1998 Economic Report of The President

8/8/2019 1998 Economic Report of The President

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EconomicReportof the

PresidentTransmitted to the Congress

February 1998


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Economic Report

of the President

For sale by the U.S. Government Printing Office

Superintendent of Documents, Mail Stop: SSOP, Washington, D.C. 20402-9328

Transmitted to the Congress

February 1998

TOGETHER WITH

THE ANNUAL REPORT

OF THE

COUNCIL OF ECONOMIC ADVISERS

UNITED STATES GOVERNMENT PRINTING OFFICE

WASHINGTON : 1998


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C O N T E N T S

ECONOMIC REPORT OF THE PRESIDENT ............................

ANNUAL REPORT OF THE COUNCIL OF ECONOMICADVISERS* .................................................................................

CHAPTER 1. PROMOTING PROSPERITY IN A HIGH-EMPLOYMENT

ECONOMY .......................................................................................

CHAPTER 2. MACROECONOMIC POLICY AND PERFORMANCE ................

CHAPTER 3. THE ECONOMIC WELL-BEING OF CHILDREN ................

CHAPTER 4. ECONOMIC INEQUALITY AMONG RACIAL AND ETHNICGROUPS .........................................................................................

CHAPTER 5. IMPROVING ECONOMIC EFFICIENCY: ENVIRONMENTALAND HEALTH ISSUES ......................................................................

CHAPTER 6. RECENT INITIATIVES INANTITRUST ENFORCEMENT .......

CHAPTER 7. THE BENEFITS OF MARKET OPENING ............................

APPENDIXA. REPORT TO THE PRESIDENT ON THEACTIVITIES OF THECOUNCIL OF ECONOMICADVISERS DURING 1997 ..........................

APPENDIX B. STATISTICAL TABLES RELATING TO INCOME, EMPLOY-MENT,AND PRODUCTION .................................................................

1

7

19

43

89

119

155

195

215

261

273

* For a detailed table of contents of the Councils Report, see page 11

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ECONOMIC REPORT

OF THE PRESIDENT


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To the Congress of the United States:

For the last 5 years this Administration has worked to strengthenour Nation for the 21st century, expanding opportunity for all Ameri-cans, demanding responsibility from all Americans, and bringing ustogether as a community of all Americans. Building a strong economyis the cornerstone of our efforts to meet these challenges.

When I first took office in 1993, the Federal budget deficit was out ofcontrol, unemployment was unacceptably high, and wages were stag-

nant. To reverse this course, we took a new approach, putting in placea bold economic strategy designed to bring down the deficit and give

Americas workers the tools and training they need to help them thrivein our changing economy.

Our strategy has succeeded: the economy has created more than 14million new jobs, unemployment is at its lowest level in 24 years, andcore inflation is at its lowest level in 30 years. Economic growth in 1997was the strongest in almost a decade, and the benefits of that growthare being shared by all Americans: poverty is dropping and median

family income has gone up nearly $2,200 since 1993. We also saw thebiggest drop in welfare rolls in history. Many challenges remain, but

Americans are enjoying the fruits of an economy that is steady andstrong.

THE ADMINISTRATIONS ECONOMIC STRATEGY

From the beginning, this Administrations economic strategy hashad three crucial elements: reducing the deficit, investing in people,and opening markets abroad.

Deficit reduction. In 1993 this Administrations deficit reduction planset the Nation on a course of fiscal responsibility, while making criticalinvestments in the skills and well-being of our people. When I tookoffice, the deficit was $290 billion and projected to go much higher. Thisyear the deficit will fall to just $10 billion and possibly lower still. Thatis a reduction of more than 95 percent, leaving the deficit today small-er in relation to the size of the economy than it has been since 1969.

And this year I have proposed a budget that will eliminate the deficit

entirely, achieving the first balanced budget in 30 years.Beyond that, it is projected that the budget will show a sizable sur-plus in the years to come. I propose that we reserve 100 percent of thesurplus until we have taken the necessary measures to strengthen theSocial Security system for the 21st century. I am committed to address-

ECONOMIC REPORT OF THE PRESIDENT


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ing Social Security first, to ensure that all Americans are confidentthat it will be there when they need it.

Investing in our people. In the new economy, the most preciousresource this Nation has is the skills and ingenuity of working Amer-icans. Investing in the education and health of our people will help all

Americans reap the rewards of a growing, changing economy. Thosewho are better educated, with the flexibility and the skills they needto move from one job to another and seize new opportunities, will suc-ceed in the new economy; those who do not will fall behind.

That is why the historic balanced budget agreement I signed intolaw in 1997 included the largest increase in aid to education in 30years, and the biggest increase to help people go to college since theG.I. Bill was passed 50 years ago. The agreement provided funds toensure that we stay on track to help 1 million disadvantaged childrenprepare for success in school. It provided funding for the AmericaReads Challenge, with the goal of mobilizing a million volunteers topromote literacy, and it made new investments in our schools them-selves, to help connect every classroom and library in this country tothe Internet by the year 2000.

The balanced budget agreement created the HOPE scholarship pro-gram, to make completion of the 13th and 14th years of formal educa-tion as widespread as a high school diploma is today. It offered othertuition tax credits for college and skills training. It created a new Indi-vidual Retirement Account that allows tax-free withdrawals to pay foreducation. It provided the biggest increase in Pell grants in twodecades. Finally, it provided more funds so that aid to dislocated work-ers is more than double what it was in 1993, to help these workers getthe skills they need to remain productive in a changing economy.

But we must do more to guarantee all Americans the quality edu-cation they need to succeed. That is why I have proposed a new ini-tiative to improve the quality of education in our public schools

through high national standards and national tests, more charterschools to stimulate competition, greater accountability, higher quali-ty teaching, smaller class sizes, and more classrooms.

To strengthen our Nation we must also strengthen our families. TheFamily and Medical Leave Act, which I signed into law in 1993,ensures that millions of people no longer have to choose betweenbeing good parents and being good workers. The Health Care Porta-bility and Accountability Act, enacted in 1996, ensures that workerscan keep their health insurance if they change jobs or suffer a family

emergency. We have also increased the minimum wage, expanded theearned income tax credit, and provided for a new $500-per-child taxcredit for working families. To continue making progress towardstrengthening families, the balanced budget agreement allocated $24billion to provide health insurance to up to 5 million uninsured chil-


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drenthe largest Federal investment in childrens health care sinceMedicaid was created in 1965.

Opening markets and expanding exports. To create more good jobsand increase wages, we must open markets abroad and expand U.S.exports. Trade has been key to the strength of this economic expan-

sionabout a third of our economic growth in recent years has comefrom selling American goods and services overseas. The InformationTechnology Agreement signed in 1997 lowers tariff and other barriersto 90 percent of world trade in information technology services.

To continue opening new markets, creating new jobs, and increasingour prosperity, it is critically important to renew fast-track negotiatingauthority. This authority, which every President of either party hashad for the last 20 years, enables the President to negotiate tradeagreements and submit them to the Congress for an up-or-down vote,

without modification. Renewing this traditional trade authority isessential to Americas ability to shape the global economy of the 21stcentury.

SEIZING THE BENEFITS OF A GROWING, CHANGING ECONOMY

As we approach the 21st century the American economy is soundand strong, but challenges remain. We know that information andtechnology and global commerce are rapidly transforming the econo-my, offering new opportunities but also posing new challenges. Ourgoal must be to ensure that all Americans are equipped with the skillsto succeed in this growing, changing economy.

Our economic strategybalancing the budget, investing in our peo-ple, opening marketshas set this Nation on the right course to meetthis goal. This strategy will support and contribute to Americasstrength in the new economic era, removing barriers to our economyspotential and providing our people with the skills, the flexibility, andthe security to succeed. We must continue to maintain the fiscal disci-

pline that is balancing the budget, to invest in our people and theirskills, and to lead the world to greater prosperity in the 21st century.

THE WHITE HOUSE

FEBRUARY 10, 1998


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THE ANNUAL REPORT

OF THE

COUNCIL OF ECONOMIC ADVISERS


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LETTER OF TRANSMITTAL

COUNCIL OF ECONOMICADVISERSWashington, D.C., February 10, 1998

MR. PRESIDENT:

The Council of Economic Advisers herewith submits its 1998 AnnualReport in accordance with the provisions of the Employment Act of1946 as amended by the Full Employment and Balanced Growth Act of1978.

