Committee on Financial Services of the United States House of Representatives At a hearing entitled "Beyond the Tax Cut: Unleashing the Economy"
Mr. Chairman, Members of the Committee:
My name is James K. Glassman. I am a resident fellow at the American Enterprise Institute for Public Policy Research in Washington, D.C., and host of www.TechCentralStation.com, which concentrates on issues of technology and public policy. I am also a senior consultant and chief columnist to Folio(fn), a financial services company that packages and markets portfolios for investors. My writing on financial and economic matters appears regularly in the Wall Street Journal, International Herald Tribune and other media, and I am co-author of Dow 36,000, a book on stock valuation. For six years, I was a columnist for the Washington Post. Prior to that, I was editor of Roll Call, the twice-weekly newspaper that covers this institution; publisher of two public affairs magazines, the New Republic and the Atlantic Monthly; and host of two television series, "Capital Gang Sunday" on CNN and "TechnoPolitics" on PBS.
My main area of academic interest is the nexus among technology, finance and public policy.
The message I bring you today is that the U.S. economy has slowed and that tax cuts and monetary easing are necessary but not sufficient to restore the rate of growth we experienced in the late 1990s. What is critical is that changes are made in regulatory policy to encourage a liberation of supply -- a resurgence of output. I will give specific recommendations on how this can be accomplished. First, however, I will briefly review the state of the economy; offer observations on why it has slowed; and present an analysis on why it has grown with such strength over the past decades.
State of the Economy
The United States economy has slowed significantly in recent months. The growth in Gross Domestic Product (GDP), the nation's output of goods and services, fell from 5.6 percent in the second quarter to 2.2 percent in third quarter to 1.1 percent in the fourth. Retail sales and job growth are flat, unemployment is rising, the critical Purchasing Managers Index has dropped by one-fourth in the past year, a majority of banks has tightened credit requirements for businesses, and industrial production has dropped for five straight months.
The high-technology sector has been hit especially hard. For example, Cisco Systems, the giant Internet infrastructure provider, was increasing its revenues at a 70 percent pace as recently as November. But by February, sales were actually down from the previous year. "This is important," writes economist Brian Wesbury of Griffin, Kubik, Stephens & Thompson, Inc., who then quotes Alan Greenspan, the Fed chairman, as saying on March 27: "High-tech goods -- semiconductors, computers, and LAN equipment...contributed two-thirds of the increase in manufacturing output between 1995 and 2000." Overall, electronic goods orders are off 4 percent over the past year. Meanwhile, the authors of a new study estimate that 80 percent of the remaining dot-com companies in the San Francisco Bay will collapse in the next year. Profit expectations for the companies of the tech-heavy Nasdaq have fallen 75 percent. We may already be living through the beginning of the first recession in 10 years; we will know for sure when the statistics are published in a few weeks.
The 1990-91 recession, which ran for nine months, was considered mild by historic standards. At its depth, the economy's output declined only 1.5 percent. Still, it is important to remember that even short and shallow recessions hurt. In the last recession, the unemployment rate rose from 5.4 percent to 7.8 percent (by the summer of 1992, after the recession had officially ended). It was not until December 1994 that unemployment returned to its pre-recession level. If we have a typical recession, three million Americans will lose their jobs. Also, even if we are not in a recession today, it feels like one. GDP growth has dropped from an average of about 4 percent to about 1 percent. That is roughly the equivalent of a decline from a GDP increase of 2 percent to a GDP decline of 2 percent.
Causes of the Slowdown
Today's slowdown has no single cause. These are the major culprits: Fed rate hikes. The Federal Reserve began raising interest rates in June 1999 with little sign of inflation. Instead, the central bank appeared to be reacting to high growth and to a buoyant stock market. The real, after-inflation, rate on federal funds, the overnight loans that the Fed targets, reached a peak of 5.1 percent in October 2000, the highest rate since September 1989 -- a year before the last recession -- constricting the flow of capital.
Tripling of oil prices. Eight of the nine post-World War II recessions, including the last four, have been preceded by an oil shock. It is the rising oil price plus tighter Fed policy that tends to cause recessions, and this double whammy is present today as well.
The drag of high taxes and a gigantic surplus. Federal tax revenues as a percentage of GDP last year were 20.6 percent -- a level exceeded only twice in U.S. history, in 1944 and 1945. The surplus itself is a reflection of these high revenues flowing into Washington. Cash that could have been used for consumption or new private investment is instead being used to retire the bonds of investors who typically use the proceeds to buy more bonds. Retiring debt -- especially with debt at such low levels (about one-third of GDP) is no way to spur an economy. (I respectfully refer the committee to my article, "The Joy of Debt" in the March 26, 2001, issue of The Weekly Standard.)
The end of the high-tech "enterprise zone." The past year, especially, has seen increased government intervention in the economy, especially in the high-technology sector and federal and state mismanagement of the planned deregulation of telecommunications. A year ago, I argued that this change in political approach to high tech threatened a "regulatory recession." We may be in it. It is no coincidence that high-tech stock prices began their 60 percent slide at almost the same moment that the Justice Department asked a federal court to break up Microsoft Corp., the software company that is credited with igniting the computer revolution in the early 1980s. While the antitrust suit against Microsoft was instigated by its competitors, the result has been to damage the capital-raising ability of nearly every high-tech firm -- and to encourage further interventions at federal, state and local levels, threatening to end the status of high tech as a kind of "enterprise zone," free from high taxes and onerous regulation. In telecommunications, the persistence of monopoly power in local markets has greatly deterred the rollout of broadband technology and deferred indefinitely much of the promise of the Internet.
Why the Economy Boomed