National Center for Policy Analysis

MONTH IN REVIEW

Economy & Income
September, 1996

DOWNSIZE GOVERNMENT TO ACHIEVE GROWTH

In countries throughout the world, economic growth slows when government spending increases, according to the current annual report on world competitiveness from the World Economic Forum. According to the Swiss foundation's report, the "current social welfare system is proving to be to heavy a burden -- even for rich European countries such as France, Germany and Sweden."

The report ranks 50 countries on their growth prospects for the next five to ten years.

Among the rapidly developing nations of Asia -- where government spending averages only 25 percent of gross domestic product -- Singapore, Hong Kong, Taiwan, Malaysia and New Zealand are in the world-wide top ten in terms of future growth prospects.
Singapore ranks first, while the U.S., with government spending at about 35 percent of GDP, is fourth.
European Union countries -- with government spending averaging 54 percent of GDP -- can only look forward to very low levels of growth, with Britain coming in eighth, Sweden 21st; and Germany 22nd.
Once-promising Mexico -- partly due to its failure to privatize Pemex, the national oil company -- ranked 33rd, and Russia brought up the rear in the ranking at 49th place.

The U.S. scores well because of free trade policies, world-class research centers and relatively flexible labor markets. But our high tax rates keep us out of first place.

The U.S. corporate income tax rate of 31 percent compares with 16.5 percent in Hong Kong.
Moreover, the average American worker faces a marginal tax rate of 20 percent -- the same as Japanese workers.
By comparison, the marginal tax rate in India is zero, only 2 percent in Hong Kong, and 9 percent in Peru, Thailand and Korea.

U.S. growth prospects are also hurt by our inefficient legal system. The U.S. rates 49th, for example, in the efficiency of our product liability law.

Source: Editorial, "Free to Grow," Wall Street Journal, September 3, 1996.

For more information on Taxes & Growth, visit the NCPA's Tax page at http://www.public-policy.org/~ncpa/pi/taxes/taxes2.html

SLAYING INFLATION ONCE AND FOR ALL?

Federal Reserve chairman Alan Greenspan believes that inflation in major nations has largely been tamed. "And now, for the first time in at least a generation, the goal of price stability is within the reach of all major industrial countries as well as a substantial number of others," he told a gathering of central banks over the weekend.

In nearly all the large economies, price inflation has been brought down below 3 percent.
After experiencing the ravages of rampant inflation in earlier years, central bankers now enjoy often strong support in their inflation-fighting efforts -- even if this means tight monetary policies.
The question now being debated is whether zero inflation is possible or even desirable -- with some saying it would be too costly a goal.

But Harvard economist Martin Feldstein estimates that reducing the inflation rate to 1 percent from 3 percent would yield a one-time, permanent gain in gross domestic product of 1 percent.

Although the Federal Reserve has never adopted an explicit inflation target, Fed officials are said to have tended to favor rates between 1 percent to 3 percent. Legislation introduced by U.S. Sen.. Connie Mack (R-FL) would require the Fed to adopt a numerical target.

Source: Richard W. Stevenson, "Fed Ponders Possibility That Inflation Is Extinct," New York Times, September 3, 1996.

LESS COSTLY GOVERNMENT YIELDS SAME BENEFITS

Government has grown too big and is seriously hampering the improvement of living standards, according to a new study from the International Monetary Fund. In fact, some countries are achieving the same levels of social welfare with lower expenditures, lower taxes and higher growth.

The authors of the IMF study reviewed the growth of government in major Western countries from 1870 to 1994.

They found that government's share of gross domestic product grew from an average of about 8 percent to 50 percent.
Most of the increase in government spending has occurred since 1960 -- more than in the previous 90 years.
Spending as share of GDP increased an average of 19.6 percentage points between 1870 and 1960, and 19.3 percentage points from 1960 to 1994.

While the early growth of government may have benefited society -- for example through better public health measures -- recent spending increases have added few additional benefits while causing slower growth, higher unemployment, lower investment, higher inflation and larger underground economies.