Sincerely,

Janet L. Yellen,Chair

Jeffrey A. Frankel,Member

Rebecca M. Blank,Member-Nominee


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CHAPTER 1. PROMOTING PROSPERITY IN A HIGH-EMPLOYMENTECONOMY ..................................................................................... 19

The Administrations Economic Strategy .............................. 21A Credible Plan for Deficit Reduction............................. 22Investing in People and Technology................................ 22Opening Markets at Home and Abroad.......................... 23

A Record of Accomplishment................................................... 25Benefits of a High-Employment Economy...................... 25Deficit Reduction: Completing the Task......................... 26Policies to Raise Growth, Reduce Inequality, and

Increase Opportunity ................................................... 28Strengthening Cities and Communities......................... 34Strengthening the Performance of Domestic Markets.. 35Opening Foreign Markets................................................ 36Promoting an Economically Sound Environmental

Agenda .............................................................................. 36Facing the Challenges Ahead ................................................. 37Conclusion................................................................................ 42

CHAPTER 2. MACROECONOMIC POLICY AND PERFORMANCE ....... 43Overview of 1997: A Burst of Growth..................................... 44

Aggregate Spending in 1997 ........................................... 45Monetary Policy and Financial Markets ........................ 52Inflation and the Labor Market ...................................... 54Productivity ...................................................................... 57

Explaining Recent Inflation Performance ............................. 57Recent Inflation Performance and the NAIRU.............. 57

Alternative Measures of Utilization and Capacity ........ 60A New Era for the Economy?........................................... 62

The Economic Condition of Households................................. 63The Confident Consumer................................................. 64The Condition of Household Balance Sheets ................. 66The Personal Saving Rate ............................................... 70The Long-Term Uptrend in the Bankruptcy Rate ......... 74

Long-Term Growth: Budget Deficits and National Saving .. 75Saving in a Closed Economy ........................................... 77Saving in an Open Economy ........................................... 77Implications...................................................................... 78

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Forecast and Outlook .............................................................. 78The Administration Forecast .......................................... 78Components of Long-Term Growth................................. 80Productivity ...................................................................... 81Inflation Considerations.................................................. 84

The Demand for Housing ................................................ 84The Near-Term Outlook................................................... 85

CHAPTER 3. THE ECONOMIC WELL-BEING OF CHILDREN .......... 89Trends in the Economic Well-Being of Children ................... 90

The Link Between Income and Childrens Well-Being.. 90Measuring Trends in Child Poverty Rates ..................... 91Explaining Recent Changes in Child Poverty................ 94Policy Initiatives to Support Family Incomes................ 98

Other Measures of Childrens Material Well-Being.............. 100Availability of Food .......................................................... 100Adequacy of Housing ....................................................... 101New Housing Policy Initiatives....................................... 102

Health Status and Health Insurance..................................... 102Health Outcomes.............................................................. 102Health Insurance ............................................................. 104Recent Initiatives to Expand Childrens Access

to Health Insurance ..................................................... 108Child Care and Education ...................................................... 109

Child Care......................................................................... 109Early Childhood Education ............................................. 110Elementary and Secondary Education ........................... 111

Conclusion................................................................................ 117CHAPTER 4. ECONOMIC INEQUALITYAMONG RACIAL AND ETHNIC

GROUPS ....................................................................................... 119Population Composition.......................................................... 122Economic Status ...................................................................... 124

Family Income.................................................................. 124Household Wealth ............................................................ 129The Role of Family Structure in Income and

Poverty .......................................................................... 131Education ................................................................................. 133

Differences and Trends in Educational Attainment...... 134Explaining Educational Attainment Gaps ..................... 136

Affirmative Action in Higher Education Admissions .... 138Labor Markets ......................................................................... 140

Trends in Labor Market Outcomes................................. 141Explaining Earnings Gaps .............................................. 146

Discrimination ......................................................................... 152

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CHAPTER 5. IMPROVING ECONOMIC EFFICIENCY:ENVIRONMENTAL AND HEALTH ISSUES ...................................... 155

Cost-Effective Environmental Protection .............................. 156Tradable Emissions Permits ........................................... 157

Air Quality Standards ..................................................... 162

Climate Change................................................................ 165Non-Point Source Water Pollution.................................. 176

Improving Health Care and Health Insurance Markets ...... 180Improving Access and Portability ................................... 180Consumer Protection and Quality in the Health

Care Industry................................................................ 184Food and Drug Administration Reform.......................... 187Reducing Teenage Smoking............................................. 191

CHAPTER 6. RECENT INITIATIVES INANTITRUST

ENFORCEMENT ............................................................................. 195Origins and Principles of Antitrust........................................ 196Mergers .................................................................................... 197

Market Definition............................................................. 200Competitive Effects .......................................................... 202Entry ................................................................................. 204Efficiencies........................................................................ 205

Electronic Commerce .............................................................. 206High-Technology Industries, Innovation, and

Intellectual Property ........................................................... 209Innovation and Intellectual Property ............................. 209Network Externalities ..................................................... 210Fast-Paced Technological Change................................... 211

The Global Marketplace and International AntitrustEfforts ................................................................................... 213

CHAPTER 7. THE BENEFITS OF MARKET OPENING...................... 215Trends in U.S. International Trade........................................ 216

The Sectoral Composition of U.S. Trade......................... 217The Geographic Composition of U.S. Trade ................... 218U.S. Trade by Domestic Region....................................... 219

Initiatives in Market Opening................................................ 220Trade-Negotiating Authority ........................................... 221Multilateral Initiatives .................................................... 222Regional Initiatives.......................................................... 228Bilateral Initiatives.......................................................... 233

The Effects of Market Opening .............................................. 236

The Benefits of Trade Liberalization .............................. 236Measuring the Gains from Trade.................................... 237

Trade and the American Worker ............................................ 238Trade and Average Wages................................................ 239

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Trade and Relative Wages ............................................... 241Trade and Aggregate Employment ................................. 244Trade and Job Displacement........................................... 244

The U.S. Trade Balance .......................................................... 246Foreign Direct Investment...................................................... 249

Current Trends in FDI..................................................... 253The Benefits of FDI.......................................................... 255

Current U.S. Initiatives in Investment Policy ...................... 258Conclusion................................................................................ 260

APPENDIXESA. Report to the President on the Activities of the Council

of Economic Advisers During 1997 .............................. 261B. Statistical Tables Relating to Income, Employment, and

Production...................................................................... 273

LIST OF TABLES2-1. Components of GDP and Growth in GDP, 1997 .............. 452-2. Household Debt Service Burden ...................................... 702-3. Household Credit Card Balances as a Percent of

Income............................................................................ 732-4. Expected Effects on Changes in the CPI and Real GDP

of CPI Methodological Changes ................................... 802-5. Accounting for Growth in Real GDP, 1960-2005 ............. 822-6. Contribution of Selected Determinants of Demand and

Supply for New Homes ................................................. 852-7. Administration Forecast ................................................... 863-1. Children with Family Incomes Below Different Income

Cutoffs, 1996.................................................................. 93

3-2. Changes in Child Poverty Rate and SelectedMacroeconomic Indicators ............................................ 95

3-3. Accounting for Changes in Child Poverty........................ 973-4. Children in Households Reporting That There Was

Sometimes or Often Not Enough to Eat During theLast 3 Months................................................................ 100

3-5. Housing Problems Among Households with Children.... 1013-6. Children with Health Insurance, by Age of Child and

Type of Coverage ........................................................... 1053-7. Average Number of Physician Contacts in Last Year

for Children Under 15, by Family Income................... 107

3-8. Uninsured Children by Family Income, 1996 ................. 1084-1. Racial and Ethnic Composition of the U.S. Population .. 1234-2. Ratios of Black and Hispanic to White Median Weekly

Earnings, 1997 .............................................................. 146

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7-1. Tariff Rates of Asia-Pacific Economic CooperationMembers ........................................................................ 232

