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Annual Report of the Council of Economic Advisers 1989

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Annual Report of the Council of Economic Advisers 1989 THE ANNUAL REPORT OF THE COUNCIL OF ECONOMIC ADVISERS Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis LETTER OF TRANSMITTAL COUNCIL OF ECONOMIC ADVISERS, Washington, D. C, January 6, 1989. MR. PRESIDENT: The Council of Economic Advisers herewith submits its 1989 Annual Report in accordance with the provisions of the Employment Act of 1946 as amended by the Full Employment and Balanced Growth Act of 1978. Sincerely, Beryl W. Sprinkel Chairman Thomas Gale Moore Member 15 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis CONTENTS Page CHAPTER 1. FREE MARKETS, STABILITY, AND ECONOMIC GROWTH. 23 The Pre-war Years 26 The Early Postwar Period: The United States Takes the Lead in Trade, Stability, and Growth 30 Sources of Economic Growth: 1948-73 30 Social Performance 36 The Seventies: Instability, Inflation, and Stagnation 38 Destabilizing Macroeconomic Policies 39 The Productivity Slowdown 43 Social Performance 52 The Eighties: Lower Inflation, Improved Incentives, and Improved Performance 55 Sources of the Improvement in Output, Inflation, and Productivity Performance 58 Social Performance 70 Conclusion 72 CHAPTER 2. FISCAL POLICY AND ECONOMIC EXPANSION 73 The Evolution of Fiscal Policy in the Postwar Era 75 The Growth of Government Expenditures and Revenues... 78 The Structure of Government Spending 80 The Long-run View of Fiscal Policy 85 Tax Policy and Its Impact on the Economy in the 1980s .... 86 Reduction in Typical Family Tax Burdens 89 Tax Reform and Capital Formation 90 U.S. Tax Structure and the Need for Stable Tax Rates 94 Controlling Federal Outlays and the Federal Budget Defi- cit 95 The Federal Debt and Deficit in Perspective 96 Social Security Trust Funds' Buildup and the Budget Deficit 98 Institutional Change to Control Federal Outlays to Reduce the Deficit 101 Conclusion 103 CHAPTER 3. GROWTH AND EVOLUTION OF INTERNATIONAL CAP- ITAL MARKETS 105 The Behavior of Exchange Rates 107 Digitized for FRASER 17 http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Page The Purchasing Power of the Dollar 108 Pegged and Flexible Exchange Rates: Recent Histori- cal Experiences 113 The Dollar and Competitiveness 118 International Policy Coordination Under Flexible Ex- change Rates 121 Exports, Imports, and Trade Balances 123 Measures and Meanings of External Balances 124 The Current Account Balance: Recent Historical Ex- periences 127 The Changing U.S. Net Asset Position 129 The Debt of Developing Nations 137 Conclusion 145 CHAPTER 4. WORLD TRADE AND ECONOMIC GROWTH 147 Economic Growth and Trade in the Postwar World 148 Tariff Liberalization in the Postwar Period 150 U.S. Postwar Objectives . 152 Tariff Reductions in a Multilateral Framework: GATT 153 The Tradeoffs in U.S. Trade Legislation—Tariff Re- ductions Versus Creeping Protectionism 159 The Spread of Trade-Distorting Measures 161 Sources of Increased Protectionist Sentiment 165 Political Economy of Protectionism 167 The Special Threat of Nontariff Measures 169 Textiles and Agriculture—Case Studies in Protection.. 171 Free and Fair Trade 175 Section 301 in Practice 176 Recent Modifications in the Law 178 Agenda for the Future 179 "EC 1992"—The Single Internal Market in Europe 181 Uruguay Round Negotiations 182 CHAPTER 5. RETHINKING REGULATION 187 Regulation: An Overview 190 Rationales and Motivations for Regulation 191 Trends in Regulation 193 The Effects of Regulation 193 The Movement Toward Deregulation 195 The Introduction of Executive Regulatory Oversight 196 Economic Regulation: Extending the Boundaries of Com- petition 198 Price and Entry Regulation 198 Rethinking the Limits of Natural Monopoly 204 Privatization 212 Rethinking Social Regulation 214 Digitized for FRASER 18 http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis The Expanded Use of Market Incentives 215 The Impact of Social Regulation on Innovation 217 Lessons and Challenges 220 CHAPTER 6. SCIENCE, TECHNOLOGY, AND THE U.S. ECONOMY 223 Overview 224 International Comparisons 225 Science and Technology Inputs 225 Science and Technology Outputs 229 Industrial Innovation in the United States and Japan... 231 Government Research Policy in the United States and Japan 232 High-Technology Products and U.S. Trade 234 Characteristics of the High-Technology Sector 235 U.S. Trade in High-Technology Products 235 Policy Issues of the 1980s and Beyond 238 Incentives for Private Industry 239 Federal Funds for Research and Development 241 Federal Technology Transfer 244 Federal Support for Industry 247 Potential Policy Problems 250 Conclusion 253 CHAPTER 7. THE U.S. ECONOMY IN THE 1980s AND BEYOND ........ 