On the other hand, Chile, New Zealand, Ireland and Belgium have reduced spending by more than 9 percent of GDP over the last 10 years -- equivalent to $650 billion per year in the U.S. -- but there has been no decline in social welfare indicators in those countries, while economic growth rates have increased.

Source: Bruce Bartlett, "Counterproductive Global Spending," Washington Times, September 2, 1996.

For more information on Taxes & Growth, visit the NCPA's Tax page at http://www.public-policy.org/~ncpa/pi/taxes/taxes2.html

PRIVATIZING SOCIAL SECURITY AND EDUCATION IS PRO-GROWTH

Income tax cuts aren't the only -- or best way -- to spur economic growth, says economist Rudi Dornbusch. He suggests that Bob Dole should promote a program that focuses on two key sources of growth: savings and education.

Privatizing Social Security and creating a broad voucher program for education, he argues, would create more investment and raise real wages by increasing capital formation and improving the skills of the workforce.

Under a privatized system, workers would be required to invest their money in the marketplace, rather than pay it to the government.
The resulting capital formation would support rising real wages and offer a long-term answer to eroding living standards.
Privatizing the system now means that the looming fiscal crisis 15 or 20 years from now can be averted.

Privatizing education is also long overdue, says Dornbusch. Even if the government requires education, there is no reason to assume that it is the best supplier of the service. Church schools provide a first-rate education and with vouchers a wide array of organizations -- including profit-seeking businesses -- can do the same.

Politicians don't want to privatize Social Security because it would unmask the fact that payroll taxes are now used to pay for other federal spending, and thus make the budget deficit look smaller than it actually is. Teachers' unions oppose vouchers because the market and competition would make them accountable.

Source: Rudi Dornbusch (Massachusetts Institute of Technology), "Dole Blew a Chance To Be Bold," Business Week, September 2, 1996.

WHAT'S BEHIND LOW UNEMPLOYMENT?

As sluggish and anemic as the U.S. economic growth rate has been during the 1990s, one would expect much higher unemployment, right? So why is the labor market relatively tight and unemployment curiously low?

The answer, economists say, is a familiar one: supply and demand. Labor supply has grown much more slowly in the 1990s than it did in the 1980s.

From 1985 to 1990, the workforce grew by 9 percent.
But in the first half of the present decade, it grew at a 5.1 percent rate.

The Congressional Budget Office says that the percentage of the working-age population who desire to work has leveled off. Economists suspect that higher marginal tax rates are discouraging some potential workers from entering the labor force.

In 1990 and 1993, the federal government imposed substantially higher marginal tax rates on workers and businesses.
Spouses who might have become second income earners in families may have decided to stay at home when they realized that the additional income would push their families into higher income tax brackets.

Hudson Institute economist Alan Reynolds is among those who believe higher marginal tax rates stop families from sending a second spouse to work.

Statistics show that the female labor-force participation rate rose an average of 3.6 percent every five years and never grew less than 2.7 percent in any five-year period between 1965 and 1990.
But during the first five years of the high-tax 1990s, this rate grew a mere 1.4 percent.

So by distorting personal and family preferences, high tax rates slow the growth of the economy and the work force.

Source: James Carter (Republican National Committee) and Roy E. Cordato (Campbell University), "Full Employment: A Matter of Supply and Demand," Investor's Business Daily, September 11, 1996.

FED OFFICIALS CONCERNED BY MINIMUM WAGE INCREASE

Several Federal Reserve officials, who declined to be named, are worried that the approaching increase in the minimum wage will boost inflation and contribute to a decision to raise interest rates.

They said their analysis shows that a 50-cent increase in the minimum to take place October 1 could boost average hourly earnings in the fourth quarter by 0.8 percent, on an annual basis.
A similar effect would occur next November when an additional 40-cent increase sets in.
Asserting that the timing for the increase is bad, they cite the fact that labor markets are already extremely tight and the economy is operating near full capacity.
The increase is expected to complicate the Fed's efforts to stay ahead of inflation.

Also, Federal Reserve officials expect the increase in the minimum will have the effect of decreasing the number of new jobs by 100,000 to 200,000.