7-2. Industry Compensation Premiums, 1984 ........................ 2437-3. Inward and Outward Foreign Direct Investment, by

Industry, Selected Years................................................ 255

7-4. Countries with Which the United States HasBilateral Investment Treaties ...................................... 259

LIST OF CHARTS1-1. Investment and Government Spending in Overall

GDP Growth .................................................................. 201-2. Real Household Income Growth by Quintile, 1993-96.... 271-3. Federal Budget Deficit as a Percent of GDP ................... 271-4. Net Interest as a Share of Federal Outlays..................... 29

1-5. Returns to Education ........................................................ 302-1. Inflation and Trend Unit Labor Costs.............................. 562-2. Computer Prices and Total Inflation................................ 582-3. Wage Growth and the Unemployment Rate .................... 602-4. Consumer Sentiment......................................................... 652-5. Ratio of Household Net Worth to Disposable Personal

Income............................................................................ 662-6. Household Debt by Type ................................................... 672-7. Household Debt Delinquency Rates................................. 682-8. Household Debt Service Payments .................................. 692-9. Alternative Measures of Productivity .............................. 83

2-10. Productivity Growth and the End-of-Expansion Effect .. 833-1. Poverty Rates of Children................................................. 923-2. Children Living with Their Mother Only, by Marital

Status of Mother............................................................ 943-3. Monthly AFDC and Food Stamp Benefits for a Family

of Four............................................................................ 96

3-4. Infant Mortality Rates and Incidence of LowBirthweight.................................................................... 1033-5. Child and Youth Mortality Rates...................................... 1043-6. Children Without Physician Visit Within Past Year ....... 1073-7. NAEP Long-Term Trend Assessment: Science and

Mathematics Scores ...................................................... 1123-8. NAEP Long-Term Trend Assessment: Reading Scores... 1134-1. Median Family Income ..................................................... 1254-2. Distribution of White Persons by Household Income ..... 126

4-3. Distribution of Black Persons by Household Income...... 1264-4. Gini Index for Family Income........................................... 1274-5. Poverty Rates for Persons ................................................. 1284-6. Family Structure ............................................................... 1324-7. High School Completion Rates for 25- to 29-Year-Olds .. 135

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4-8. Women Aged 25-29 with 4-Year College Degree orHigher ........................................................................... 137

4-9. Men Aged 25-29 with 4-Year College Degree or Higher . 1374-10. Unemployment Rates........................................................ 1424-11. Ratios of Median Weekly Earnings of Male

Full-Time Workers ........................................................ 1454-12. Ratios of Median Weekly Earnings of Female

Full-Time Workers ........................................................ 1455-1. Sulfur Dioxide Emissions Permit Prices.......................... 1615-2. Volume of Sulfur Dioxide Emissions Permit Trades ....... 1625-3. Sources of Nitrogen Oxides Emissions in 1995 ............... 1645-4. U.S. Greenhouse Gas Emissions, Actual and Projected . 1675-5. Cumulative World Emissions of Carbon Dioxide,

1950-95........................................................................... 1715-6. Projected World Carbon Dioxide Emissions Without

Kyoto Agreement........................................................... 1715-7. Energy Prices and Private Energy Research................... 1745-8. Clinical Trial and Drug Application Approval Times

for New Drugs ............................................................... 1896-1. Mergers Filed with the Antitrust Agencies...................... 1977-1. Exports and Imports as a Percent of GDP....................... 2167-2. U.S. Exports and Imports by Category in 1986 and

1996................................................................................ 2187-3. U.S. Goods Exports and Imports by World Region in

1986 and 1996 ............................................................... 2197-4. Exports of Goods by U.S. Region ...................................... 2207-5. U.S.-Initiated WTO Dispute Settlement Cases by Target

Country .......................................................................... 2247-6. Real Wages and Labor Compensation, and

Productivity ................................................................... 2407-7. Saving, Investment, and the Current Account Balance . 247

7-8. Real Value of the Dollar and the Trade Deficit ............... 2487-9. Growth in Real Imports and GDP.................................... 2497-10. Foreign Direct Investment Flows..................................... 250

LIST OF BOXES1-1. Poverty Alleviation, the Earned Income Tax Credit,

and the Minimum Wage ............................................... 332-1. Accounting for the Deficit Surprise During Fiscal 1997. 482-2. Turmoil in Asian Economies ............................................. 50

2-3. Circuit Breakers ................................................................ 552-4. Recent Revisions to Capacity and Utilization ................. 622-5. The National Bankruptcy Review Commission .............. 762-6. Methodological Changes in the Consumer Price Index .. 793-1. How Does Our Poverty Measure Affect Our Conception

of Poverty? ..................................................................... 91

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CHAPTER 1

Promoting Prosperity in a High-Employment Economy

THE PAST YEAR SAW THE NATIONS ECONOMY turn in itsbest performance in a generation. Over the course of 1997, outputgrowth and job creation remained vigorous while inflation declined.Real (inflation-adjusted) gross domestic product (GDP) grew 3.9

percent, and employment rose by 3.2 million, for an average rate of267,000 jobs per month. The unemployment rate dropped below 5percent for the first time in 24 years, yet core inflation (as measuredby the consumer price index, excluding its volatile food and energycomponents) averaged only 2.2 percent, its lowest rate in over 30years. This exceptional economic performance occurred during aperiod of historic deficit reduction: the Federal budget deficit, whichreached $290 billion in the 1992 fiscal year, declined to only $22 bil-lion in fiscal 1997. And the Administration has submitted a budget

for fiscal 1999 that projects a balanced budget for the first timesince 1969.

As 1998 begins, the prospects for continued growth with highemployment and low inflation remain excellent. The economy isremarkably free of the symptoms that often presage an economicdownturnsuch as an increase in inflation, an accumulation ofinventories, or evidence of financial imbalance. Inflation fell in 1997,and developments in East Asia, by reducing U.S. import prices, arelikely to exert additional downward pressure on U.S. inflation in1998. Economic turmoil in East Asia could affect the global economy,but if international efforts to restore stability there succeed, themain effect on the U.S. economy could simply be to allow continuedgrowth and job creation with a more moderate outlook for interestrates. Another sign that an expansion is nearing its end would be asudden accumulation of inventories, as businesses find their salesfalling short of production. Yet sales were strong in 1997, and inven-tory-sales ratios are near historical lows. Financial imbalances can

also threaten to disrupt an expansion. But today banks and otherfinancial institutions do not appear overextended, as they did in thelate 1980s and early 1990s, and the stock market shrugged off a one-day plunge in October (although its continuing high valuationrelative to earnings is a source of concern to some). Although thebusiness cycle may not have been vanquished, the economy is in fun-

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damentally sound shape and well-equipped to handle any unexpectedbouts of rougher weather.

A principal force behind the current expansion has been privatefixed investment. Almost none of the growth in GDP over this expan-sion has come from increased government spending, whereas close to

one-third has come from greater private fixed investment (Chart 1-1).Because of the Administrations deficit reduction efforts, the contri-bution of government spending to overall growth has been muchlower than in most previous postwar expansions (real FederalGovernment spending has actually declined), while that of privatefixed investment has been substantially higher. One benefit of thisburst of investment has been a rapid expansion of industrial capaci-ty: over the past 3 years average annual capacity growth hasexceeded every previous growth rate since 1968.

Policies such as deficit reduction have contributed to an invest-ment-led recovery and a climate conducive to sustained economic

growth. But the lions share of the credit for the economys perfor-mance goes to American workers and firms, who have risen to thechallenges of a competitive global economy and rapidly changingtechnology. The role of government in such an economy is not to propup economic growth with government spending but, more subtly, toprovide individuals and businesses with the tools they need to flour-ish through their own efforts. The range of appropriate government

20

1954-57 1958-60 1961-69 1970-73 1975-80 1982-90 1991-present-10

0

10

20

30

40

17.3

19.7

15.2

25.226.2

14.8

31.6

-0

8.1

14.7

-1.0

12.8

15.7

1.7

Share of real GDP change (percent)

Note: Change in component expressed as fraction of overall change in real GDP.Sources: Department of Commerce (Bureau of Economic Analysis) and National Bureau ofEconomic Research.

