[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]
OUTLOOK FOR THE STATE OF THE U.S. ECONOMY IN 1999
=======================================================================
HEARING
before the
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
FIRST SESSION
__________
JANUARY 20, 1999
__________
Serial 106-3
__________
Printed for the use of the Committee on Ways and Means
U.S. GOVERNMENT PRINTING OFFICE
57-275 CC WASHINGTON : 1999
------------------------------------------------------------------------------
For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 20402
COMMITTEE ON WAYS AND MEANS
BILL ARCHER, Texas, Chairman
PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
BILL THOMAS, California FORTNEY PETE STARK, California
E. CLAY SHAW, Jr., Florida ROBERT T. MATSUI, California
NANCY L. JOHNSON, Connecticut WILLIAM J. COYNE, Pennsylvania
AMO HOUGHTON, New York SANDER M. LEVIN, Michigan
WALLY HERGER, California BENJAMIN L. CARDIN, Maryland
JIM McCRERY, Louisiana JIM McDERMOTT, Washington
DAVE CAMP, Michigan GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. McNULTY, New York
JENNIFER DUNN, Washington WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio XAVIER BECERRA, California
PHILIP S. ENGLISH, Pennsylvania KAREN L. THURMAN, Florida
WES WATKINS, Oklahoma LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
A.L. Singleton, Chief of Staff
Janice Mays, Minority Chief Counsel
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C O N T E N T S
__________
Page
Advisory of January 12, 1999, announcing the hearing............. 2
WITNESS
Federal Reserve System, Alan Greenspan, Chairman, Board of
Governors...................................................... 6
SUBMISSION FOR THE RECORD
National Association of Manufacturers, statement................. 45
OUTLOOK FOR THE STATE OF THE U.S. ECONOMY IN 1999
----------
WEDNESDAY, JANUARY 20, 1999
House of Representatives,
Committee on Ways and Means,
Washington, DC.
The Committee met, pursuant to call, at 10 a.m., in room
1100, Longworth House Office Building, Hon. Bill Archer
(Chairman of the Committee) presiding.
[The advisory announcing the hearing follows:]
ADVISORY
FROM THE COMMITTEE ON WAYS AND MEANS
FOR IMMEDIATE RELEASE CONTACT: (202) 225-1721
January 12, 1999
No. FC-1
Archer Announces Hearing on
the Outlook for the
State of the U.S. Economy in 1999
Congressman Bill Archer (R-TX), Chairman of the Committee on Ways
and Means, todayannounced that the Committee will hold a hearing on the
Congressman Bill Archer (R-TX), Chairman of the Committee on Ways
and Means, today announced that the Committee will hold a hearing on
the outlook for the state of the U.S. economy in 1999. The hearing will
take place on Wednesday, January 20, 1999, in the main Committee
hearing room, 1100 Longworth House Office Building, beginning at 10:00
a.m.
In view of the limited time available to hear witnesses, oral
testimony at this hearing will be from invited witnesses only. The sole
witness at this hearing will be the Honorable Alan Greenspan, Chairman
of the Board of Governors of the Federal Reserve System. However, any
individual or organization not scheduled for an oral appearance may
submit a written statement for consideration by the Committee and for
inclusion in the printed record of the hearing.
BACKGROUND:
The U.S. economy is currently enjoying its best performance during
the post-war period, with a record-sustained period of full employment
and low inflation.
The 105th Congress passed bipartisan legislation, the Balanced
Budget Act of 1997 (P.L. 105-33) and the Taxpayer Relief Act of 1997
(P.L. 105-34), aimed at reducing the budget deficit and encouraging
economic growth. As a result of this bipartisan legislation and the
strong performance of the economy, the Federal Government ended fiscal
year 1998 with a record $76 billion surplus.
Among the challenges facing the 106th Congress are the approaching
insolvency of the Social Security system, a growing Federal tax burden,
and the Asian economic crisis. On January 19th, President Clinton is
scheduled to give his annual State of the Union address to the nation.
In announcing the hearing, Chairman Archer stated: ``The nation's
economy continues to be strong, in no small part, due to the bipartisan
policies recently passed by the Congress. I'm particularly delighted at
our success in turning the Federal budget deficit into a surplus. As
the Committee begins this year's efforts to save Social Security, cut
taxes, and promote further economic growth, the opinions of Chairman
Greenspan on the state of the economy and its future prospects will be
especially important. I look forward to hearing his views.''