Source: John R. Wilke, "Increase in Minimum Wage Worries Fed," Wall Street Journal, September 6, 1996.

JOBS FOR THE JOBLESS

One enduring economic and social myth is that the jobless are unemployed because there aren't any jobs available. But with unemployment figures currently at record lows, that simply cannot be the case.

Experts say that while the jobs are there, those who are unemployed lack skills, discipline or the desire to find and keep jobs.

Among college graduates, unemployment levels last year were only 2.3 percent for whites and 3.2 percent for blacks -- demonstrating that education is a strong factor in employment.
Among those age 16 to 24 who are not enrolled in school, about 75 percent of whites are working versus 56 percent for blacks.
Among black families with children where both husband and wife work, median wags were $836 per week last year, compared to $287 for working single black mothers.
Although the median wage for black men last year was only 73 percent of the median wage for whites, this is a considerable improvement from the 43 percent it was in 1940 and the 64 percent of 1970.

Source: Robert J. Samuelson, "The Jobs Are There," Washington Post, September 11, 1996.

SAVINGS LOWER DUE TO GOVERNMENT TRANSFERS

The fall in U.S. savings and investment rates over the last generation is mainly due to government programs -- principally Medicare and Social Security -- that transfer income from the young to the elderly, according to a new study from the Brookings Institution. If not for the effects of these programs, the study estimates that the national savings rate would be roughly three-and-a-half times as large.

The elderly now hold a much bigger share of total wealth -- which includes government benefits -- and spend a larger share of it than they did a generation ago.
In the early 1960s the typical 70-year-old consumed only 71 percent as much as a 30-year-old; but by the late 1980s, the typical 70-year-old consumed 20 percent more.
Even excluding medical services, spending by a typical 70-year-old was 63 percent of a 30-year-old's in the early 1960s, but more than 90 percent in the late 1980s.

The authors of the study, Jagadeesh Gokhale of the Federal Reserve Bank of Cleveland, Laurence Kotlikoff of Boston University and John Sabelhaus of the Congressional Budget Office, reason that in the past the elderly consumed less so that they would not outlive their wealth, and because they could leave the remainder to their children.

But due to government-guaranteed benefits, and because they cannot pass any unspent benefits (particularly for medical care) on to their children, the elderly save less and spend more.

The authors also found that younger and middle-aged people are saving more of their wealth than their elders.

The long-term decline in the country's rates of investment and savings is blamed by many for the slower rate of growth in output per worker today -- less than half as fast as it was a generation ago.

U.S. investment (net of capital depreciation) has fallen more than 50 percent since the 1950s, from 8.2 percent of output to less than 4 percent today.
Savings -- total national output minus household and government consumption -- has fallen from 9.1 percent in the 1950s to 2.7 percent in the 1990s.

Source: "Growing Old Expensively," Economist, September 7, 1996.

THE DYNAMIC NATURE OF JOB CREATION

Large layoffs at major corporations grab headlines. But the steady -- some might say spectacular -- pace of job creation by small business entrepreneurs too often goes unnoticed.

In the 1980s the 500 largest U.S. corporations reduced their combined employment by three million workers.
In the decade of the 1990s, employment at the largest 500 firms is expected to fall by two million.
Yet in the 1980s, net U.S. employment increased by 18 million jobs, meaning that 21 million new jobs were created overall -- many by the 1.5 million new businesses formed in the 1980s.
In the first half of 1996, there were 85,000 U.S. business starts that created 406,000 jobs, according to Dun & Bradstreet.

The difference in job growth between the U.S. and Europe is staggering.

Although the European Union has one-third more people than the U.S., it added just 8.5 million jobs -- 6 percent of the workforce -- in the past 25 years.
Over the same period, the U.S. increased its workforce by more than 46 million, or 65 percent.
The EU expects this year to register its only net job gain of the entire 1990s -- a mere 500,000 jobs.
Over the same period, the U.S. will have added 17 million to 18 million new jobs. European unemployment is 10 percent of the workforce -- twice what it is here.

The U.S. has four factors working in its favor: entrepreneurs, commercial banks seeking to make loans, large pools of venture capital and outstanding capital markets -- factors missing in Europe.