Real GDP growth during this expansion has been driven by private spending,particularly on fixed investment.

Investment and Government Spending in Overall GDP GrowthChart 1-1

Government spending

Private fixed investment

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policies in such an economy includes promoting private investmentthrough sound macroeconomic policies, encouraging the formation ofskills through training and education, securing opportunity for themarginalized members of our society, andwhere necessaryprovid-ing assistance to the most vulnerable. Using government to

complement, not replace, the market and the private sector has beena fundamental, guiding principle of this Administrations economicstrategy from the very beginning. And it is this strategy that hasborne fruit over the last 5 years.

Despite the economys recent exemplary performance, a number ofchallenges remain. The first is to preserve and nurture the successesachieved so far. And although progress has been made in addressingthe longer term problems that have affected the economy since theproductivity slowdown of the early 1970sproblems like slow growth

in wages and incomes and widening income inequalitymore needsto be done. This chapter describes the principles and policies of this

Administration for achieving its two basic, overarching goals: secur-ing high and rising living standards now and in the future, andensuring that the benefits of a higher standard of living are extendedto all Americans.

THE ADMINISTRATIONS ECONOMIC STRATEGY

The Employment Act of 1946 (which created the Council ofEconomic Advisers), together with its later amendments, gave theFederal Government responsibility for stabilizing short-run economicfluctuations, promoting balanced and noninflationary economicgrowth, and fostering low unemployment. This Administrationsstrategy in pursuing this mandate has focused on getting the funda-mentals right: reducing the budget deficit, investing in technologyand the American people, and opening markets at home and abroad.These were the right policies for encouraging the job creation needed

to move the economy to full employment, and they are the right poli-cies for attacking the longer term problems of sluggish productivitygrowth and widening income inequality that began to afflict the econ-omy in the early 1970s.

But there is more to the Administrations policy agenda than canbe measured by aggregate economic statistics alone. Getting the funda-mentals right means removing the barriers that block people fromrealizing their potential; it means promoting their sense of individualresponsibility and giving them the tools to succeed. Getting the funda-

mentals right also means fostering a personal commitment byall Americans to help others, a sense of shared responsibility forour Nations children, and a sense of community in an increasinglymultiethnic society.

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A CREDIBLE PLAN FOR DEFICIT REDUCTION

The policy course set in 1993 has contributed to the Nations recenteconomic health and strength. In 1993 the economy was still recover-ing from the 1990-91 recession, and it labored under the burden of aFederal budget deficit that had ballooned to $290 billion, an all-timerecord. The linchpin of the Administrations economic strategy was acredible budget plan that could achieve substantial deficit reductionover the longer term, yet be balanced and gradual enough to allow theeconomy to gather strength and move toward full employment in theshort term. The success of this program rested on achieving an inter-est rate environment conducive to investment, which would allow theeconomy to grow in the face of a contractionary fiscal policy. This inturn required that financial markets correctly anticipate an appro-

priately accommodative monetary policy. In large measure, that isexactly what happened. Long-term interest rates fell to 25-year lowsin 1993, spurring a pickup in economic growth.

A key feature of the Administrations deficit reduction plan was itscredibility. A credible and realistic program for deficit reductiononethat observers and financial markets judged likely to be fully imple-mentedwas a precondition for the reduction in interest rates thatspurred investment-led growth. Fundamental to the plans credibilitywas the adoption of a set of economic projections that represented

conservative, mainstream forecasts of future growth and inflation.These projections eschewed the rosy scenarios of previous budgets,which invariably fell short of reality; they were not meant to indicatethe best that the economy could do, but rather how the economy wasmost likely to perform given past experience. In fact, the economysperformance has been stronger than the Administration projected.

In the 1980s expansive fiscal policy required relatively tight mone-tary policy in the form of high interest rates to prevent the economyfrom overheating. This policy mix is particularly unfavorable from

the standpoint of fostering longer term growth: high interest ratesimpede capital formation, while burgeoning government deficitsdepress national saving and contribute to more borrowing fromabroad. The net result of deficit reduction in the 1990s has been topromote a more balanced mix of fiscal and monetary policy. Deficitreduction has also had an important collateral benefit, namely, arestoration of Americans confidence in the ability of their governmentto manage its own affairs.

INVESTING IN PEOPLE AND TECHNOLOGYThe primary purpose of deficit reduction, however, is to encourage

investment. Hence, this Administration recognized from the outsetthat a plan that balanced the budget at the expense of the govern-ments own productive investments would ultimately beself-defeating. Far from curtailing public investment, the

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Administration has given investment in people and technology amajor place in its economic agenda.

Government invests in people by promoting public health and safe-ty, encouraging opportunity and individual responsibility, andassisting in the formation of human capital through education and

training. This last function is especially vital in todays high-technol-ogy economy, where a skilled work force is an essential condition forfuture growth. Education is critical if Americans are to capitalize onthe opportunities created by new technologies and more open globalmarkets. And education and training programs are of particularimportance in the present economic environment as a means of pre-venting poverty and ensuring opportunity for all. The return toeducation has risen dramatically since the late 1970s; today, highlyskilled workers command a large premium in the labor market over

their less skilled counterparts. This rising skill premium is an impor-tant reason why earnings inequality is greater today than it was inthe late 1970s. Governments have an important role to play in ensur-ing that all Americans have the opportunity to accumulate the skillsnecessary for economic success. This requires initiatives to improvepublic education at the primary and secondary levels, as well as pro-grams to make higher education more accessible. It also requiresrecognizing that learning must be a lifelong activity in an economywhere technological change is ongoing.

Investing in basic research and the development of new technolo-gies is another important function of government. The private sectorspends billions of dollars every year on research and development.But economists have long recognized that private sector spendingalone in these areas will be less than the optimum. Since the fruits ofa new scientific discovery, for example, are enjoyed not merely by thediscoverer but by society as a whole, the private incentive for pursu-ing scientific research falls short of the total social benefit. Moreover,

new theories of economic growth place a special emphasis onadvances in knowledge through research and development as themotive force behind long-run increases in living standards. Thisanalysis implies that the return to government investment in basicresearch and technology is likely to be especially high.

OPENING MARKETS AT HOME AND ABROAD

A third major component of the Administrations economic agendais the promotion of freer and more competitive markets at home and

abroad. Domestically, this has involved the pursuit of initiativesdirected at enhancing competitionparticularly in such industries astelecommunications, electric power, financial services, and healthcareand a vigorous approach to antitrust enforcement. It has alsomeant addressing market failures in such areas as health care andenvironmental protection. In some cases the effect of these initiativesis a one-time boost to the level of output, through greater efficiency

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and lower costs. But these policies can also sometimes lead to a fasterrate of economic growth. For example, past experience provides evi-dence that sensible deregulation can not only help raise efficiency, butalso spur continued innovation through greater competition.Moreover, some benefits of these policies are not captured in the GDP

statistics at all, but rather take the form of improvements in our qual-ity of life.

The Administration is also committed to reducing the burden ofgovernment regulation and ensuring that the benefits of new regula-tions justify their costs. Many government regulations apply toindustries in which technological change is rapidly altering thenature of market competition. A key precept of this Administrationsapproach to regulation, therefore, is that the regulatory process mustbe dynamic, with regulatory policies under constant review so as to

minimize their burden on consumers and businesses. Another impor-tant precept is to refrain from policies that regulate throughgovernment fiat in favor of policies that use market-based incentivesto attain the desired outcome. Experience with such policies as per-mit trading for sulfur dioxide emissions suggests that this approachcan help ensure that compliance with socially beneficial goals isachieved efficiently and cost-effectively.

This Administration has also worked hard to open markets abroadby encouraging fairer and freer international trade. From his earliestdays in office, the President has advocated an outward-looking, inter-nationalist trade policy. During the Administrations first 4 years theUnited States concluded over 200 trade agreements with other coun-tries. Some of these agreements, such as the North American FreeTrade Agreement (NAFTA) and the Uruguay Round agreement of theGeneral Agreement on Tariffs and Trade, were comprehensive inscope, whereas others had much more limited aimsbut all are vitalto our Nations competitive future.

