National Center for Policy Analysis

MONTH IN REVIEW

Economy & Income

January, 1996

FOR ECONOMIC GROWTH, CUT GOVERNMENT SPENDING

A new study suggests that cutting federal spending can increase economic growth. Ohio University economists Lowell Gallaway and Richard Vedder contend that the bigger government gets, the less likely it is that the benefits of more spending outweigh the costs.

Here are some of their findings:

By their definition, the minimum functions of government include a strong defense, crime fighting, a judicial system, and building a basic infrastructure such as roads and highways.
Each additional dollar spent on programs beyond basic functions increases the likelihood that benefits will not outweigh costs.
Spending for social programs increased from less than 10 percent of the budget in 1948 to 25 percent by 1960, one-third in the mid-1960s and half in the 1970s.
From 1990 to 1995, government added more money to social programs than it added to the overall budget.
Although it has been estimated that the optimum size of government should be no more than 17.6 percent of Gross Domestic Product, the government has exceeded this level of spending every year since 1965.
This excess spending is estimated to have cost the economy an average of 2 percent per year in economic growth -- for a total loss of about $2.3 trillion in output.

The authors note that under the Republican budget plan spending would fall from 21.4 percent of GDP to 18.5 percent by 2002.

Source: Perspective, "Cut to Grow," Investor's Business Daily, January 2, 1996.

PURSUE GROWTH STRATEGY, NOT REDISTRIBUTION SCHEMES

The GOP's Contract With America was based on a commitment to economic growth; Republicans claim the Clinton administration's commitment is to redistribution of income. The Republicans have already given up more than half of their pro-growth tax cuts and may give up more in order to get a budget deal with the President.

Yet there is no way to reduce the deficit more efficiently and more painlessly than with a higher rate of economic growth. And there is no way of reducing the need for welfare spending more rapidly and permanently than by achieving higher incomes for everyone.

The administration is committed to a growth rate of only 2.5 percent a year -- compared to the 3.3 percent rate of the last five years of the 1980s.
That difference amounts to $2.3 trillion in economic output over the next five years, including $520 billion of additional revenue for the government.
That additional government revenue would pay for all the tax cuts in the original House GOP plan, and still leave about $150 billion.
Of the six pro-growth tax cuts in the original Contract, only three -- in one form or another -- have survived to the current negotiations.
They are expanding Individual Retirement Accounts (IRAs), cutting the capital gains tax and increasing the estate tax credit.
By delaying indexing of capital gains taxes until 2002, the Republicans have already cut the growth impact of this measure in half.
The pro-growth measures that didn't make it into the budget reconciliation are indexing depreciation (or "neutral cost recovery"), reducing the social Security benefits tax to its pre-1993 level and increasing or eliminating the Social Security earnings limit.

So the economic stimulus effects of these provisions has been lost, for now.

A successful budgeting process must include two vital elements. Slowing the growth of government spending is one. Encouraging economic growth, however, is a higher priority, for it also creates jobs and increases take-home pay while reducing the deficit through greater tax receipts.

Source: Former Delaware Governor Pete du Pont (National Center for Policy Analysis), "Whatever Happened to the Growth Principle?" Wall Street Journal, January 4, 1996.

WAGES, PROFITS AND PRODUCTIVITY

Studies which have been widely reported recently in the media purport to show that wages paid to U.S. workers have declined while corporate profits have increased. But more reliable studies show that the opposite is true.

Here are some of the latest findings:

Labor's share of national income has grown by about 4 percent since 1959.
Also, it has remained above 70 percent since the late 1960s.
While corporate profits have been erratic over the past 30 years, they have hovered between 10 and 12 percent of national income for most of the 1960s and into the 1970s.
In the 1980s, profits dropped to less than 8 percent of national income.
During the 1990s, they have returned to almost 9 percent -- still well below 1960s levels.

Part of the problem of arriving at reliable figures is that some economists use the Consumer Price Index to adjust compensation for inflation. But using the more reliable implicit price deflator, which is used to derive real measures of output and productivity, we find that:

Real hourly compensation grew by 0.9 percent between 1993 and 1994 -- as opposed to 0.1 percent as calculated from the CPI.
While real hourly compensation growth has slowed since 1959 in the non-farm business sector, this is due to a slowing in productivity growth.
From 1959 to 1972, output per hour in the non-farm business sector grew at a 2.4 percent average annual rate, the same as hourly compensation.
l But from 1973 to 1994, productivity growth slowed to 1 percent per year, just above compensation's growth rate.

