. Harvard's Robert Reich and other economists contend that in the next decade, the skills of a country's work force will be a major determinant of its competitiveness in the world. Some experts argue that all who qualify academically should have access to a college or a vocational-training program, even if they lack the money for tuition. Arkansas Governor Bill Clinton suggests that needy students could pay for their education by performing some kind of public service after they graduate or by repaying loans through modest payroll deductions over many years.

Where, the skeptics ask, will the money come from? At least some of the billions must come from the old cold war defense budget. Some economists think the Pentagon could eventually provide $50 billion in defense savings a year, beyond those that have already been budgeted. Internal Pentagon reports conclude that such a cut would not endanger national security. Last week congressional leaders called for elimination of the legal barriers between military and domestic spending, which would make it easier for Congress to use Pentagon cutbacks for other federal programs. A defense windfall, some economists say, should be used to repair the nation's infrastructure. Heilbroner quips that the defense contractor Northrop could be transformed into the North American Road Corp.

But if infrastructure projects are to get further than a contractor's sketch pad and the economy is to be permanently transformed, not just temporarily revived, a long period of low interest rates is essential. For that reason, the overwhelming majority of economists argue that the Federal Reserve must keep the discount rate near its current 27-year low of 3.5%. Still, the central bank can do only so much. Since the bond market remains quite wary of a ballooning federal deficit -- and would undoubtedly drive up interest rates in anticipation of dramatically rising deficits -- Congress will have to keep a constant eye on the mood of the markets to prevent interest rates from spiking up.

Several of the President's economic advisers believe a sizable deficit financed stimulus program would not drive up interest rates significantly, so long as the caps on future federal spending are kept in place, as agreed in the 1990 budget deal. Michael Boskin, chairman of the President's Council of Economic Advisers, has argued in White House meetings that although the Federal Government already expects to run a $360 billion deficit this year, U.S. fiscal policy is essentially neutral because almost all the deficit is accounted for by interest payments on the federal debt and by the cost of bailing out depositors in failed banks and thrifts. Neither of these payments has any stimulative effect. Meanwhile, the states and cities are running contractionist fiscal policies by raising taxes and cutting spending. If caps on future federal spending are kept in place, Boskin has told his colleagues, the economy could benefit from stimulative tax cuts of about 1% of economic output, or about $57 billion, without driving up long-term interest rates more than half a point.

In an approach that frankly apes the New Deal, Iowa Senator Tom Harkin goes even further and proposes massive investment in public works. His rhetoric is plainly Rooseveltian: one of his stock speeches aims to evoke 1930s nostalgia by recalling how Harkin's father, an unemployed coal miner, got a job working on a WPA construction site.

In response to such echoes of New Deal policies, some economists point out that the New Deal focused squarely, and sensibly, on dragging the economy out of its nightmare. The goal was essential, but it was a decidedly short-term fix. Roosevelt launched heavy government spending, priming the pump to mitigate the drastic economic contraction. Some economists argue too that in a sense the New Deal was an incomplete economic success. In 1940 the unemployment rate had been more than halved -- but still stood at about 14%. Not until World War II did the economy reach virtually full employment.

Even the staunchest proponents of a 1990s New Deal admit that their schemes have one real risk: an outbreak of inflation. "That's the one big hitch," concedes Heilbroner. He adds, though, that if the U.S. had its own type of loose alliance between labor, business and government, as some European nations do, such a structure could provide a means to control excessive wage increases. But most Americans would oppose that kind of state involvement in the marketplace.

Americans have always been good at muddling through. Defining a course of bold action -- and finding the political will to make the first move -- is inevitably more difficult. But the pervasive pessimism that seems to define the American spirit today is itself a cause for optimism. People are worried -- and that may mean they are finally ready to accept tough measures and discomfort. "I am more encouraged now than I've been in a long time," says Sinai, in marked incongruence to his words of warning. "The country is waking up to the fact that we're in deep trouble. That's the first step." The long- term goal seems clear: a fundamental overhaul of the basic structure, the capital core, of the U.S. economy.

With reporting by Laurence I. Barrett and Dan Goodgame/Washington