Economists generally recognize that an open economy offers bothstatic and dynamic advantages. First, trade benefits an economy byallowing it to specialize in what it does besta point that economistshave made since the early 1800s. Even if a country is more efficientthan its neighbors at producing every good it consumes, it can stillbenefit from trade by specializing in the production of goods in whichit is relatively more efficient, and then trading its surplus productionfor whatever else it wants to consume. In addition, a new view ofinternational trade argues that increased trade actually raises an

economys rate of growth, because increased competition and largermarkets spur the acquisition of new skills and the development ofnew technologies. If so, the case for trade liberalization becomes evenmore compelling, since raising the economys growth rateeven by afew tenths of a percentage point per yearhas vastly more signifi-cance for long-run living standards than even a relatively largeone-time increase in the level of output.


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A RECORD OF ACCOMPLISHMENT

Focusing on the fundamentals in shaping economic policy has paidoff by helping to produce an economy that is stronger than it has beenin decades. This past year alone saw a drop in the unemployment rate

to its lowest level in a generation and the forging of a budget agree-ment that promises to bring the Federal deficit under control for thefirst time in decades. Last year also saw significant advances in this

Administrations economic agenda along other fronts.

BENEFITS OF A HIGH-EMPLOYMENT ECONOMY

Driven largely by strong growth in business fixed investment,growth in real GDP and employment picked up in the second half of1993 and persisted in 1994. This robust growth led to a series of mon-

etary policy tightenings over the course of 1994, which resulted inmore moderate growth in 1995. In retrospect, 1995 may have been thepause that refreshes. Economic growth exceeded expectations in1996, and strong growth continued through 1997. The result has beena high-employment economy with the potential to overcome some ofthe longer term problems of productivity growth and income distrib-ution that built up in the 1970s and 1980s.

A high-employment economy brings enormous economic and socialbenefits. Essential to personal economic security is the knowledge

that work is available to those who seek it, at wages sufficient to keepthem and their families out of poverty. A tight labor market increasesthe confidence of job losers that they will be able to return to work,lures discouraged workers back into the labor force, enhances theprospects of those already at work to get ahead, enables those whowant or need to switch jobs to do so without a long period of jobless-ness, and lowers the duration of a typical unemployment spell.Returning the economy to full employment yields a direct benefit byensuring that the economys resourceshuman and materialarenot squandered by needless cyclical unemployment. On average,reducing the unemployment rate by a percentage point raises outputby approximately 2 percent; in 1997, 2 percent of GDP was $160 bil-lion, or roughly $600 for every American man, woman, and child.Wasted resources from not producing at potential, together with thehuman cost of unemployment, are intolerable; the elimination of thiswaste is the principal benefit of a sustained return to full employ-ment.

But a high-employment economy in which jobs are plentiful andlabor markets tight yields other benefits as well. Short-term econom-ic conditions can affect long-term structural unemployment. A tightlabor market encourages participation by those who might otherwisebe forced to sit on the sidelines, and makes it easier to absorb lessskilled or younger and more inexperienced workers into the laborforce. These new labor market entrants gain much-needed job experi-

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ence, building the skills they will need to hold down a job in thefuture. The importance of this can be seen from the experience ofsome European countries: prolonged stagnation or recession mayhave led to a permanent increase in unemployment there, as theunemployed and the never-employed have seen their skills atrophy or

become obsolete. Running a high-employment economy, then, may beone of the surest ways to ensure that an unacceptably large fractionof our citizens are not consigned to long-term joblessness and eco-nomic marginalization.

From the 1980s until the early 1990s, the economys ability toreduce poverty through growth alone was hampered by a strong head-wind: sustained declines in wages at the low end of the earningsdistribution that offset the benefits of an expanding economy for thepoorest Americans. As a result, holding a job no longer ensured that

a less skilled worker would be able to lift his or her family out ofpoverty. This adverse secular trend raises even further the stakes ofmaintaining a high-employment economy.

Keeping the unemployment rate low and job growth high is alsonecessary if we are to move current welfare recipients into the workforce. Early, indirect evidence here is encouraging: employment andlabor force participation rates among single women who maintainfamiliesabout two-thirds of whom have children under 18haveincreased in the past few years. This is probably in part the result ofrecent welfare reform: the greatest acceleration in employment rateshas occurred among those single women most likely to be affected bywelfare reform, namely, those with young children. Nevertheless, it isobvious that fostering an economy in which job opportunities areplentiful plays a crucial part in aiding the transition from welfare towork.

We have begun to see heartening signs that the current expansionis yielding gains in living standards for all Americans, especially

those at the bottom of the income distribution. The poverty rate fellto 13.7 percent in 1996, from 15.1 percent in 1993; the poverty ratefor black Americans is at a historical low, and in 1997 unemploymentamong blacks fell to its lowest rate since 1973. Since 1993, householdincome has grown in each quintile of the income distribution, with thelargest percentage increase going to the poorest members of our soci-ety (Chart 1-2). Maintaining a full-employment economy is essentialif this progress is to continue.

DEFICIT REDUCTION: COMPLETING THE TASKThe most significant economic policy event of 1997 was the passage

of a deficit reduction package that will finish the task of balancing theFederal budget by 1999. This will be the first balanced budget since1969, and only the ninth since World War II (Chart 1-3).

Some have claimed that the expanding economy, not governmentpolicy, deserves all the credit for vanquishing the deficit. It is cer-

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tainly true that ups and downs in the business cycle have an impor-tant effect on both revenues and outlays, leading to fluctuations inthe deficit. But even when cyclical factors are thus accounted for, it

Lowest Second Third Fourth Highest

0.0

0.5

1.0

1.5

2.0

2.5

2.2

1.4

1.5

1.3

1.7

Quintiles

Average annual percent change

Source: Department of Commerce (Bureau of the Census).

From 1993 to 1996, households in the lowest quintile of the income distribution enjoyed

the fastest growth in real incomes.

Real Household Income Growth by Quintile, 1993-96Chart 1-2

27

Sources: Department of Commerce (Bureau of Economic Analysis) and Office ofManagement and Budget.

The budget is projected to be in balance in fiscal 1999 for the first time since 1969.Federal Budget Deficit as a Percent of GDPChart 1-3

1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998-4

-2

0

2

4

6

8

Fiscal years

Percent of GDP


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is evident that policy has played a major role in bringing the deficitunder control. It is also worth noting that in January 1993, before the1993 deficit reduction package was adopted, the Federal deficit wasprojected to reach $350 billion in fiscal 1998 and to rise to $650 billionin fiscal 2003, even when the economy was projected to be at full

employment. Finally, it is difficult to imagine that the economys per-formance would have been anywhere near as strong as it has beenwithout a credible and successful attempt to put the governments fis-cal house in order. Improvements in economic conditions have playeda part in reducing the deficit, but a balanced budget would not now bein sight had the Nation remained on the fiscal course in place in 1992.

Although a balanced budget is often taken as the goal of fiscal pol-icy, from an economic standpoint the motivation for deficit reductionis to raise national saving, thereby augmenting societys future con-

sumption possibilities. When the governments budget is in surplus,in the sense that revenues exceed outlays, the government makes apositive contribution to national saving. As discussed in Chapter 2 ofthisReport, a case for higher national saving can be based on the highreturn on saving in the United States and the fact that private sav-ing remains low. A higher rate of national saving now would lead to alarger economy when the baby-boom generation retires, thus makingit easier to provide for their retirement without imposing undue bur-dens on younger generations. Although a balanced budget does notadd to the governments outstanding debt to the public, which pastdeficits have ballooned, it does not subtract from it either. Leaving alarge public debt in place implies that a sizable portion of existinggovernment resources will continue to be absorbed by interest pay-ments, leaving less for all other spending. Indeed, one legacy of therunup in the national debt that accompanied the deficits of the 1980sand early 1990s has been a sharp increase in the share of total out-lays that must be used to make interest payments on the debt (Chart

1-4).POLICIES TO RAISE GROWTH, REDUCE INEQUALITY,

AND INCREASE OPPORTUNITY

A significant part of the Administrations economic agenda alsoinvolves investment in people: in a broad sense, this encompasseseducation and training, measures to promote health, and policies thatextend opportunity to all Americans. A number of policies have beenput in place to ensure that these investments are made.