Source: Peter Lynch (Fidelity Management and Research Company), "The Upsizing of America," Wall Street Journal, September 20, 1996.

STUDY FINDS RICH GETTING RICHER, POOR POORER

The gap in income between the highest and lowest income groups has been widening, according to a USA Today computer analysis of Census Bureau data from 1980 to 1995. The trend has accelerated significantly during this decade.

Income inequality is surging in almost every state and region of the country.
Since 1990, the gap grew wider than in all of the 1980s, especially along the coasts and in major urban areas.
The largest income gaps remain in the South and Southwest, according to the data.
In the early 1990s, the U.S. had one of the largest wage gaps of any industrialized nation.

Researchers say factors responsible for this trend include the decline of high-income manufacturing jobs and educational disparities. Those that prepare themselves with college degrees are significantly better rewarded than those who don't.

Source: David J. Lynch, "Dying Dreams, Dead-end Streets," USA Today, September 20, 1996.

LIVING BETTER ON LESS?

As measured by the size of our houses and the number of boats and recreational vehicles we own, Americans are much better off than we were a quarter century ago, despite the fact that average income in the 1990s has fallen.

Since 1970, the size of the average American home has increased from 1,500 square feet to 2,080; the number of homes with central heat and air has doubled; and we own twice as many boats and ten times as many recreational vehicles.
Real consumption grew by about 2 percent a year on average for a century up to 1990.
Yet from 1989 to 1994, real median family income fell 5.2 percent, and spending on consumption has grown by only 1 percent a year since 1990.

The recent fall in median income reversed the trend from 1982 to 1989, when real median family income grew by 12.5 percent. Many economists blame the reversal on the growth of federal taxes and the regulatory state, which are eroding gains in worker productivity -- the average output per worker per hour.

From the end of World War II to 1973, productivity grew by close to 3 percent per year on average -- but by only 1 percent per year on average since then.
Experts caution that statistical problems may understate current productivity somewhat.
But the decline in education and capital investment are, without a doubt, substantial contributing factors.
Since 1990, net domestic investment has grown less than 4 percent a year -- compared to 8 percent during the 1950s.

That decline in investment capital is not surprising, given the fact that our net national savings rate declined from 12.3 percent of after-tax income in the 1950s to 3.5 percent in 1994.

A number of economists say Americans are not saving as much as they did previously because of rising taxes for Social Security and Medicare. Some claim Social Security alone has been responsible for cutting private savings in half.

Then there is the economic drag of government regulations and red tape. Economist Richard Vedder, at the Center for the Study of American Business, claims the nation's economic output would be 30 percent higher today if expansion of the regulatory state had not occurred.

Source: Charles Oliver, "Why Paychecks Haven't Kept Up," Investor's Business Daily, September 23, 1996.

COMPARING POVERTY DATA THEN AND NOW

The Census Bureau's report yesterday that the poverty rate fell last year was good news. But it is still higher than it was at the end of the Reagan era. Similarly, among adults who worked full time last year the poverty rate was higher than in 1988.

The report found that 36.4 million Americans were living in poverty last year -- four million more than when Reagan left office.
Roughly 13.8 percent of the population were below the poverty line, compared to 13 percent in 1988.
Median household income stood at $34,076 last year, down from $35,421 in 1989 (in 1995 dollars.)

A number of experts point to the effect of "regulatory drag" on the economy to explain why things -- though relatively good -- are not as good as they once were.

Economist Thomas Hopkins, of Washington University's Center for the Study of American Business, has estimated the regulatory burden at around $668 billion a year.
As tax rates have increased since the Reagan years, economic growth has slowed from an average of 3.3 percent a year during the 1980s to about 2.3 percent today.

According to the Institute for Policy Innovation, the U.S. economy has lost an estimated $2.6 trillion in total economic output since 1990 -- thanks to increased regulation and taxes.

Source: Perspective, "Politics and Poverty," Investor's Business Daily, September 27, 1996.

