*EPF314 02/06/2002
Text: White House Adviser on Economic Recovery, Policy Agenda
(Open trade one of president's priorities, he says) (4200)

President Bush's long-term economic agenda is built around policies that support a flexible economy and rapid economic growth, Council of Economic Advisers Chairman Glenn Hubbard said.

In a February 5 testimony before the congressional Joint Economic Committee, he said that one of Bush's priorities is the U.S.-led effort for freer global trade. He added that the United States has the opportunity to reap significant gains from future trade agreements, including those pursued under new World Trade Organization negotiations.

Hubbard said that the outlook for the U.S. economy remains "strongly positive" but a slower recovery in capital spending, rising energy prices or security concerns may make it less so.

In this context he emphasized the importance of the president's economic stimulus package and his energy policy.

Hubbard said that growth in the United States will be initially slow in 2002 but added that over four quarters, inflation-adjusted gross domestic product (real GDP) is expected to grow 2.7 percent. Consumer spending is projected to continue at "solid rates", he said, while business investment and exports are likely to start growing significantly only later in the year.

He said that the Bush administration is proposing increased funding to develop measures for collecting better and timely economic data, which both government and private decision-makers need to track the economy as accurately as possible.

Following is an excerpt of Hubbard's testimony:

(Note: In the text "billion" equals 1,000 million, and "trillion" equals 1,000,000 million.)

(begin text)

TESTIMONY OF
R. GLENN HUBBARD
CHAIRMAN, COUNCIL OF ECONOMIC ADVISERS
BEFORE THE
JOINT ECONOMIC COMMITTEE, U.S. CONGRESS

February 5, 2002

Chairman Saxton, Vice Chairman Reed, and members of the Committee, it is a pleasure to appear before you today to discuss the release of the Economic Report of the President, along with the economic outlook for the United States and the Administration's policy agenda.

The events of 2001 brought new challenges for the U.S. economy and for economic policy. The war against terrorism has increased the demands on our economy, and we must do everything in our power to build our economic strength to meet these demands. At the same time, we must take pains to ensure that the benefits of economic growth are shared as widely as possible, both within and beyond our borders.

Economic growth is not an end in itself. As it raises standards of living -- consumption, in the language of economists -- growth also provides resources that may be devoted to a variety of activities beyond the traditional marketplace. Growth can fund environmental protection, the work of charitable organizations, and many other activities of interest and value to the United States, other industrialized economies, and developing economies alike.

RESTORING PROSPERITY

The economy entered 2001 growing slowly, and growth continued to decelerate through most of the year. After expanding at an annual rate of 5.7 percent in the second quarter of 2000, gross domestic product (GDP) -- a standard measure of economy-wide production -- began to falter later in the year, and the weakness persisted into 2001. Some sectors stumbled into outright decline; for example, industrial production peaked in June 2000, and then entered a prolonged slump. Although the National Bureau of Economic Research has said that the recession -- the first in ten years -- officially began in March 2001, the terrorist attacks of September 11 delivered a further blow to the economy. The experiences of 2001 have emphasized the importance of timely economic information, with one area deserving considerable attention being the need for readily accessible real-time data. Investment in sources of these data could yield handsome dividends, especially at key junctures in the business cycle.

Moreover, the quality of existing statistics is far from perfect and could be enhanced with further investment. Even real GDP, generally thought of as a reliable measure of overall activity in the U.S. economy, is susceptible to considerable revisions. For example, in the third quarter of 2000, real GDP was first estimated to have grown 2.7 percent at an annual rate -- a subpar but respectable growth rate. That rate was then revised downward to 2.4 percent and then again to 2.2 percent. Seven months later it was further revised downward to 1.3 percent, providing evidence that the economy had begun to slow dramatically at that time. A key component of the revision came from revised data on gross private domestic investment, initially estimated to have risen 3.2 percent but later revised to show a contraction of 2.8 percent. Such revisions lead to uncertainty for both government and private decision-makers, which can cause costly delays. Although most revisions are not that large, the average quarterly revision of real GDP growth over the last decade was about one percentage point, while real GDP growth averaged 3.2 percent. This amounts to a revision of about one-half the standard deviation of the quarterly growth rate of real GDP.