Sources: Kenneth P. Voytek (National Alliance of Business), "The Myth of Lagging Wages," Investor's business Daily, January 8, 1996.

SCANT EVIDENCE GOVERNMENT JOB-TRAINING PROGRAMS WORK

In the vast literature on government-funded public education programs there is little evidence that additional funds to teach basic work-related skills would actually result in improvement.

Over the past 20 years, the average real wages of those with little education has declined, while college graduates have seen actual gains.
Scores of studies have shown that despite huge growth in public spending for schools, student performance in basic math and language skills has declined since the 1970s.
In fact the decline in the growth of labor productivity that began in the early 1970s is closely associated with declining student performance.

A recent study of public employment programs in 17 industrialized countries revealed that each additional percentage point of gross domestic product devoted to these programs was associated with a 1.3 percentage point increase in the unemployment rate.

Researchers asked why this was happening and came up with three fundamental reasons:

Taxes and borrowing that finance government programs tend to crowd out funds for private employment initiatives.
Government programs are not adequately driven by changing market conditions to precisely meet needs of employers.
Public initiatives tend to be inefficient since government lacks the discipline imposed by markets and competition.

The most effective training is for students to acquire basic skills in schools, augmented by formal on-the-job training or informal practical training.

Source: Richard Vetter (Center for the Study of American Business, Washington University in St. Louis), "Why Government Job Training Fails," Investor's Business Daily, January 10, 1996.

THE FAMILY-FRIENDLY 1980s

Some economists claim the traditional American family is declining due to long-term economic stagnation. For example, the Bureau of Labor Statistics (BLS) reports that the median real wage for full-time male workers fell from $34,048 in 1973 to $30,407 in 1993. However:

"Real wages" do not include health and pension benefits, which are a rising percentage of total compensation.
Although real wages have fallen for the "non-supervisory" and production workers sampled by the BLS, more than half of all jobs created in the United States since 1983 have been managerial and professional.
There are now twice as many people in these positions as in the old-style factory jobs, 34 million versus 17 million.

Per capita national income is a better measure of economic well-being than real wages because it captures total compensation, transfer payments and investment income. Per capita national income fell 1.4 percent from 1973 to 1980, grew by 18 percent from 1980 to 1989, then slipped 0.8 percent from 1989 to 1993.

Median family income did stall during the inflationary 1970s, but during the Reagan years it grew by 9.0 percent for white families and 5.8 percent for black families. However, it slipped from 1989 to 1993, falling 6.3 percent for whites and 8.6 percent for blacks.

Intact families still fare well compared to single-parent households:

According to the Population Council, a husband's income declines by 6 percent in the first year after divorce, while the wife's income falls by 24 percent.
Research shows that only 5 percent to 7 percent of all married couples have incomes below the poverty line, compared to 35 percent of female-headed families and 16 percent of families headed by single males.

Source: Ed Rubenstein, "Right Data," National Review, December 25, 1995.

HOW POOR ARE THE POOR?

The "poor" among us may not be all that poor. And there may not be all that many of them, according to a study by Bruce Bartlett, recently published by the American Enterprise Institute.

For instance, 93 percent of Americans living below the official poverty line owned at least one color TV.
Sixty percent owned microwave ovens and video cassette recorders, and 72 percent owned a washing machine.
In most instances, ownership of these appliances by poor Americans exceeds rates of ownership among the entire general populations of industrialized European countries.

Particularly startling is the fact that per-capita spending among the lowest 20 percent of income earners in the U.S. is about double their reported income.

Bartlett advances some explanations for this seeming anomaly:

Subsidized housing, food stamps and other forms of welfare are not counted as income in government statistics.
Some people with low reported income may be supported by family members or living off reserves accumulated earlier.
Perhaps the "off the books" underground economy is greater than previously imagined.
Also, about 37 percent of low-income Americans are elderly and have accumulated assets they can draw upon.

And since economists estimate that inflation as measured by the consumer price index has been overstated by about 1.5 percent per year since 1967, only 15 million people may live below the poverty line -- rather than the 38 million listed by the government.