FAMILIES NOT BETTER OFF THAN IN 1989

The Census Bureau recently released its annual report on poverty and income in the United States. The news seemed to be very good; but a closer examination shows many Americans are worse off than in 1989 -- or even two years ago.

The Census report says real median household income rose by 2.7 percent in 1995 over 1994, and the number of people living in poverty fell from 15.3 million to 14.7 million.

However, there is a difference between a household and a family: households include unrelated individuals living together. Thus while the Census highlighted the increase in household income,

The 1.8 percent increase in real median family income was much less.
Although real median family income has now risen two years in a row, families are still worse off than they were in 1989.

In fact, earnings of year-round, full-time workers fell for both men and women according to the report.

An average man working full-time all year earned $31,496 last year compared to $31,728 in 1994, a decline of $232 or 0.7 percent.
The average woman earned $22,497 in 1995 compared to $22,834 in 1994, a decline of $337 or 1.5 percent.
Thus the average income for Clinton's first three years is not significantly higher than George Bush's last year: $39,824 versus $39,727.

This is consistent with Bureau of Labor Statistics data showing that real average weekly earnings for workers have not risen at all under Clinton. Workers earned $254.99 per week on average in 1992 and $254.07 in July, the latest month available (1982 dollars).

Source: Bruce Bartlett (Senior Fellow, National Center for Policy Analysis), Washington Times, September 30, 1996.

THE BANKRUPTCY OPTION

Some one million Americans are expected to file for bankruptcy this year. Surprisingly, they are not from poor households, but are in the $50,000 to $100,000 annual income range which have taken on more debt than they can service.

Between 1992 and 1995, the proportion of these well-to-do households reporting credit-card debt rose 13 percentage points -- from 51 percent to 64 percent.
Overall, about 60 percent of the increase in non-mortgage debt over that period can be attributed to this group.

A recent study by the National Bureau of Economic Research (NBER) found that higher-income households have taken on more credit in states where laws allow them to shield many of their assets from liquidation under bankruptcy laws.

With permission under federal law, states are allowed to set the amounts of assets those entering bankruptcy can shield from confiscation. The changes have come under Chapter 7 of the U.S. Bankruptcy Code, a harsh punishment that requires debtors to sell off some assets.

As of 1983, seven states -- Florida, Arkansas, Kansas, Minnesota, Oklahoma, South Dakota and Texas -- had completely shielded a debtor's home from liquidation.
The NBER study found that households with lots of assets in high-exemption states tend to have higher demand for credit.
But creditors in those states were more likely to turn down applicants for new credit lines.
The probability of being turned down or discouraged from borrowing was 5.5 percent higher in states where homes were completely shielded from liquidation.

Although more generous exemptions were supposed to help lower-income households, the effects have been the reverse. Less well-off borrowers are eight percentage points more likely to get turned down for loans in states with higher exemptions, the study showed.

Source: Perspective, "White Collars, Red Ink," Investor's Business Daily, September 30, 1996.

TATES TAKE UP MINIMUM WAGE ISSUES

With the national minimum wage increasing tomorrow to $4.75 an hour, voters in several areas will decide on increasing local minimums this November.

States involved are California, Missouri, Montana, Oregon -- as well as the city of Denver.
Missouri would have the highest minimum wage of any state -- rising to $6.25 next year, then increasing to $6.50 in 1998, $6.75 to 1999, and 15 cents more each year thereafter.
The state of Missouri would, itself, have to pay $100 million more a year to state workers.
By 1999, Denver's minimum wage would be $7.15 an hour -- $2 more than businesses would have to pay if they moved to one of Denver's suburbs.

Voting is expected in December and January to raise the minimum to $6.50 in Albuquerque and Houston. And local governments in New Orleans, Minneapolis/St. Paul and Boston are considering a higher minimum wage for companies that get government contracts or are subsidized by the government.

Observers say the economic results of these increases will be studied by economists over the years to evaluate the impact of legislated minimums, specifically to answer a key question: do minimum wage increases eliminate of entry level jobs and lead to fewer new ones?

Source: Del Jones, "Minimum Wage Debate Now on State, Local Levels," USA Today, September 30, 1996.