FOCUS OF THE HEARING:
The Committee expects to receive testimony on the state of the
economy and the outlook for future economic performance from the
Honorable Alan Greenspan, Chairman of the Federal Reserve.
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Chairman Archer. The Committee will come to order. The
Chair would ask all of our guests to take seats.
Good morning and welcome to our first hearing of the year
with our special guest, Chairman of the Federal Reserve Board,
Alan Greenspan.
Mr. Chairman, you have not been before our Committee since
December 18, 1991. That is too long a period of time.
Mr. Greenspan. I observe the economy seems to have done
exceptionally well since.
Chairman Archer. But you have not been in absentia as this
economy has grown, and you have made an enormous contribution
to the growth of the economy and the reduction of inflation and
unemployment. But welcome back. We are honored to have you with
us today. I think you already know of my high regard for you as
well as my warm personal friendship with you. We look forward
to hearing your views on the economy.
I intend for this to be a very busy and productive year for
the Committee on Ways and Means. We look forward to advancing
an agenda to secure America's future, and it will be built
around four items: Strengthening Social Security, improving
education, providing tax relief, and rebuilding our national
defense. I would hope that we would be able to add a fifth
item, which is paying down the national debt.
This Congress has much to be proud of. The economy is
strong and hope is high. More Americans are working now than at
any time in the last 29 years. Welfare has turned into
workfare. The budget is in surplus and taxes have been cut. We
stabilized Medicare and, in a hallmark achievement of this
Committee, we protected the people from the IRS.
Last night the President announced his agenda for our
Nation and it is truly a busy agenda. It is full of new
spending programs. It promises tax increases and it calls for
direct government investment in stocks. Sadly, I did not hear
of any spending cuts.
The agenda will test our ability to maintain fiscal
discipline. Instead of using the surplus to pay down the debt
or provide growth-oriented tax cuts, the White House spends
every penny of the surplus on more government.
I believe we must maintain fiscal discipline, and that is
why I want to use the surplus to save Social Security, cut
taxes and pay down the debt. Cutting taxes can achieve two
goals. Tax cuts reduce wasteful spending and promote economic
growth. The less money people send here, the less money the
politicians in both parties will have to waste.
In addition to the tax cuts the House passed last year, I
hope we can enact growth-oriented tax cuts this year. It is
vital that America's economy remain the engine that helps pull
the rest of the world's economies. One look at Brazil and Asia
tells us how important growth is. We must maintain economic
growth, and cutting taxes appropriately can help get the job
done.
To his credit, Secretary Rubin asked the Japanese to cut
taxes to foster growth. In America, the Fed cut rates to
achieve growth. It is in that spirit that I seek to cut taxes.
Mr. Chairman, you have accomplished much in your career. In
a fragile economic time, your hand is steady, guiding our
Nation and shaping our economy. You are a man who puts
principles before politics and ideas before ambition. That
should be the hallmark for every Member of Congress. Again,
welcome here today.
Please tell us what you want us to hear. But before that, I
am going to recognize Mr. Rangel for any minority views that he
might like to make.
[The opening statement follows:]
Statement of Chairman Bill Archer, Representative in Congress from the
State of Texas
Good morning.
I'm pleased to welcome everyone to our first hearing of the
year, featuring Federal Reserve Chairman Alan Greenspan.
Mr. Chairman, you haven't been before our Committee since
December 18, 1991. Welcome back. We're honored to have you
here. You already know of my high regard for you and I look
forward to hearing your views on the economy.
I intend for this to be a very busy and productive year at
Ways and Means. I look forward to advancing an agenda to secure
America's future. Our Congressional agenda will be built around
four items:
Strengthening Social Security
Improving education
Providing Tax Relief and
Rebuilding our national defense.
This Congress has much to be proud of. The economy is
strong and hope is high. More Americans are working now than
any time in the last twenty-nine years. Welfare has turned into
workfare, the budget is in surplus, and taxes have been cut. We
stabilized Medicare and we protected people from the I.R.S.
Last night, the President announced his agenda for our
nation. It's a busy agenda. It's full of new spending programs.