A number of steps can be taken to improve the accuracy and timeliness of economic statistics. One cost-effective measure would be to ease the current restrictions on the sharing of confidential statistical data among Federal statistical agencies. Such data sharing, which would be done solely for statistical purposes, is currently hindered by lack of a uniform confidentiality policy. Confidentiality is of key importance to all agencies and to the individuals and businesses who participate in Federal surveys, but a uniform confidentiality policy would allow agencies such as the Bureau of Economic Analysis, the Bureau of Labor Statistics, and the Bureau of the Census to compare and improve the quality of their published statistics while preserving confidentiality. In the past, attempts have been made to pass legislation, together with a conforming bill to modify the Internal Revenue Code, allowing such data sharing under carefully crafted agreements between or among statistical agencies. Meaningful data-sharing legislation still offers the opportunity to improve the quality and effectiveness of Federal statistical programs.

In addition to data-sharing legislation, the Administration is proposing new and continued funding for the development of better and more timely measures to reflect recent changes in the economy. For example, these resources would allow for tracking the effects of the growth in e-commerce, software, and other key services, and for developing better estimates of employee compensation. The latter are increasingly important given the expansion in the use of stock options as a form of executive compensation, as well as for tracking the creation and dissolution of businesses, given the importance of business turnover in a constantly evolving economy. Improved quality-adjusted price indexes for high-technology products are also an important area for future research. As the economy continues to change and grow, the need persists to create and develop such new measures, to provide decision-makers with better tools with which to track the economy as accurately as possible.

The Near-Term Recovery

The Administration expects real GDP growth to resume early in 2002. The pace is expected to be slow initially, followed by a pickup thereafter; over the four quarters of 2002 real GDP is expected to grow 2.7 percent. The unemployment rate -- currently 5.6 percent -- is projected to rise through the middle of 2002, when it is expected to peak around 6 percent.

The decline in aggregate demand during the past year was concentrated in inventory investment, business fixed investment, and exports. Of these downward pressures, inventory draw downs are anticipated to reverse course soonest and most rapidly, moving from liquidation to accumulation in the first quarter of 2002. Thus the initial source of the recovery of growth will likely take the form of the accumulation phase of an inventory cycle.

Growth in business investment and exports is likely to take longer to develop. Nonresidential investment fell sharply in 2001, and some downward momentum may still remain. Still, the financial foundations for investment remain positive: Real short-term interest rates are relatively low, prices of computers are falling, and equity prices moved up during the fourth quarter. Perhaps due to these factors there was an upturn in new orders for non-defense capital goods in the fourth quarter, a promising sign for the outlook for business fixed investment.

Personal consumption expenditure grew quite rapidly in the fourth quarter -- a 5.4 percent annual rate -- driven in large part by purchases of motor vehicles. While auto purchases may have been influenced by special financial considerations, the overall strength of household spending in the fourth quarter suggests a strong impact of the tax cut passed by Congress and signed by the President last spring. During the fourth quarter consumption of non-durables and services increased $39.5 billion despite the fact that personal income rose only $0.2 billion, suggesting that purchases were financed in part by the downpayment on the tax relief mailed out during the third quarter. This interpretation of the data is entirely consistent with the reaction of households to a permanent tax cut, as a temporary tax cut would have been largely saved and not spent. In the same way, it also suggests that any perceived undermining of the permanence of this tax cut would have immediate adverse repercussions in the level of consumption demand.

Consumption spending is expected to continue at solid rates in 2002, albeit a bit slower than the rapid pace in the fourth quarter. One impact, however, of the war against terrorism is the need for enhanced expenditures for defense and homeland security. The growth in these outlays represents an impetus for aggregate demand in the short run; for example, in the fourth quarter, Federal government purchases rose at roughly a 9 percent annual rate. More rapid government spending in general, however, is not a sure recipe for economic growth. Indeed, the loss of fiscal discipline represents a threat to long-run growth. The need to address the terrorist threat is very real; however, we must be vigilant against a loss of budgetary discipline and remain committed to re-prioritizing our needs and controlling the growth of government spending.

