Tuesday, December 2, 2003

It's Not The Deficit Stupid!... Tech is the Primary Driver of Economic Growth

During the Clinton years, the two most common things I heard from high-profiled Democrats was how the deficit reduction caused the boom times, or how Clinton asking Greenspan to lower short-term rates caused the Internet boom. I would just roll my eyes at such simplistic statements. If only cause and effect could actually be that simple, the Merovingian would truly rule our matrix. The reality is that for every effect there are probably at least 5 or more factors causing it… probably a dozen more. But that is the way of politics, pick one of the causes or statements that can effectively cling to the minds of most voters and spread the virus of malcontent against your opponent, or create a statement of “fact” that makes a candidate or party a hero.

Anyway, the article from last week’s BusinessWeek begins to unravel the Democrats' claim that Clinton caused the boom times of the ‘90s. It almost similar to Al Gore claiming he invented the Internet. Interesting article to read below (for those wondering, i paste the whole article on my blog because many online publications archive the articles after a few weeks and are not accessible anymore for free), but not really the focus of this entry.

The cause of the boom times can be traced back to the DARPA's (Defense Advanced Research Projects Agency) project that led to the birth of the Internet (yes, not Al Gore, DARPA... with respect to Joseph E. Stiglitz below, I'm going to take a step back into a bigger picture). More importantly, this was the result of the unique matrix within the fabric of the U.S. that invests public and private money into science. University labs, corporations, and government research centers all heavily invest into science. Whether the search for the "truth" in the universe, basic science, or research for a commercial purpose, applied science, all types of research have led to the benefit and growth of our society and economy. On top of this layer, is America's strong encouragement of entrepreneurship and the availability of risk capital, especially for early-stage companies. This complex web of universities, government institutions, corporate entities, venture capital firms, wealthy individuals investing in high-risk ventures, and the abundance of entrepreneurs have allowed the U.S. to prosper at various times and lead the charge into new eras of economics growth and technological advances.

To be upfront, I'm influenced by my former professor, Michael Crow, who taught U.S. science policy while he was at Columbia University (also gracious advisor to my first startup and failed early-stage fund effort). He was influenced by Richard Nelson, a neo-Schumpeter, considered a founder of evolutionary economics.

Nelson and others within the same camp believe technical advance or growth in technology account for 50%-70%+ of long-term economic growth. Seeing how the U.S. has become the world's foremost economic power, it's difficult to deny some of the truth and theories developed from Nelson and others. Whole new industries were created by developments that sprouted from U.S. R&D labs throughout the 20th century. From Xerox's fabled Palo Alto Research Center (PARC) to AT&T's Bell Labs to DARPA, inventions such as laser printing (1971), Ethernet, the graphical user interface, the Internet (1969), and cellular communications (1947) were given birth to in these halls.

One of the people most responsible was Vannevar Bush, Director of the Office of Scientific Research and Development under FDR. His report to President Roosevelt, "Science The Endless Frontier" (July 1945), help set forth and secure U.S. investment into scientific research as one of its core policies. Heavy investment by the government into various military and non-military labs were initiated.

One danger that is recently occurring is the decrease in funding for basic research. Basic research allows scientists to research for the sake of researching. To seek out their curiosities and find the truths of the universe. This is more of a non-linear approach that allows for a wide-range of possibilities, and many inventions that have changed our lives have come from basic research (e.g. x-rays, superconductivity, laser... what would you do without CDs or DVDs?). Over the past decade, corporations under pressure to perform have cut back or closed down their basic research efforts and only focused on applied research that seeks out a specific solution or product that can eventually generate revenue for the company. Even universities have scaled back on their basic research efforts since the licensing of their patents and inventions have become huge sources of funding since the Bayh-Dole Act of 1980, and have become more focused on applied research.

I really don't know the true impact of this shift in research funding and focus, but I hope it does not lead to the loss of leadership for the U.S. in the area of technical advance. Of course, the funding shift alone probably will not lead to the U.S.'s decline since there are many factors that make the U.S.'s innovation engine unique in world history (e.g. spirit of 'mother necessity', educational development of its citizens, legal foundation of the U.S... such as separation of church and state, freedom of speech, and so on). As long as the U.S. maintains its leadership in technology, I believe it will be in good position to remain the dominant power in the world.

