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Boom and bust

The latest economic news is good -- but not good enough

HAS THE ECONOMY suddenly shifted into high gear? Make no mistake: The unexpected quarterly gross domestic product (GDP) figures released by the commerce department recently, which showed an annual growth rate of 7.2 percent, come along rarely and will probably have 6 to 12 months of ripple effects. At last the economy will start producing some new jobs on balance after the longest drought since the Great Depression, and maybe a few people will even get a raise. Friday's better-than-expected employment report, which saw an increase of 126,000 jobs in October, was sub-par for this stage of a recovery but may be a harbinger of more jobs to come.

The solid growth is not merely a lucky accident. This economy was not going to stay in the muck forever in the face of enormous military and security spending, as well as two of the largest tax cuts in the nation's history -- even if they did go largely to the rich. But there are many ways to stimulate an economy in the short run. For example, you could eliminate all environmental regulations. Reduced costs would stimulate all kinds of companies to pump up investment. But what kind of nation would that leave us?

The example may be extreme, but these are precisely the kinds of questions we should be asking ourselves today. The economic policies of the Bush administration have been about as crude and destructive a cocktail of stimulants -- lavish income and estate tax cuts for upper-income Americans, elimination of taxes on dividends, stepped-up military and homeland security spending -- as we have ever seen.

The result is short-term growth and long-term damage. Even if the "Bush boom" hailed by some pundits temporarily takes hold, the administration's policies will weaken the economy over time, fall particularly harshly on its working middle- and low-income citizens, and fail to prepare the nation for a century of far more intense global competition.

. . .

In fact, we've been here before. It is fitting that the 7.2 percent rate of growth of America's GDP -- in effect, its national income -- is the fastest since the first quarter of 1984, under Ronald Reagan, when the annual rate reached 9 percent. Reagan's enormous tax cut of 1981 was of about equal size compared to the economy (properly adjusted for inflation and a couple of other factors), and he aggressively pumped up military spending. We then embarked on a solid recovery, with 7.3 percent growth reported for the entire year of 1984, tapering off to under 4 percent in succeeding years. The stock market set out on its long bull market as well, which Reagan enthusiasts hailed as the beginning of a new age.

But the federal budget deficit did not dissipate as promised with growth, capital investment did not rise as a proportion of GDP, and wages stagnated for most and fell for many even as jobs were created. Americans began borrowing at maddening, and mad, rates to support flattening incomes and the nation's savings rate just kept falling. In the end, when you measured growth over a complete business cycle, both recession and expansion, the Reagan reforms produced no increase in the rate of growth over the 1970s.

But things may not be even that good this time around. True, there are some hopeful signs. At last businesses are starting to invest in high technology again. Moreover, business inventories were run down in the quarter. That means they will have to rebuild in coming months, which should sustain some of the growth. And consumers continue to spend aggressively.

But much of last quarter's consumer spending was made possible only by the high volume of home refinancings as mortgage rates hit long-term lows. Now those rates are rising again. There were also about $100 billion of tax cuts, and their impact will diminish significantly in the fourth quarter.

A good Keynesian economist should believe that this spending, whatever the cause, will at least have some "multiplier" effect: It will encourage businesses to invest and even hire, and stimulate a virtuous cycle of growth. My bet is that it will do so.

But the draconian tax cuts will soon undermine these stimulative forces as those now legendary bond traders begin to size up the consequences of a federal budget deficit that, despite the current economic growth, may reach 5 percent of GDP in the fiscal year that began this October. (By contrast, the European Union is currently up in arms because France's budget deficit exceeds the EU's 3-percent threshold.)

The rates on 10-year US Treasury bonds are already up substantially to nearly 4.5 percent. Real interest rates -- that is, the nominal rate less inflation, which economists think has the most influence on capital investment -- have risen to about 2 percent, high for this early stage of recovery. It is also not yet clear that businesses have as yet utilized all the capital additions they zealously made in the high-flying 1990s, so they may have less need to invest than they typically would.

Most important, wages and salaries as reported by the Bureau of Economic Analysis did not rise at all in the third quarter. As a result, consumers are spending in lieu of saving, borrowing against their homes, and racking up credit card debt to compensate for a recovery that is not tightening labor conditions sufficiently to produce either jobs or raises. This economy will have no legs if 1.5 million jobs are not created in the next six to nine months, and preferably 2 to 3 million. But it is not likely that growth will be adequate to do that.

In addition, business attitudes seem to have changed. The first line of defense against a downturn in profits is now to cut jobs and squeeze more hours out of workers. The nation's data do not adequately capture how many more workers are working in this environment, say many economists.

The issue is not that the Bush tax cuts will have no stimulative impact, or that the economy will never produce jobs again under this president. Rather, we could have been rising from this morass much sooner, and we could be making the economy stronger in the long run rather than weaker.

Some say this is a Clinton recession. Indeed, there were speculative investments in the late 1990s that needed to be corrected, including the absurdly overvalued stock market. But these were more the handiwork of Federal Reserve chairman Alan Greenspan, who kept pumping money into the system and rhapsodizing on the long-term miracles of the New Economy. ("The Greenspan recession" certainly has less of a partisan ring.)

Regardless, Bush bungled the recovery. Sensible economic policies under a new president would have included moderate tax cuts (if any) directed to middle-income and working-poor Americans, aid to the badly strapped states, and investment in education, daycare, and other neglected public goods.

But instead, Bush has pursued some $2 trillion in callous tax cuts and requested another $87 billion for operations in Iraq and Afghanistan -- and that is likely only a down payment. He is not fully funding his No Child Left Behind Act for improving education, is only halfheartedly supporting the $400 billion plan for prescription drugs for the elderly (which many still think inadequate despite the cost), and hesitates to extend unemployment benefits at a time when long-term unemployment has reached record levels. If Bush's fiscal policies are not changed, when it finally comes time to pay the piper for Social Security about 10 years from now, when the baby boomers begin to retire, the nation will likely either have to raise taxes substantially or cut back benefits sharply to meet the cost.

Let's hope we have learned the lessons of the 1980s. For all the good news lately, the president has put us on a path toward a weaker economy, unable to meet future demands.

Jeff Madrick is editor of Challenge Magazine, a contributing economics columnist to The New York Times, and author most recently of "Why Economies Grow." He is also an adjunct professor at New School University.

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