Education

The 1997 balanced budget agreement included the largest Federalinvestment in education in a generation, in the form of initiatives toimprove the quality and accessibility of primary, secondary, and high-er education.

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Higher education is a particular priority. The earnings of collegegraduates have risen sharply relative to those of workers with only ahigh school education; in todays economy, a college degree hasbecome as vital for success as a high school diploma was a generationago. Even post-high school education that does not lead to a bachelorsdegree (such as an associates degree program or vocational or tech-nical training) boosts earnings substantially over just completinghigh school (Chart 1-5).

Moreover, learning must be a lifelong process. A fundamental char-

acteristic of our economy is constant technological change. Suchprogress holds the promise of higher living standards for all, but italso requires workers to adapt to employers demands for a well-trained, highly skilled work force. It is therefore critical to provide allindividualsincluding those not traditionally thought of as schoolagewith access to additional education or training.

The Presidents higher education initiatives reflect these principles.Specific measures include:

The largest Pell grant increase in 20 years. The balanced budgetagreement raises the maximum Pell grant by over 10 percent, to$3,000. Approximately 3.7 million students receive Pell grants, andclose to a quarter of a million families will become eligible for thegrant for the first time.

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1967 1972 1977 1982 1987 1992 19974

6

8

10

12

14

16

Fiscal years

Percent

Source: Office of Management and Budget.

Net interest payments now represent twice as large a share of total outlays as they didin the 1970s.

Net Interest as a Share of Federal OutlaysChart 1-4

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influence primary and secondary education is somewhat less direct.Nevertheless, this Administration recognizes that there is much thatthe Federal Government can do to improve our public schools, andhas worked to enact programs that will ensure that our children haveaccess to the best possible primary and secondary education. These

initiatives include:

Establishing national standards. Research shows that students incountries that have standardized, mandatory examinations do bet-ter than students in countries that do not. The Administrationsvoluntary national testing program has received full funding; thiswill allow for the development of national fourth-grade reading andeighth-grade mathematics examinations.

Expanding Head Start. The balanced budget agreement raised

funding for Head Start by $374 million, to $4.4 billion, to reach theAdministrations goal of having 1 million children in the Head Startprogram by 2002. Since 1993, funding for this program, which hasshown great success in preparing low-income preschoolers to enterschool, has increased by 57 percent. The program will serve over830,000 children and their families in 1998, including 40,000infants and toddlers in the Early Head Start program.

Establishing a comprehensive literacy strategy. Every child should

be able to read by the third grade. To meet this basic goal, thePresidents comprehensive literacy strategy will receive nearly $46million in new funding in 1998 for State teacher training, family lit-eracy, and tutoring efforts; $210 million was provided in an advanceappropriation to be available in 1999, contingent on authorizationof a literacy initiative such as the America Reads Challenge.

Increasing funding for charter schools. The President set a goal ofhaving 3,000 locally designed public charter schools in operation by

early in the next century. Funding for charter schools is increasedby over 50 percent in the balanced budget agreement, to allow theDepartment of Education to support nearly 1,000 charter schools bythe end of 1998.

Health

This Administration has made promoting health, increasing accessto health insurance, and improving the functioning of health insur-ance markets a major priority. The Balanced Budget Act of 1997

allocates $24 billion over 5 years to assist States in providing healthinsurance for up to 5 million children through Medicaid or State pro-grams. This represents the single largest investment in childrenshealth since Medicaid was begun in 1965. The Administrations 1999budget proposes to expand access to health insurance further byallowing uninsured Americans between 62 and 65 years old, as wellas 55- to 61-year-olds who have been laid off or displaced from their


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jobs, to buy into the Medicare program. These measures are fully off-set so as not to increase the cost of Medicare to the government.

The Balanced Budget Act also takes important steps toward ensur-ing that Medicare itself remains viable. Structural reformssuch asexpanded choice among health care plans and the restructuring of

payment systemswill help save $115 billion over 5 years. Recentlypassed legislation also provides additional funding for preventivecare, such as mammograms, which can help keep health care expens-es down by catching and treating health problems before they becomeserious. These and other measures will keep the Medicare trust fundsolvent for at least the next decade. The Balanced Budget Act also cre-ated a commission to examine long-term solutions to the problemsthat will face Medicare as a result of the demographic changes com-ing in the 21st century.

The Administration has also promoted policies to improve the func-tioning of health insurance markets, increase consumer protection,and improve access to new pharmaceuticals. The Health InsurancePortability and Accountability Act of 1996 helps workers who change

jobs by making it easier to carry their health insurance with them tothe new job. In 1997 the Presidents Commission on ConsumerProtection and Quality in the Health Care Industry, established toadvise the President on changes in the health care system, respond-ed to the Presidents request to develop and recommend a ConsumerBill of Rights and Responsibilities. The President urged theCongress to pass appropriate and necessary legislation to ensure thata range of protections are extended to all Americans. And the Foodand Drug Administration Modernization Act of 1997, which codifies anumber of initiatives taken by this Administration as part of thereinventing government initiative, will help ensure the timely avail-ability of safe and effective new drugs. These policies and others areconsidered in greater detail in Chapter 5 of thisReport.

Finally, teenage tobacco use is one of the most important publichealth concerns that the Nation faces, and it has been rising in recentyears. The increase in the tobacco tax passed last year not only willhelp fund the expansions in childrens health insurance coveragedescribed above, but also will help reduce teen smoking. The rise inthe tax complements recent Food and Drug Administration rules tolimit advertising targeted at youth. Finally, the Administration hasindicated its support for national legislation designed to achieve largereductions in teen smoking, with strict financial penalties on the

tobacco industry if specific targets in this effort are not met.

Welfare Reform and Poverty Alleviation

Welfare reform presents an ongoing challenge: to ensure that ourneediest citizens can maintain a decent standard of living withoutcreating incentives that encourage a life of dependency. This

Administration has committed itself to a policy that combines work

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incentives and community efforts to move people off of welfare andinto employment. This has contributed to the largest reduction inwelfare rolls in history.

The same long-term changes in the wage structure that give greaterrewards to education and skill also imply that some workers will find it

difficult to raise themselves and their families out of poverty, even witha full-time job. To make work pay, all those who work must be guaran-teed a minimum level of earnings. The Administration has made anexpansion of the earned income tax credit (EITC), which raises thetake-home pay of eligible low-income workers, a cornerstone of itsstrategy to promote work and reduce poverty (Box 1-1). This expansionhas occurred alongside two increases in the minimum wage (the second

33

Box 1-1.Poverty Alleviation, the Earned Income TaxCredit, and the Minimum Wage

A typical cash assistance program guarantees its maximumbenefit to those who receive no income, then phases out this ben-efit as the recipients income from other sources (usually labor)rises. The disincentive to work that such programs create hasbeen a major concernperhaps the major concernof policy-makers with regard to welfare policy. These disincentives will

persist so long as we confine ourselves to considering policieswith this structure.One way to avoid these work disincentive effects is to design

programs that add to the wages of low-income workers. Onesuch program, the earned income tax credit, was expanded sub-stantially in 1993. Under the EITC, eligible low-wage workersreceive a credit against their income and payroll tax liability;this credit is rebated in cash if the workers income tax liabilityis zero. The EITC differs from the typical cash assistance pro-

gram in that no benefits are paid to those who do not work, andbenefits rise as earnings increase (up to some threshold earn-ings level). It therefore largely eliminates the typical programswork disincentive effects.

The minimum wage complements and enhances the EITC.When used by itself to guarantee a subsistence level of income,the minimum wage must be set very high. But an excessivelyhigh minimum wage (that is, substantially above the currentone) could discourage hiring. On the other hand, using the EITC

alone to guarantee an income floor would require payment of alarge subsidy, which would then have to be phased out slowly tominimize the disincentive to earn additional income. Thismakes the program much more costly. Hence, the minimumwage and the EITC are best employed jointly in designing anoptimal assistance package.


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and flexible grants and are entitled to apply for waivers of certainFederal regulations; the underlying principle of the program is thatcommunities know best how to solve their own problems but may lackthe necessary resources.