Inflation is expected to remain low and stable. As measured by the GDP price index, inflation was stable at about 2.2 percent during 2001. The Administration expects this measure of inflation to fall to 1.9 percent in 2002. The unemployment rate is now above the level that the Administration considers to be the center of the range consistent with stable inflation, and capacity utilization in the industrial sector is substantially below its historical average. Despite faster-than-trend growth of output in 2003 and 2004, some downward pressure will be maintained on the inflation rate, because the unemployment rate is projected to remain above the center of the range over that period.

Risks to the Near-Term Recovery

The Administration forecast mirrors the outlook of private sector analysts such as the Blue Chip consensus forecast. We must recognize, however, that the basic economic outlook is subject to risks.

To begin, one downside risk to the consensus outlook is a slower recovery in capital spending. In particular, some observers have emphasized the possibility of a "capital overhang" that impedes a recovery in business fixed investment. A capital overhang develops when the amount of capital in the economy exceeds the amount that businesses desire for the production of goods and services. The emergence of such an overhang complicates both business planning and policymaking. Businesses often have to alter their capital spending plans and curtail their investment spending -- sometimes quite abruptly. A large overhang may also reduce the stimulative effects of tax policies designed to boost investment, possibly lengthening the recovery time during a period of sluggish economic activity, especially for the manufacturing sector.

Empirical evidence suggests that a capital overhang did develop in 2000. The overhang was modest for the economy on average, but various types of capital equipment such as servers, routers, switches, optical cabling, and large trucks were disproportionately affected. Over the past year and a half, the decline in investment spending and depreciation of the existing capital stock appear to have combined to slow capital accumulation sufficiently to eliminate the overhang.

However, estimates of the total overhang must be interpreted with caution. There is considerable uncertainty about its size, because it is difficult to estimate precisely both the capital stock that businesses desire and the capital stock they actually possess.

The remarkable slowdown in capital accumulation during 2001 and the possibility that the capital overhang has persisted longer than the data suggest some risk to the outlook This underscores the importance of the President's tax relief recommendations for economic stimulus. The partial expensing provision will encourage business investment, stimulating economic activity in the short run and laying the foundation for stronger growth in the long run. The reductions in marginal income tax rates will help spur investment by providing incentives for flow-through entities, mainly small businesses, to grow and create jobs. The President's tax relief will also help foster a smooth and more predictable transition to a period of sustainable growth.

One factor that contributed to the onset of the current recession was a sharp rise in the energy prices. Another risk to the outlook is another such rise, especially as the United States is heavily reliant on imported oil to meet its energy needs. The Administration has made a comprehensive energy policy a priority, as indicated in the President's National Energy Policy.

The House energy bill addresses many of the legislative recommendations contained in the National Energy Policy and the President has called on the Senate to act as well. H.R. 4 creates opportunities and provides incentives to foster conservation, improve energy efficiency, increase domestic energy production, and expand the use of renewable energy sources. H.R. 4 represents an important step in ensuring the Nation's future energy security.

Finally, we must acknowledge that in the current security environment our economy remains at risk. The events of September 11 had a pronounced, disruptive impact on the path of the economy. Certainly, we are hopeful that the economy will not be subjected to such adverse events in the future. The Administration worked with Congress to suggest legislation to provide a backstop against catastrophic terrorism risk and continues to support passage of measures to help the private sector build capacity to provide such insurance.

The Long-Term Economic Outlook

The economic difficulties that began in 2000 and continued into 2001 and 2002 should not blind us to the fact that the outlook for the economy remains strongly positive. The Administration projects real GDP growth to average 3.1 percent a year during the 11 years through 2012. The growth rate of the economy over the long run is determined primarily by the growth rates of its supply-side components, which include population, labor force participation, productivity growth, and the workweek.