Harping On The Deficit May Undo The Dems
NOVEMBER 24, 2003


By Robert Kuttner

I hope the Democratic candidates for President are in touch with Joseph E. Stiglitz, the 2001 Nobel prize co-winner in economics, who served as chairman of President Clinton's Council of Economic Advisers from 1995 until 1997. In Stiglitz' new book, The Roaring Nineties, and at a recent conference at Columbia University honoring his work on market failures,

Stiglitz challenged a premise that has become like holy writ: the idea that deficit reductions caused the boom of the 1990s.

Under this scenario, Clinton agreed to cut the deficit, the Federal Reserve obliged with lower short-term rates, markets were reassured, and the great boom was on. Message: A balanced budget equals prosperity. Stiglitz has a more persuasive view: Other forces, most notably higher productivity growth, allowed the Fed to run a hotter economy. "Deficit reduction," he writes, "accelerated the decline in interest rates, which helped recapitalize the banks. But interest rates would have fallen anyway. The forces taming inflation -- weaker unions and increased international competition in addition to rising productivity -- were already at play. It was the lower inflation as well as the deficit reduction that lowered long-term interest rates."

STIGLITZ DID SUPPORT REDUCTION of the structural deficits inherited from the Reagan and Bush I administrations, resulting from excessive tax cuts. These had to be reduced because they had put the budget on a path to ever-rising national debt. But in Stiglitz' view, Clinton overdid a good thing. He writes that if the Clinton Administration had put less money into deficit reduction and more into research and development, technology, infrastructure, and education, "given the high returns for these investments, [gross domestic product] in 2000 would have been even higher, and the economy's growth potential would have been stronger."

Stiglitz told Clinton all this. But he lost that argument with Treasury Secretary Robert E. Rubin, on whom Clinton relied to understand the markets' pulse. Recently, Rubin reiterated that high deficits cause high interest rates because government competes with other users of credit for a limited supply of savings. However, this premise is true only at full employment.

Stiglitz' point on the deficit is especially important now, as George W. Bush repeats Reagan's squeeze play: cut taxes, generate huge deficits, make Democrats play the role of fiscal Scrooges, and force permanent program cuts. As Rubinomics has more sway over most Democrats than Stiglitz-omics, Democrats are about to repeat Clinton's mistake.

It's hardly surprising that the immense deficits have stimulated sizzling short-term growth. The third-quarter growth is impressive, but entirely Keynesian. And while temporary deficits can generate short-term stimulus, permanent structural deficits can sap productivity.

As Stiglitz made clear at the recent conference, the Bush tax cuts should certainly be repealed, save those for middle- and lower-income taxpayers. But the revenue gained should not go entirely for deficit reduction. Rather, it would be better in the short term if the money went to help states and localities avoid cutting jobs. In the long term, it would be better for more money to go into productivity-enhancing public investments in education and technology. And the proposed new corporate tax cuts? They won't spur much investment, given the capacity overhang.

Bush's earlier tax cuts were so huge that even if those for the rich are repealed, there appears to be little room for increased public outlay. Here, I commend The New York Times reporter David Cay Johnston's Perfectly Legal, the definitive investigation of legal (and illegal) tax cheating. Johnston shows how tax avoidance among corporations and upper-income individuals is far outrunning the audit capacity of the Internal Revenue Service. There's a $113 billion gap between what corporations should be paying and what they pay. And 78% of the cases of known underpayment by partnerships were not even pursued by the IRS.

Combine a repeal of much of the tax cut with a serious effort to collect revenue, and the deficit can be brought down to, say, 2% of GDP, with money to spare for new public outlays. This would be sensible economics and better politics, since it would let Democrats offer something tangible to voters. But it's more likely the Dems will wrap themselves in the reassuring -- and suffocating -- blanket of Rubinomics.

Robert Kuttner is co-editor of The American Prospect and author of Everything for Sale

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