The Administration has also worked to promote fair access to

loans and investment capital for residents of low- and moderate-income areas. Reform of the Community Reinvestment Actregulations required banks to focus on performanceactual lend-ing, investments, and servicesrather than paperwork. Since 1993,conventional home mortgage lending to black Americans hasincreased by 67 percent, lending to Hispanic borrowers is up nearly50 percent, and lending activity in low- and moderate-income com-munities has risen by 37 percent. The Administration also obtained$80 million in funding for Community Development Financial

Institutions, which make investment capital and other financialproducts available to low- and moderate-income communities. ThePresidents 1999 budget requests an additional $45 million for thisprogram.

In addition, the President signed into law the brownfields pro-gram, which will provide tax incentives for the restoration of urbanland contaminated by pollution. These incentives will leverage morethan $6 billion for nationwide private sector cleanups and the rede-velopment of 14,000 contaminated and abandoned sites ineconomically distressed urban areas.

Several basic principles inform these policies. First, they seek toequip communities with the tools they need in order to flourishtheyare helping hands, not handouts. Second, they place the principalresponsibility for community development with the communitiesthemselves, because they are closest to their problems. Third, theyemphasize private sector engagement rather than government man-dates. And finally, they stress results over process: the Enterprise

Communities/Empowerment Zones program, for example, gives com-munities broad scope to determine for themselves the best path fordevelopment; similarly, the reformed regulations implementing theCommunity Reinvestment Act use criteria based on actual outcomesto judge compliance with its provisions.

STRENGTHENING THE PERFORMANCE OFDOMESTIC MARKETS

As part of this Administrations commitment to free and open mar-

kets, the Antitrust Division of the Department of Justice has workedtogether with the Federal Trade Commission to vigorously enforce theNations antitrust laws. Recent cases and investigations reveal thatthe Department of Justice and the Federal Trade Commission haveboth pursued an aggressive but balanced approach in enforcingantitrust law; in particular, both agencies have sought to ensure thecontinued growth and competitiveness of high-technology industries.

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Chapter 6 of this Report describes how the antitrust agencies haveworked to attain these goals in several recent cases.

OPENING FOREIGN MARKETS

Progress was also made in 1997 toward opening foreign markets to

U.S. goods, as a number of important international trade initiativeswere made final. Trade agreements affecting three important sectorswere reached, concluding some unfinished business from theUruguay Round of multilateral negotiations. The first of these agree-ments, the Information Technology Agreement (ITA), will eliminatetariffs on a large array of information technology products, in whichU.S. firms tend to be highly competitive. Also successfully concludedwere an agreement covering financial services, which will fosterbroad liberalization of banking, securities, and insurance markets,and a key agreement to liberalize basic telecommunications services(including telephone services). Chapter 7 of thisReport considers the

Administrations trade policies in more detail.These negotiations illustrate an important point about trade liber-

alization. Even though all three agreements involved sectors in whichthe United States is generally thought to have a competitive advan-tage, other countries were willing nevertheless to agree to theirliberalization. They did so because they recognized that the entry of

efficiently produced foreign products in these markets would improvethe competitiveness of their own economies: securing goods of thehighest quality at the lowest possible price is good for any economy.

PROMOTING AN ECONOMICALLY SOUNDENVIRONMENTAL AGENDA

The Administration took several important steps in 1997 to pro-tect the environment. These included efforts to address globalclimate change and to improve air quality. In December representa-

tives of the United States and some 160 other countries, meeting inKyoto, Japan, agreed to establish binding limits on industrial coun-tries greenhouse gas emissions. These limits are intended to stemthe disruptive effects of climate change by stabilizing atmosphericconcentrations of greenhouse gases. (Because developing countrieswill emit an increasing share of global greenhouse gases, thePresident has indicated that the Kyoto agreement will not be sub-mitted for ratification without meaningful developing-countryparticipation.)

The Administration has proposed several market-based approachesto meeting the Kyoto limits. Domestically, tax incentives for energy-efficient technologies and research and development will spur earlyefforts to reduce emissions. A national system of tradable permits forgreenhouse gas emissions, patterned after the successful permit trad-ing program for sulfur dioxide emissions, will be implemented later

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under the Presidents proposal. In addition, the Kyoto agreementallows for trading in greenhouse gas emissions permits on an inter-national scale, as well as opportunities for firms in the industrialcountries to receive emissions credits for investing in climate-friend-ly technologies in developing countries. All of these efforts will help

the United States attain its greenhouse gas emissions target in a cost-effective way.

In July 1997 the Environmental Protection Agency (EPA) issued asignificantly more stringent standard for ground-level ozone and a newstandard for fine particulate matter in the atmosphere. Although theClean Air Act does not allow for the consideration of costs in settingthese standards, under the Presidents policy the EPA must implementthese health-based standards in a cost-effective manner. The

Administrations plan for achieving the new air quality standards

departs from traditional command-and-control approaches by design-ing regional strategies that will complement local efforts, andencouraging the development of trading programs for emissions ofnitrogen oxides, which are ozone precursors. The nitrogen oxide trad-ing program, like the acid rain program and the trading programenvisioned for greenhouse gas emissions, enlists market incentives incontrolling pollution and should reduce pollution more cheaply than dotraditional regulatory approaches. Chapter 5 of thisReport provides adetailed assessment of the Administrations environmental policies.

FACING THE CHALLENGES AHEAD

In many ways the U.S. economy today is very different from that inwhich our parents and grandparents lived and worked. Today, 24 per-cent of families are headed by a single parent, compared with 14percent 25 years ago. And three in five married mothers with childrenunder 6 are in the work forcetwice as large a share as in 1970. Thismakes affordable, quality child care a pressing concern for most fam-

ilies. Meanwhile the nature of the labor market has changedsignificantly: few American workers expect to be working for the sameemployeror even to be in the same careerwhen they retire.Industry has also changed radically: in the 1950s the informationtechnology industry barely existed; today it employs a larger share ofthe labor force than the automobile industry did in the 1950s and1960s. And the U.S. population is aging, implying that in the nextcentury there will be fewer workers for every retiree.

This Administrations economic agenda is designed to deal with

these changes and the challenges they pose. If the American economyis to maintain its preeminence as the strongest and most dynamic inthe world, both policymakers and citizens will have to meet and over-come a number of challenges in the 21st century.

Several such challenges already loom large for this Administrationand Congress. Perhaps the most important is preparing for the aging

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of the population, which requires reforming Medicare and SocialSecurity and promoting retirement security more generally. Asreported above, some progress was made in addressing Medicaresimmediate problems, but comprehensive reforms are still needed toensure the programs long-term viability. Likewise, steps will have to

be taken to strengthen the finances of the Social Security system.For almost 60 years Social Security has provided Americans with

income security in retirement and protection against loss of familyincome due to disability or death. A large share of elderly Americans,particularly those with low incomes, rely on Social Security as theirprimary source of pension income in retirement. The system hasenjoyed dramatic success in reducing poverty rates among older

Americans. However, many Americans now fear that Social Securitywill not be there for them when they are ready to retire. This concern

reflects the widespread recognition that, under current intermedi-ate projections of the Social Security trustees, the system faces along-term funding gap: beginning in 2012, unless the system isreformed by then, the government will be unable to pay current SocialSecurity benefits in full out of current payroll taxes; it will then haveto draw down the systems trust fund, and by 2029 those funds will beexhausted. If still nothing has been done, the government would thenface several options which it could adopt singly or in combination: itcould reduce benefits until they are in line with collections, raise pay-roll taxes to cover an unchanged level of benefits, or finance theshortfall from other parts of the budget, by raising other taxes, cut-ting expenditures on other programs, or borrowing and allowing thebudget deficit to increase. One or more of these measures will have tobe taken so long as no changes are made to the present system.

