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SPEAKING FREELY
The end of American
economic supremacy?
By Hussain Khan
Speaking Freely is an Asia Times Online
feature that allows guest writers to have their say.
Please click here if you
are interested in contributing.
It is
beginning to appear that the events of September 11,
2001 have had such an impact that it could end American
economic supremacy in the world. The peril to the US
economy has been compounded by fiscal actions taken by
the administration of President George W Bush.
The costs of fighting and occupation in
Afghanistan and Iraq, reconstruction and relief after
September 11, and homeland security combined over the
next two years, are expected to explode. Bush has
already requested an additional US$87 billion for war
funding alone. Administration tax cuts, according to the
Congressional Budget Office, will cost the economy
nearly three times as much as the costs of
reconstruction and defense.
Moreover, these tax
cuts are expected to rise to about $2 trillion over the
decade. That is assuming that the sunset provisions
phasing them out are enacted. If, as seems likely, they
are not, the 10-year budgetary costs of the tax cuts
will rise by another $2 trillion.
Bush wanted to
follow on the footsteps of Ronald Reagan by relying on
the theories of the supply-side economists, who believe
that tax cuts generate so much additional economic
activity that they increase government revenues. In his
election campaign, Bush used tax-cut philosophy to
appeal for votes. But the enactment of these theories is
producing unforeseen negative effects rather than the
positive qualities that the original supply-siders had
assumed.
They had assumed that by cutting taxes,
demand would increase due to surplus money available
with the consumers for purchases. But this theory had
already failed in Japan. Instead of spending, the
Japanese simply increased their savings. The benefits of
tax cuts were not cycled into the market to boost the
economy, as consumers feared unemployment or business
uncertainty. The situation is similar in the US today.
In a scenario changed by September 11, and after
the administration's decision to invade Afghanistan and
Iraq to attempt to round up terrorists, the strain on
the American economy has been so tremendous that these
supply-side theories have fallen apart. Uncertainty and
unemployment fear has grown due to this scenario.
Psychologically, as in Japan, consumers were not
encouraged to increase their spending as the
supply-siders believed would happen under the tax cut
measures. Their benefits were confined to the
well-to-do, who simply deposited the extra money instead
of spending it.
The federal government enjoyed a
projected 10-year budget surplus of $5.6 trillion when
Bill Clinton left the presidential office. But the Bush
administration is now confronting sizable annual
deficits just three years later. Private economists now
forecast a 10-year deficit of around $4 trillion-$6.7
trillion, excluding the social security surplus. As a
share of the economy, government debt and interest
payments are expected to double over the next decade.
In a recent annual survey of the US economy, the
International Monetary Fund (IMF) last month quoted a
White House forecast that the federal budget deficit
would explode to a record $455 billion in 2003 and then
$475 billion next year. The IMF further quoted the Bush
administration that the deficit - 50 percent bigger than
that projected just five months ago – had been
exacerbated by a weak economy, the Iraq war and a $350
billion tax cut package.
The deficit has thus
increased more than 50 percent in just five months. This
unforeseen increase is said to have occurred due to the
Iraq war and the tax cuts. It actually shows that the
tax cuts did not produce the results that the
administration had expected. In fact, they were exactly
the opposite.
The IMF notes two improvements in
the US economy. First, its rate of economic growth was
set to rise from 2.25 percent in 2003 to 3.5 percent
next year. Second is the high growth in productivity, or
output per hour work. As a matter of fact, the expected
rise in the rate of economic growth is mainly due to the
rise in productivity. If productivity growth were
stifled, economic growth would also be affected
negatively. And that is the factor about which the IMF
has expressed concern in the following words:
"In particular, the worsening of the longer-term
fiscal position, including as a result of the recent tax
cuts, will make it even more difficult to cope with the
aging of the baby-boom generation, and will eventually
crowd out investment and erode US productivity growth."
That means that despite some possible
improvements in a short-term scenario, the longer-term
prospects are doomed to erode productivity growth and
hence cut economic growth, leading to eventual crowding
out of new investment, while the US has to face the
challenge of an aging baby-boom generation. This is the
IMF's final conclusion. It added two further worries
concerning social security and medicare in the following
words:
"The risks to the fiscal outlook appear
especially worrisome given the significant actuarial
deficit arising from the longer-term demographic
pressures on the social security and medicare [health
care] systems. As a matter of fact, this temporary
increase in the economic growth rate and in the
productivity is going to occur at the cost of dismissing
hundreds and thousands of workers. It is the result of
increasing unemployment, which was accelerated by the
9/11 events. "
The number of employed workers
continued to decrease after September 11 and overstocked
goods had to be cleared. This situation resulted in a
temporary increase in productivity or output per hour of
work and hence the increase in the rate of economic
growth.
As the IMF has pointed out, this
situation cannot continue for long, as interest payments
to fund the budget deficits will erode savings and drive
out new investment. Increasing unemployment can be
expected to erode purchasing power and shrink the urge
for consumption and hence decrease demand, in turn
bringing about stagnation and stifling growth.