Productivity growth in the United States accelerated during the second half of the 1990s, and economists generally believe that much of that faster productivity growth is permanent. New technology deserves much of the credit -- but by no means all of it. Better, more efficient ways of doing business also contributed, and only a fraction of the many possible improvements have yet been made. Our economic challenge is, in large measure, to discover how to reap the benefits of the remainder.

The Administration expects non-farm labor productivity to grow at a 2.1 percent average pace over the projection period, the same as over the entire period since the previous business cycle peak in the third quarter of 1990. This projection is noticeably more conservative than the 2.6 percent average annual growth in actual productivity from 1995 to 2001.

The Long-Term Policy Agenda

The 1980s and 1990s witnessed a long boom (punctuated by a short recession) in which private sector technological advances and entrepreneurial innovation fueled productivity growth and increases in our standard of living. This strong productivity performance derives from advantages of our economic approach -- notably, the strength of our institutions and the flexibility of our business culture. Public policy was in many ways supportive, with tax cuts in the 1980s, deregulation, and a stable anti-inflationary monetary policy leading the way. With some exceptions, policy generally promoted economic growth in the private sector.

The 2002 Economic Report of the President focuses on those institutions and on that culture, and proposes strategies for improving them and putting them to use, to sustain our growth and broaden our prosperity. Institutions are a key issue. Productivity growth does not arrive from the heavens. New technologies, process innovations, and other aspects of private-sector productivity gains are the result of investment, effort, testing, and implementation. In Europe, commentators from both the OECD and the European Central Bank have noted the lack of acceleration in productivity growth comparable to that witnessed in the United States. Rigidities in labor and product markets, sometimes exacerbated by regulatory impediments, are often cited as culprits.

Put differently, the important economic outcome -- productivity growth -- hinges on the structure of economic incentives. It is now understood that the effective use of economic incentives hinges upon the institutions in which they are embedded. The Report is organized around the need to build strong institutions to support a flexible economy and rapid economic growth.

As an example, one of the President's priorities is the U.S.-led effort for more open global trade. The large contribution of reduced trade barriers to growth in our standard of living has long been recognized. In 2001, the United States exported over $1 trillion in goods and services -- or 10 percent of GDP.

The United States has the opportunity to reap significant gains from the future trade agreements. A recent study finds that a new World Trade Organization (WTO) round that lowers barriers to services and reduces tariffs by one-third on agricultural and industrial products would yield gains roughly equivalent to a $2,500 permanent increase in the annual income of the average family of four. An agreement on the Free Trade Area for the Americas that removes bilateral tariffs would increase GDP by about $53 billion, or about a $740 permanent increase in the annual income of a family of four.

These are important benefits for the average American household. Trade is sometimes portrayed as a threat to lower-income individuals. This is not the case. To take one example, in 1997 there was roughly $18 billion in tariffs, with nearly one-half on clothes and textiles. Who pays those tariffs? In a $10 trillion dollar economy, this might not seem like an important question -- after all, $9 billion in clothing tariffs is a trivial fraction of overall consumption spending. The reality is that -- measured as a fraction of their income -- tariffs paid by the lowest-income quintile were roughly three times that of the highest-income quintile.

Trade helps our domestic productivity. Expanding global trade allows the most efficient producers to grow because selling goods in the competitive international marketplace demands higher productivity. In fact, exporting plants have up to 20 percent higher productivity non-exporting plants.

Furthermore, many domestically produced goods are shipped abroad for further processing or assembly and then returned to the United States. In 1998, for example, the United States imported $27 billion of "production sharing" goods from Mexico, and these goods may be re-imported subject to lower duties. Not duty-free. Nearly 60 percent of the value of these imports derived from U.S.-made components -- roughly 16 percent of all U.S. imports from Mexico.

The benefits of free trade are substantial and investments in the institutions that support a global trading system are valuable. Indeed, an institutional commitment is a good way to overcome instances of shortsightedness. In developing countries, the advantages of international trade produce income for not only commercial consumption, but also access to better food, better health care, better education, and technologies that will help improve the environment. In a developed country, stiff import barriers on labor-intensive goods from developing countries such as clothing, leather, or agriculture not only harm consumers but reduces the income of people in developing countries as well.

