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If This is a Hangover, the Exuberance was Rational

By JAMES K. GALBRAITH
The Washington Post

Is it Morning in America, Again? President Bush seems to think so. But the type of morning he has in mind is, well, not exactly bright and cheery. We've been on a "binge," the president declared last week in Birmingham, and we've got a "hangover."

What a difference two years make. As late as mid-2000, no less an authority than Federal Reserve Chairman Alan Greenspan had a very different view. We were, he wrote, living through a technological transformation that could permit full employment, balanced growth and low inflation to continue for a long time.

Bush has rejected Greenspan's view. For this, given the news, he can't be blamed. But what about the image of binge and hangover? Does it succeed as diagnosis -- and as a guide to what we should now do? Were the '90s lived in a stupor, and is recovery merely a matter of sleeping it off? Is a drinking problem, in short, a good metaphor for our economic problem?

We do know that the tech boom was mainly bubble. Its scientific component was vastly oversold. Huge capital sums were raised, and wasted. Meanwhile, throughout corporate America, profits were overstated under the relentless pressure of the markets. And billions were diverted to the pockets of corrupt directors, officers and CEOs.

But the fact that profits were lower than we thought is not all bad news. Living standards were actually higher than many realized at the time. The '90s were a good time for American workers, who enjoyed full employment, rising wages and unprecedented access to credit. Poverty fell during these years, health improved, crime declined and inequalities in pay (though not wealth) diminished. Home ownership reached record levels. These things, unlike profits, cannot be faked.

Productivity gains in the '90s were also real. But they owed more to full employment than to technological change. When labor is tight, businesses find ways to save on labor. But the benefits of these gains did not especially show up in profits, as equity investors imagined that they would. Instead, they flowed back to households, in lower prices and higher quality -- the fruits of competition. As such, productivity gains contributed not so much to profits as to rising living standards.

All this was wonderful. The problem was only that this prosperity could not be sustained. The tech bubble, which Greenspan failed to discourage in good time (by raising margin requirements), was bound to burst. Meanwhile, broader growth was fueled by rising corporate and household debt. From 1997 onward, for the first time in history except for brief periods, Americans ceased to save. Instead they financed spending out of loans -- against their homes mainly and also against their stocks. This, too, could not go on forever, not once asset prices ceased to rise.

The tech bubble popped back in April 2000, of course. And we are only now learning just how much damage it did. By the summer of 2001, it looked as though the boom in household spending was ending. But Sept. 11, in tragic irony, gave America's families a boost. Government spending soared, raising private incomes. The earlier revisions of a Bush tax cut to include a cash rebate also helped. Interest rates were cut. Oil prices dropped. American automakers slashed prices (which, incredibly, they continue to do). Good weather prolonged the construction season. And so the consumer hung on, bringing us the inventory bounce and the false recovery -- ballyhooed by paid optimists on Wall Street -- of early 2002.

Here is where the hangover metaphor breaks down. Because we are "fundamentally strong," Bush tells us, our troubles will pass. (Greenspan claims to agree.) Recovery is underway; the hangover evident in the markets will be only an unpleasant memory, soon enough.

But in fact, we won't be all right by lunchtime. Consumer finances are getting worse, not better, as debts rise and asset prices fall. All of the Sept. 11 stimuli have ended, and some (like the price of oil) have been reversed. (True, there is strength in housing, which may keep things going for a while yet.) Meanwhile states and localities are in fiscal crisis, and they will be cutting spending and raising taxes all through the coming year.

Part of what sustained the U.S. economy in the late 1990s was an influx of foreign capital after 1997. But capital that flows in can flow out -- now that a seemingly stable place to go has appeared in pedestrian, social-democratic Europe. The almighty dollar is, it appears, not invincible, as shown by its drop to parity with the euro last week. The falling dollar will further undermine financial markets, raise some import prices, and yet crush developing countries that export to us but buy from the larger world. Long-term benefits, such as higher exports, may not materialize unless we first get serious about rebuilding both our industrial base and the global financial architecture on which stable development relies.

In short, we face major threats: unsustainable private debts, rising oil prices, a confidence crisis, fiscal woes at all levels of government and a falling dollar amid weak export markets. Not a hangover, in other words, in a healthy organism -- but an underlying disease. Call it debt dependence. Or, perhaps, "capital"-ism.

Both political parties are in denial. Bush's platitudes about fundamental strength and the need for "confidence" reveal the emptiness of his recovery program. The Democrats have not escaped from their own rhetoric of years past. They had claimed to discover the one true elixir for perpetual health: "fiscal responsibility," low interest rates and an indomitable belief in technological change. It is true, this formula worked in the 1990s. But that does not mean it will work now.

What would work? Only major changes in policy. The Senate's action on corporate scandals was a start. Here is a five-step program for what should come next.

• Save the cities and the states. Last week the governors owned up to their problem: a $50 billion shortfall this past fiscal year in the states' budgets and no one knows how much in the year to come. Local government deficits are probably equally big. There is no justification for allowing cutbacks in schools, health care, roads, and mass transit and environmental safety. Congress should ride to the rescue, with a revenue-sharing block grant to prevent such cuts. Former ambassador to France Felix Rohatyn (the financier who helped save New York City from bankruptcy in the '70s), California Treasurer Phil Angelides, New York Comptroller Carl McCall and I presented such a proposal to congressional leaders in February. It's time now to get moving.

• Find new ways to help American households. Enact a prescription drug benefit. Raise the minimum wage. A new round of tax rebates could help. So would expanding the Earned Income Tax Credit. A temporary cut in payroll tax rates, say for three years, would cut the cost of new employment and spur hiring. To make sure the Social Security trust funds stay whole, corporate and estate taxes could be credited to the funds to make up the difference.

• Freeze and repeal the out-year or future tax cuts. The need is for action -- necessarily involving larger federal deficits -- in the short- and medium-term. The U.S. government remains an excellent credit risk, and we can afford this action. But the federal deficit should not be allowed to rise forever. Thus we can no longer afford Bush's gifts to the wealthy in the form of lower income tax rates, and especially the phased repeal of estate taxes -- which would perpetuate the ill-gotten fortunes of so many corporate crooks.

• Start conserving oil. This administration's determination to increase (and control) oil supplies rather than to conserve energy is a formula for permanent war. The only serious recourse is to invest now, at home, on transport systems, using light rail, subways and trains, exploiting every alternative to gas-guzzling cars and our vulnerable airlines. Investment in energy conservation, by increasing auto fuel efficiency, for example, could not only stimulate the economy, but reduce our trade deficit. Such would be a true homeland security program.

• Rebuild the global financial system. The age of the high dollar -- of cheap imports and unlimited trade deficits, financed by the world's poor -- seems to be ending. The 30-year-old system of free global capital markets has failed to produce the development on which our export prosperity, not to mention global peace and security, depends. A rush to the euro would be disastrous for us, yet we cannot afford to raise interest rates to defend the dollar. And so we need a new system of international reserve assets and stabilizing control over global capital flow. We must shut down overseas tax havens, impose excise taxes on foreign exchange transactions and more. We have now seen the devastating consequences of unregulated private power in our capital markets. This should help us understand the complaints of so many other countries in recent years.

A true recovery cannot happen overnight. But it will not happen at all unless we begin to discuss it now. We can begin by shaking off the illusion that we are okay. The 1990s were a golden and a gilded age, but we cannot return to them -- and we should not want to. So we must also discard Bush's hangover illusion. That metaphor implies an invitation, after all, to get ready for the next binge.

(On Sept. 1, James Galbraith will become Lloyd M. Bentsen Jr. Professor of Government/Business Relations at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin.)

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