Source: Perspective, "There's Money In Poverty," Investor's Business Daily, January 11, 1996.

SUPPLY-SIDE ECONOMICS FAR FROM DEAD

Those media pundits who thought they had written the obituary of supply-side economics were a little premature. The evidence is too strong to deny that tax reductions do spur economic growth. And a number of once-prominent politicians who reversed course and found economic salvation in raising taxes have in recent years been retired by the voters.

High tax rates aren't just unpopular with U.S. voters. People hate them everywhere. And cutting tax rates is paying worldwide dividends in terms of economic growth.

South Korea slashed its top tax rate from 89 percent in 1979 to 45 percent by 1993, with interest and dividend income taxed at only 21.5 percent and capital gains on real estate and securities being tax free.
After 1979, Singapore cut its top tax rate from 55 percent to 30 percent -- it takes an annual income of $175,000 to reach the highest level -- and capital gains are not taxed at all.
Hong Kong is a supply-sider's paradise with a top individual income tax rate of just 20 percent and a corporate rate of just 16.5 percent, with dividend income for corporations and individuals exempt from taxes.
Hong Kong features no withholding tax on wages, no Social Security or VAT tax, no estate or gift tax and no tariffs -- yet collects tax revenues equal to 18.3 percent of gross domestic product.

U.S. tax policy writers, please take note: that's almost as much as our federal government collects in taxes.

Source: Perspective, "The Supply-Side Decade," Investor's Business Daily, January 11, 1996.

PATH TO NOWHERE

"Path dependence" is the idea that insignificant historical events can lock-in an economy to accept inferior standards or products, even though superior alternatives exist, are known and the choice of switching would not be high.

Thus path dependence -- if it exists -- is a kind of market failure and is used to justify government intervention, from setting standards to determining "rational" development.

The crucial example of alleged path dependence -- and also a popular myth--is the adoption of the QWERTY typewriter keyboard, named after the arrangement of the letters, as the standard typewriter keyboard. According to the story:

C.L. Sholes, who patented a mechanical typewriter in 1867, developed the QWERTY keyboard to slow down typists so that the hammers wouldn't.
Remington bought rights to the machine and typing schools popularized the use of the QWERTY keyboard in touch typing.
In the meantime, the mechanical problems of hammer-jamming had been solved, but the economy was locked in to the QWERTY keyboard.
We couldn't change, even though a simpler, easier-to-learn keyboard developed by August Dvorak was unveiled in 1936, and a study by the U.S. Navy showed it had an advantage of between 20 to 40 percent.

A recent Fortune magazine article claimed that billions of dollars in productivity are lost annually because of the QWERTY keyboard. Thus, claim path dependence supporters, the decentralized decision making of the marketplace failed, and only government intervention to require a different keyboard could make us change.

However, the myth is not accurate: Dvorak, a Navy officer, was the author of the study touting his own keyboard; whereas an objective study in 1956 by Penn State professor Earle Strong for the U.S. General Services Administration found little or no advantage to the Dvorak arrangement.

No other convincing examples of path dependence have been found, because the theory is defective. Although consumers and producers have imperfect knowledge, they do have foresight, and no one has shown that government is better at making choices than they are.

By the way, the QWERTY keyboard wasn't designed to slow typing down. Rather, it solved the jamming problem by placing pairs of letters frequently struck in succession far from each other so that the paths of the hammers wouldn't interfere with each other, but it didn't have anything to do with typing speed.

Source: Stan Liebowitz and Stephen E. Margolis, "Policy and Path Dependence: From QWERTY to Windows 95," Regulation, Vol. 18, No. 3, 1995, Cato Institute, 1000 Massachusetts Avenue, N.W., Washington, DC 20001, (202) 842-0200.

FOCUS ON PRODUCTIVITY FOR HIGHER LIVING STANDARDS

Since 1870, productivity -- the output of goods and services the economy produces per hour of work -- has grown an average of 2.25 percent a year. But since 1973 it has slowed to an average rate of only 1 percent per year. This is a source of frustration not only for policy-makers and economists, but most notably for workers who have seen their living standards progress more slowly.

Average wages and salaries have more or less stagnated since 1973, something they have not done over so long a period since the Civil War.