255 The Lowering of Inflation in 1981 and 1982 256 The Expansion in Perspective 258 Growth in Real Output 259 Saving and Investment 260 Employment and Unemployment 265 Inflation and Productivity Growth 267 Monetary Policy 269 The Economy in 1988 270 The Impact of the Stock Market Crash 271 Sources of Demand 274 Prices, Wages, and Employment 276 The Impact of the Drought 278 Macroeconomic Policies 279 The Economic Outlook..... 280 Projections for 1990-94 283 Determinants of Growth 1989-94 285 The Legacy of this Administration 288 APPENDIXES A. Report to the President on the Activities of the Council of Economic Advisers During 1988 291 B. Statistical Tables Relating to Income, Employment, and Production 301 Digitized for FRASER 19 http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis List of Tables and Charts Tables 1-1. Growth Rates in Real GNP/GDP, Selected Periods, 1900-88 27 1-2. Real Capital Stock per Worker and GDP per Capita Rel- ative to the United States, Selected Years, 1913-87 31 1-3. Growth in Value Added per Hour Paid, 1948-87 67 2-1. Income Tax Reductions: Current Law Versus 1980 Law, Median Income One-Earner and Two-Earner Families of Four 89 2-2. Growth of Real Gross Domestic Investment in the Seven Summit Countries, 1965-86 ,.... 90 2-3. Estimated Average Effective Tax Rate on Investment 93 2-4. Deficit Targets Under the Gramm-Rudman-Hollings Act, 1990-93 95 2-5. Unified Budget Impact of Projected OASDI and HI Sur- pluses (Excluding Interest), Selected Years, 1988- 2065 100 3-1. The Dollar and Import Prices Since 1980 119 3-2. Currency Denomination of International Bond Issues, 1983-88 , 136 4-1. Output and Export Growth, 1870-1987 150 4-2. Tokyo Round Tariff Cuts by Stage of Processing, Se- lected Countries 156 4-3. Tokyo Round Tariff Cuts by Industry for United States, European Community, and Japan 157 4-4. Growth of Subsidies in Selected OECD Countries, 1960-86 162 4-5. Industrial Country Imports Subject to "Hard-Core" Nontariff Measures, 1981 and 1986 164 5-1. Deregulatory Initiatives, 1971-88 '. 196 7-1. Comparison of Current and Past Expansions 261 7-2. Economic Outlook for 1989 281 7-3. Administration Economic Assumptions, 1988-94 284 7-4. Accounting for Growth in Real GNP, 1948-94 286 Charts 1-1. Change in Unemployment Rates in the Seven Summit Countries '. 26 1-2. Real Family Income Relative to 1948 Levels 37 1-3. Poverty Rate, All Persons 39 1-4. Unemployment Rate and Inflation Rate at Business Cycle Peaks, and Current Rates 40 1-5. Alternative Rates of Return on Capital Investment 47 20 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Charts 1-6. Output per Hour and Capital Stock per Worker, Manu- facturing and Nonmanufacturing 50 1-7. Actual and "Predicted" Proportion of Families with Income Below $10,000 in 1987 Dollars 54 1-8. Composition of Families in Poverty 55 1-9. Gross and Net Investment Shares of GNP 62 1-10. Real GDP per Employed Person in the Seven Summit Countries, 1987.. 70 2-1. All Government and Federal Expenditures as Percent of GNP 78 2-2. Federal Receipts and Expenditures as Percent of GNP ... 80 2-3. Federal Investment Outlays as Percent of GNP 82 2-4. Federal Expenditures by Type 83 2-5. Debt and Deficit in the Seven Summit Countries in 1987 97 3-1. Nominal and Real Exchange Rate 109 3-2. Exchange Rates and Relative Prices 111 3-3. Net Exports and the Current Account Balance 126 3-4. U.S. Net Asset Position Abroad as Percent of Net Wealth 131 3-5. Asset Earnings Flows 134 3-6. Foreign Direct Investment Position in the United States. 135 4-1. U.S. Tariff Rates, 1860-1987 151 5-1. Real Federal Outlays for Regulatory Activities 195 5-2. Bank and Thrift Failures 201 6-1. The National R&D Effort 226 6-2. National R&D Expenditures, Selected OECD Countries . 227 6-3. Federal and Private Funding of Research and Develop- ment 242 6-4. Federal Obligations for Research and Development by Major Agency 243 7-1. Actual and Target M2 Growth 257 7-2. Gross Saving and Investment as Percent of GNP 262 7-3. Expansion Duration and Inflation Change 268 7-4. Hourly Compensation and Prices 277 21 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis CHAPTER 1 r'ree Markets, Stability, and Economic Growth THE FOUR DECADES SINCE WORLD WAR II stand out as a period of remarkable growth for the developed market economies. More people in more countries increased their standard of living than in any other era. Real gross national product (GNP) per capita in each of the major industrialized nations has grown significantly faster since 1948 than before World War II. This success is based in part on reliance by the United States and the other nations on pri- vate incentives and free markets, with governments attempting to provide both a stable macroeconomic framework and a stable world political environment.
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