A recent World Bank study identified developing countries as "globalizing" on the basis of the growth in trade related to GDP and their reduction in average tariff note. It found that, in the 1990s, the income per person in globalizing developing countries grew more than three-and-a-half times faster than it did in non-globalizing developing countries. In the six years following completion of the Uruguay Round, exports from developing nations grew by nearly $1 trillion, to a level of $2.4 trillion last year. The United States in particular has been an engine of export growth for developing nations. There has been an 82 percent increase in U.S. imports from developing countries (87 percent increase in chemical products and 72 percent increase in textiles) between 1994 and 2000.

Building on this success is important. One study indicates that new global trade negotiations would generate income gains for developing countries greater than recent flows of official assistance, and roughly comparable to total inflows of foreign direct investment. An IMF [International Monetary Fund]/World Bank study notes that eliminating all barriers to merchandise trade would yield static welfare gains of between $80 and $180 billion to developing countries. These numbers are well in excess of annual aid flows to these countries.

That there is tremendous value to multilateral agreements that institutionalize a commitment to free trade among countries is clear. Trade Promotion Authority (TPA) provides the President with negotiating flexibility and gives the United States additional credibility in the international community. It enhances our bargaining power in these negotiations. It also ensures that trade agreements will maintain a focus on trade, as intended by the negotiating parties. TPA sends a signal to other countries that U.S. is united in active engagement in trade negotiations that will benefit all participating countries. Obviously, Congress still has its final, rightful say on whether or not the United States signs any trade agreement.

International trade is one force behind the "creative destruction" -- the continual competitive pressure to innovate, improve, and outperform competitors -- that is central to our economy. Of course, for an individual worker, finding a new job in another firm or another industry may be difficult. The United States recognizes this possibility and has put programs in place to assist those who lose their jobs due to trade in finding a new position. Workers who are displaced from their jobs due to imports are given special assistance by the Federal government to smooth their transition to new jobs. For example, the Trade Adjustment Assistance (TAA) and NAFTA [North American Free Trade Area]-Transitional Adjustment Assistance (NAFTA-TAA) programs provide those misplaced workers with training, income support, and out-of-area job search aid, and relocation allowances; these benefits are in addition to unemployment insurance, employment-related services under the Workforce Investment Act, and other programs. The Administration is committed to reauthorizing and improving the existing TAA and NAFTA-TAA programs that expired last September and were continued through FY 2002 by the action of the appropriators. The Bush Administration has worked this year to improve the TAA programs so that they more effectively ease the transition into new employment.

Another example is the President's proposed Health Insurance Tax Credit. The tax credit proposal included in President Bush's budget for 2003 is a refundable income tax credit to cover the cost of health insurance purchased by individuals under age 65. It would provide a subsidy for a percentage of the health insurance premium, up to a maximum credit of $1,000 per adult and $500 per child. A two-parent family with two children would be eligible for a maximum credit of $3,000. The maximum subsidy percentage would be 90 percent for low-income taxpayers and would phase down with income. A broad-based policy of this type anticipates the insurance needs of workers -- dislocated or otherwise -- and permits labor market adjustments to be less impeded by health insurance considerations.

There is great value to institutions that meet the short-run needs of displaced workers and move them quickly toward productive activities. The events of the past year have illustrated -- in an extreme form -- the shocks to which our economy is subjected. The President's vision of economic security recognizes that many events impact the economy all the time. We should think comprehensively about these policies and focus our efforts on incentives for getting workers back to work, and quickly. Resources should be devoted flexibly to basic needs, job search for reemployment, and retraining, without creating an incentive for unnecessarily long spells between jobs, because benefits extended under the wrong conditions create a "tax" when a new job is taken and those benefits are lost.

Finally, getting the most out of the economy will require an emphasis on efficiency in government as well. If government spending grows without discipline, billions of dollars will be siphoned away from private sector innovation, taxes will rise, and growth will suffer. The President's Management Agenda seeks to shift the emphasis of government toward results, not process. It aims to replace the present Federal government hierarchy with a flatter, more responsive management structure and to establish a performance-based system.

[...]

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