Had productivity grown at more than 2 percent over the last 20 years, the typical American family would have earned some $60,000 more during that period -- and better than $5,000 more during 1995 alone.
There would be no federal deficit at all at current levels of government spending, but rather a substantial surplus.
Taxes have thus become an increasing burden, and a significantly smaller percentage of Americans under 45 now own their own homes.

Economists cite many reasons for the slowdown. Among them are the increasing stranglehold of government regulations, as well as the decline in education in the U.S. and low rates of savings among Americans.

Source: Jeffrey Madrick, "Post-1973, the Era of Slow Growth," New York Times, January 16, 1996.

GREAT EXPECTATIONS

Since World War II, Americans have made extraordinary gains in nearly every area of human endeavor. But this unparalleled progress has fueled even greater expectations which have been forced onto government, according to author Robert Samuelson's new book, "The Good Life and Its Discontents: The American Dream in the Age of Entitlement, 1945-1995."

Among Samuelson's observations:

In 1930 in America, average life expectancy at birth was 58 years for men, 61 for women -- rising to 71 and 79 respectively by 1990.
Until the 1930s, the average manufacturing worker toiled nearly 50 hours a week with few rights or benefits.
Now, 80 percent of workers have employer-paid health insurance.

Creature comforts once considered luxuries are now common place. In 1940, most Americans were renters and most households had neither a refrigerator nor central heating. Thirty percent lacked inside running water, coal fueled most furnaces and stoves, and wood was the second-most-used fuel. Elsewhere:

In 1940, more than a fifth of Americans lived on farms, less than a third of which had electric lights, and only one-tenth had flush toilets.
Then, one in 20 Americans had a college degree, compared to one in five, 50 years later.
Over the past 45 years, industrial production has increased 350 percent.
In 1976, the average supermarket offered just 9,000 products; 15 years later it offered 30,000.

Samuelson observes that post-War prosperity bred an entitlement mentality which led to disappointment that the nation was not living up to unattainable promises, accompanied also by a decline in the sense of responsibility. A distinction between government and private responsibility became blurred.

The illusion that government is the source of economic growth and is responsible for the "fair" allocation of wealth took hold. Samuelson recommends that "we need to curb our casual use of government" and "either we reconstitute our expectations, or we condemn ourselves to permanent disappointment."

Source: George F. Will, "Richer, Freer, Healthier -- and Entitled," Washington Post, January 18, 1996.

THE INFLATION VS. GROWTH DEBATE

Are we allowing our fears of rekindling inflation to stifle our national economic growth rate? A great number of economists think so.

Yet increasing economic growth would solve many of our country's ills -- including helping balance the federal budget, raising worker compensation and paying for tax cuts. And inflation appears to have been tamed long ago.

Presently, the nation's economic growth rate is an anemic 2.0 to 2.5 percent annually -- compared to a more historically normal 3.7 percent.
Raising economic growth by a mere half a percentage point would generate nearly $200 billion in increased tax revenues over the next eight years.
A half a percentage point increase would raise personal disposable income $180 billion between 1995 and 2003.
Inflation alarmists warn that current growth rates are the best we can sustain. Many analysts dispute that conclusion. Here's why:
By using equipment more efficiently and integrating technology in the service sector, we should be able to achieve growth rates of at least 3 percent.
Because structural changes in labor markets now make it possible to hire far more workers, the old definition of "full employment" as an unemployment rate of 6 percent can now be lowered to 5.2 percent without significant inflationary pressures.
Since many policy analysts believe the consumer price index probably overstates inflation by up to 50 percent, estimates of a growth rate consistent with stable inflation are probably lower than they ought to be.

Failure to recognize these changing factors means that official policies underplay our potential for growth. And monetary policy remains more restrictive than at any time since the late 1980s.

Source: Dana G. Mead (Chairman and CEO, Tenneco, Inc.) and Jerry J. Jasinowski (President, National Association of Manufacturers), "The Answer is Higher Growth," Investor's Business Daily, January 23, 1996.

SHARING THE RICHES

The media have made much recently about the rise in wealth inequality. Supposedly the rich are getting too rich, while the poor get poorer.

But a new study by Benjamin Schwartz in World Policy Journal points out that income inequality has been a constant feature of U.S. economic history.