Not only the IMF but the Republican-controlled
Joint Committee on Taxation as well, using a variety of
dynamic scoring assumptions, was forced to acknowledge
that these cuts are likely to reduce the economy's
long-term growth. Explaining the reason as to why the
committee has come to this conclusion, Laura d'Andrea
Tyson, dean of London Business School writes:
"Any positive business-investment incentives
from lower taxes will be outweighed by the curtailing of
national saving and investment caused by mammoth budget
deficits. To the extent that larger deficits diminish
domestic saving, they eat into productive investment. To
the extent that larger deficits are funded by borrowing
from the rest of the world they raise the nation's
foreign debt and drive future income into servicing this
debt. Contrary to the claims of administration
ideologues, larger deficits mean lower future living
standards.
"The administration argues that its
tax cuts are necessary to stimulate growth in a sluggish
economy. But this argument is specious. The economy may
have needed a temporary infusion of additional demand
during the past three years. But temporary tax cuts or
spending hikes for hard-pressed working families,
unemployed workers, and state governments would have
stimulated demand much more effectively than tax cuts
for the rich."
The tax cuts were designed to
increase demand and employment opportunities, but they
have backfired. The average tax cut is said to be about
$1,000 per person. But half of the taxpayers will get a
nominal tax cut of $120 only and one-third receive no
benefit at all. The average refund is much higher
because the benefit to the few rich taxpayers is very
great. When more than half and the additional one-third
do not benefit significantly from the tax cuts, how are
those blessings going to come about that the supply-side
theorists claim in the form of increased overall demand
or in the purchasing power of the majority, while the
number of the unemployed has peaked to a nine-year high
level?
The increase in unemployment is a scourge
in itself. A lot of companies like Enron and some
airlines have been bankrupted. Those that survived
dismissed a lot of their workers as a result of the
September 11 events. The Clinton administration had
created millions of new jobs and reduced unemployment to
less than 4 percent. The events of September 11 reversed
this trend. Unemployment is 50 percent higher than the
Clinton administration figures, rising to a nine-year
high of 6.1 percent. It has remained above that level
for the last few months, despite slight negligible
monthly adjustments.
The US had just emerged
from recession in the beginning of 2001. But September
11 drove growth down again. Growth of at least 3 percent
is needed to encourage hiring, say economists, but such
growth has not occurred in consecutive quarters since
the final six months of 1999. The economy grew only 1.4
percent annually in the first quarter of 2003. In an
attempt to boost growth, the Federal Reserve cut
short-term interest rates to 1 percent, their lowest
level in 45 years.
The US Federal Reserve, the
nation's central bank, said at the time that the economy
was still weak despite previous cuts in interest rates.
But the impact of September 11 was so strong that all
these efforts by the Bush administration and the Fed
failed to spur growth and create new jobs.
On
the contrary, under the so-called jobless recovery, more
than 2 million jobs have disappeared since Bush took
office in January 2001, reviving memories of 1929
depression. Bush could be the first president since
Herbert Hoover, who was in the White House from 1929 to
1933, the years of the Great Depression, to oversee a
decline in total US jobs during his term. By contrast,
22 million jobs were created during the Clinton years.
With presidential elections looming next year,
Democrats have focused on the economy as Bush's weak
spot. Nancy Pelosi of California, the House Democratic
leader, has described Bush's economic record as "$3
trillion deeper in debt, three million fewer jobs".
As long as fiscal deficits continue to increase
and erode savings and investment, there is no
possibility of creating new jobs to significantly reduce
unemployment. In addition to the increasing large fiscal
deficits, unemployment, slow economic growth and falling
living standards, other problems are hovering. One is in
the form of the fall in federal revenues. Usually, with
yearly growth, however small, revenues also continue to
grow every year. But the war adventures of the Bush
administration have reversed this historic trend.
In 2003, federal revenues are expected to fall
to as far back as the 45-year-old level. The forecast is
that the American economy will regress to the level of
the 34th American president, Dwight D Eisenhower
(1953-61). Federal revenues include a variety of sources
of income, one of them tax revenue. If only tax revenue
is compared, it is going to fall to about the
60-year-old level of 1943.
The present state of
social security is such that one third of the dollars in
this account have to be borrowed from outside, as
internal revenues are not sufficient to cover costs.
This is the largest share of deficit-financed spending
in the past 50 years. This deficit spending is forecast
to increase $400 billion by 2008. If no cuts are made in
social security, medicare, defense and debt service,
government spending on everything else - from education
to homeland security - would have to be slashed by more
than 80 percent to restore budgetary balance. The United
States is in for a rough ride.
Hussain
Khan holds a Master's degree in Economics from Tokyo
University, and worked for a German bank subsidiary
selling Japanese stocks to institutional buyers in
Japan, the Middle East, Europe and the US. He is an
analyst on current affairs and economic issues for
various newspapers and magazines. Email:
hk@ourquran.com
Speaking Freely is an Asia
Times Online feature that allows guest writers to have
their say. Please click here if you
are interested in contributing.
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