Although the seriousness of the financial imbalance facing SocialSecurity should not be downplayed, its magnitude is not so large as tobe insurmountable, particularly if early action is taken. For example,

even if nothing is done and the trust fund is exhausted, payroll taxeswill still be sufficient to permanently finance roughly 75 percent ofbenefits. Put another way, the difference between the anticipatedincome and the anticipated expenditures of the Old Age, Survivors,and Disability Insurance program over the next 75 years amounts toaround 2 percentage points of taxable payroll, or approximately 1percent of GDP. (The imbalance is somewhat larger when viewed overa longer horizon.) These facts suggest that the problem of placingSocial Security on a sound financial footing can admit of eventual res-

olution, and the President has proposed a process to devise anappropriate solution over the next 2 years. The President has alsoproposed that any budget surpluses should be reserved until SocialSecurity reform is achieved.

Medicare reform presents a somewhat thornier problem, in termsof both its complexity and its scale. Unlike Social Security, Medicarepromises not just the payment of a sum of money but the delivery of

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a service: health insurance. The government has little influence overthe rate of increase in the cost of providing this service, which hasbeen rising faster than general inflation for decades, largely driven bytechnological advances in medical care. Higher costs for medical careare projected to account for the bulk of the increase in Medicare

expenditures for the next 25 years or so, after which the aging of thebaby-boom generation will act to raise expenditures still furtherthrough increases in program enrollment. Hence, any long-termreform will have to involve slowing both the rise in health care pricesand the growth in volume and intensity of use of covered services.Neither will be accomplished easily.

Before last years budget legislation was enacted, the trust fund forthe component of Medicare that covers hospital costs was projected tofall to zero in 2001. The 1997 reforms will delay the trust funds deple-

tion until 2010. The legislation also calls for the establishment of abipartisan commission to assess and recommend the structuralchanges that will be needed to ensure Medicares long-term viability.

A second major policy challenge involves continuing the drive formore open international markets. Preferential trade agreements arebeing negotiated among countries around the world at a rapid pace,and the United States could easily be left behind through inaction.Since 1992, countries in Latin America and Asia have negotiated 20preferential trade arrangements that exclude the United States. Oneof these is MERCOSUR, a customs union among four South Americancountries. The European Union has begun a process intended to cul-minate in a free trade agreement with Brazil, Argentina, and theother MERCOSUR nations; the President of one European nation haseven gone so far as to declare that the economic interests of Latin

America lie with Europe, not the United States. Meanwhile the MER-COSUR nations are attempting to extend their preferential tradearrangement to the entire continent. It is clear that now, more than

ever, continued engagement with the world trading system willrequire an active effort on the part of the United States.In 1997 the Senate voted to move forward on extending the

Presidents so-called fast-track negotiating authority. This authorityallows the President to negotiate trade agreements and submit themto the Congress for a yes-or-no vote, without amendments. However,in the House of Representatives the vote to renew fast-track was post-poned. Some have voiced concern that free trade hurts Americanworkers and contributes to the U.S. trade deficit. As discussed in

Chapter 7, however, market-opening initiatives do not cause net joblosses to the U.S. economy as a whole, although they do result in areallocation of jobs into expanding, export-oriented industries. As thechapter documents, the jobs created by increased trade are good jobs,offering high pay. But some workers are indeed hurt by more openmarkets, just as some workers are harmed by technological innova-

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tion, even though market-opening initiatives unambiguously benefitthe economy as a whole.

This Administration has realized from the beginning that the gov-ernment can minimize the impact of dislocations affecting workerswho lose their jobs, by speeding the adjustment process. For example,

one of the key provisions of NAFTA involved monitoring those indus-tries that were in danger of being adversely affected by theagreement, and the Administration committed itself early on to pro-viding for dislocated workers through retraining programs. ThePresidents 1999 budget includes proposals to expand the scope oftrade adjustment assistance and to increase funding for these pro-grams. More generally, the Administrations commitment to investingin people through education and training serves as a strong comple-ment to its policy of trade liberalization.

A widespread misconception is that one of the benefits of increasedtrade comes in the form of an improved balance of trade. Economicpolicies do indeed affect the current account (the broad measure ofU.S. international transactions that includes investment income andtransfers as well as trade in goods and services), but it is budget, sav-ing, and investment policies, not trade liberalization policies, that doso. The Nations current account deficit equals its borrowing abroadto finance any excess of investment over domestic saving. The currentaccount is therefore a macroeconomic phenomenon that mirrors thegap between what we as a Nation invest and what we save. The largeFederal budget deficits of the 1980s and early 1990s were a form ofnegative saving, or dissaving, which reduced the total amount ofnational saving available to cover the Nations investment in plantand equipment. In an important sense, the Nation was overconsum-ing in the 1980s, financing its consumption binge by borrowing fromforeigners. The result was a large and persistent current accountdeficit.

We still have a current account deficit today, but for a very differ-ent reason. The near elimination of the budget deficit has left moresaving available for investment in plant and equipment by the pri-vate sector. National saving has risen. But because of the investmentboom during this expansion, the gap between investment and savinghas persisted. Once again, this shortfall is made up by borrowingfrom abroad, and the result is a current account deficit. But there isa big difference between borrowing to investas the Nation is doingnowand borrowing to consume, as it did in the 1980s. In fact, run-

ning a trade deficit in order to expand the Nations productivecapacity is not new to American historywe did much the same thingin the last century, to build up the Nations infrastructure, mostnotably during the railroad construction boom. Ironically, therefore,todays trade deficit reflects the economys current success in growingmore rapidly than our trading partners and investing so muchandnot our free trade policies.

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It is always difficult to explain this macroeconomic perspective onthe trade deficit to those who are primarily concerned with the micro-economics of their daily lives. But making the case in favor of trade isparticularly important now, because real danger threatens shouldcountries turn their backs on a progressive and integrated world eco-

nomic order. Besides postponing the renewal of the Presidentstraditional trade-negotiating authority, the Congress chose not tosupport the sort of financial participation in international institu-tions that is vital for the sound functioning of the internationalsystem. Meanwhile financial crises in East Asia have made U.S.international engagement more important, rather than less. Otheremerging-market countries are themselves in danger of reacting tothe East Asian crises by turning inward. It is important for their eco-nomic well-being, as well as our own, that they continue along the

path toward an outward-oriented market system, on which they haduntil recently been making such astonishing progress. This willrequire difficult macroeconomic and structural adjustments on theirpart, including reducing their dependence on foreign borrowing. As aresult, these countries will have to reduce their trade deficits, and insome cases even turn them into trade surpluses. This will inevitablylead to an increase in U.S. bilateral trade deficits with some East

Asian countries. Again, however, such deficits are not the propergauge of the success or failure of U.S. trade policy.

The Nation faces other, broader challenges in shaping economicpolicies for the 21st century. First, we must act to help familiesaddress the problems they face in todays economy. More Americanworkers today are faced with the need to juggle the demands of theworkplace with the demands of family and home. Government mustact to ease this burden by ensuring that families have access to qual-ity child care and health care. For this reason the Presidents 1999budget includes a $21 billion increase in funding for child care, to

make it accessible to more families and raise its quality. An importantpart of this proposal is increased tax credits for 3 million workingfamilies to help them pay for child care, as well as an increase in blockgrants to States that will directly subsidize child care for low-incomefamilies. In addition, the proposal calls for a new Early LearningFund, along with support for the enforcement of State child carehealth and safety standards, scholarships for up to 50,000 child careproviders per year, and funding for research and consumer education.

We must also continue to invest in our Nations children. Chapter 3

of this Report shows that the last 3 years have witnessed notableimprovements in childrens well-being along several fronts, includingdecreases in child poverty, increases in consumption of basic healthcare services, and improvements in health status and in some mea-sures of educational achievement. However, many children remaineconomically vulnerable. One in five children in the United Stateslives in a family whose income is below the poverty line, one in seven

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AGGREGATE SPENDING IN 1997

An accounting of the sectoral contributions to growth in 1997 showsthat increases in private domestic spending for consumption and invest-ment combined exceeded growth in gross domestic product (GDP; Table2-1). Modest increases in State and local government expendituresaccounted for the increase in total government spending. Net exportsbecame more negative.

Private Domestic Spending

The factors traditionally thought to determine household spendingare household income, consumer sentiment, and household net worthin the current and recent years. Signals were favorable for all of thesefundamentals through most of 1997: real disposable personal incomegrew 3.7 percent over the four quarters of the year, consumer

1998 Economic Report of The President

Documents

Transcript of 1998 Economic Report of The President