In 1828, the richest 4 percent of New Yorkers owned 63 percent of the corporate and non-corporate wealth.
By 1845, their share had increased to about 81 percent.
By the time of the Civil War, the same could have been said for the populations of Boston, Philadelphia and all of the major cities of the South and Midwest.
By 1890, an estimated 12 percent of the population owned about 86 percent of the country's wealth.

The progressive and New Deal eras flattened this out somewhat, but the spread continued well into mid-century. In 1962, the wealthiest 20 percent of households owned 76 percent of the nation's wealth.

The difference between today and earlier eras, according to economists, is the explosion of growth in government transfer payments -- from welfare to Social Security.

This creates a burden on the productive economy that was not there previously -- and discourages those on the bottom rungs of the income ladder from climbing higher.

Source: Perspective, "Unequal Incomes," Investor's Business Daily, January 23, 1996.

PERSONAL CHOICES, NOT SEX, DETERMINE PAY

Contrary to claims that there is a "gender gap" in the wages earned by men and women due to sexual discrimination, any difference in pay appears actually to be due to different life choices made by men and women.

In 1959, the median annual earnings for a woman employed full time was 59 percent of men's pay, and rose to 72 percent of men's pay by 1995. The difference between men and women, and the changes in the pay gap over time, reflect choices in marriage and education. For example:

For men and women ages 27 to 33 who have never had children, women's earnings are close to 98 percent of men's.
In 1993, 77.3 percent of married men participated in the work force, while only 59.4 percent of married women did so.
A 1984 Census Bureau study found that while only 1.6 percent of a man's work years were spent away from work, 14.7 percent of a woman's were -- an eightfold difference that results in more average work experience for men.

In education, too, women make different choices. In 1994, for example, women with bachelor's degrees earned an average 75 cents for each dollar of men's pay, those with master's degrees earned an average 79 cents and those with doctoral degrees earned an average 85 cents. These pay differentials reflected the career choices of men and women. For example:

In 1992, more than a third of the bachelor's degrees received by women were in the lower-paying liberal arts, while fewer than 4 percent were in engineering and mathematics and fewer than 1 percent in physical sciences.
The largest category of bachelor's degrees earned by women was in business, at 20 percent, while 26 percent of men were awarded degrees in business and 13 percent in engineering.
At the post-graduate level, 37 percent of master's degrees and 27 percent of doctorates conferred on women were in education, while 34 percent the master's degrees men received were in business and 22 percent were in engineering.
Thus, one out of four women attaining doctorates did so in education, in which the mean (average) monthly income is $3,048, while one out of five men got doctorates in engineering, in which monthly income is $4,049.

The gender pay gap disappears when age, educational attainment, career choices and continuous time in the work force are factored in.

Source: Katherine Post and Michael Lynch, "Free Markets, Free Choices: Women in the Workforce," December 1995 Briefing, Pacific Research Institute, 755 Sansome Street, Suite 450, San Francisco, CA 94111, (415) 989-0833.

JOB TRAINING AND MINIMUM WAGE DOOMED TO FAILURE

President Clinton announced in his State of the Union message that he wants to raise the minimum wage and give job training vouchers to underemployed or unemployed workers.

But a number of policy analysts believe such plans are cosmetic, quick-fix schemes that won't benefit workers.

Take the minimum wage proposal:

One economic study after another has shown that raising the minimum wage forces employers to meet payrolls by laying off their least qualified employees.
It also lures some youngsters out of high school in search of seemingly large paychecks.
They, in turn -- along with other people such as spouses of full-time workers -- displace those on the bottom rung of the economic ladder.
What about the job-training program?
The President wants to consolidate 70 of these programs and give out vouchers worth $2,600 to the unemployed to enter training or attend community colleges.
But a 1994 study estimated it would cost about $25,000 per worker -- or $1.6 trillion -- just to raise the earnings potential of today's high school dropouts to the level enjoyed in 1979 by people who lacked high school diplomas.
Nearly three-quarters of all people who leave jobs are under the age of 28 -- indicating that youngsters search around for careers that are satisfying and offer better pay and benefits.

The program is wasteful since the youth who today thinks he or she wants to be an auto mechanic may decide tomorrow to become a chef.

Source: Tony Snow, "Job Security: whose, Clinton's?" USA Today, January 29, 1996.