It promises tax increases and it calls for direct government
investment in stocks. It contains no spending cuts.
This agenda will test our ability to maintain fiscal
discipline. Instead of using the surplus to pay down the debt
or provide growth-oriented tax cuts, the White House spends
every penny of the surplus on more government.
I believe we must maintain fiscal discipline and that's why
I want to use the surplus to save Social Security, cut taxes,
and pay down the debt.
Cutting taxes can achieve two goals. Tax cuts reduce
wasteful spending and they promote economic growth. The less
money people send here, the less money the politicians--in both
parties--will have to waste. In addition to the tax cuts the
House passed last year, I hope we can enact growth-oriented tax
cuts this year.
It's vital that America's economy remain the engine that
helps pull the rest of the world's economies. One look at
Brazil and Asia tells us how important growth is. We must
maintain economic growth and cutting taxes can help get the job
done.
To his credit, Secretary Rubin asked the Japanese to cut
taxes to foster growth. In America, the Fed cut rates to
achieve growth. It's in that spirit that I seek to cut taxes.
Mr. Greenspan, you have accomplished much in your career.
In a fragile economic time, your hand is steady, guiding our
nation and shaping our economy. You are a man who puts
principles before politics and ideas before ambition. Again,
welcome here today and say what you want us to hear.
Mr. Rangel. Thank you, Mr. Chairman. Let me join with you,
Chairman Archer, in welcoming Chairman Greenspan here and in
thanking you, not only for the Committee Members and the
Congress but for the American people, for the leadership that
you have demonstrated. We owe you so much for the healthy
condition of our economy.
I had really hoped when the Chairman started, that in
lauding you, it would have been the beginning of a new era of
bipartisanship. And certainly, if I was in the majority with a
five-member vote margin, I would have been much kinder to the
President than the Chairman appeared to be. But maybe that is
why you haven't been to this Committee that often, because you
have managed to stay far away from the partisanship that we
have in the House. In any event, no matter how much we may
differ on this Committee, we all agree that you have done a
wonderful job.
Mr. Chairman, while the President has not given us a Social
Security bill, he has responded to your request that you have a
framework for all of us, Democrats and Republicans, to work
with, not only for Social Security and Medicare, but also to
encourage savings by our low-income people and, of course, to
give incentives for education to make certain that most of our
citizens will become productive. Whether you want to give tax
cuts at the expense of Social Security is not an issue to
discuss at the moment.
Let us join together and welcome Chairman Greenspan for his
remarkable leadership. And you can depend that no matter what
our differences are, we will still come together to greet you
and to follow your leadership.
Thank you, Mr. Chairman.
Chairman Archer. Thank you, Mr. Rangel. The Chair accepts
your partisan comments.
[The opening statement of Mr. Ramstad follows:]
Statement of Hon. Jim Ramstad, a Representative in Congress from the
State of Minnesota
Mr. Chairman, thank you for inviting Chairman Greenspan to
address this committee on the state of the economy and the
economic outlook for 1999.
We are currently experiencing a nearly unprecedented
vibrant economy, with record-length peacetime economic
expansion, low unemployment, low inflation, low interest rates
and the welcome phenomenon of a budget surplus. A recent poll
indicated that 81% of Americans believe our nation is on the
right track.
Certainly, America's thriving businesses deserve much of
the credit for our current prosperity. But so does sound
monetary policy and the bipartisan legislation of the last
Congress that restrained spending and stimulated economic
growth through tax cuts.
Still, at a time when American families should be reaping
the benefits of economic prosperity, too much of their earnings
are being eaten by federal taxes. Federal tax revenues are
increasing at a rate of 8%--far above America's rate of
economic growth. And federal taxes as a percentage of GDP
exceed 20%--their highest level since World War II.
Because this committee may be making many decisions this
year that will have a lasting impact on our economy--including
tax policy, trade and social security reform--I am grateful we
will have the benefit of Chairman Greenspan's testimony today.
Thank you, Mr. Chairman.
Chairman Archer. Mr. Greenspan, you may proceed.
STATEMENT OF ALAN GREENSPAN, CHAIRMAN, BOARD OF GOVERNORS,
FEDERAL RESERVE SYSTEM
Mr. Greenspan. Thank you. First let me say I thank both of
you for your very kind remarks, and I take that as an
invitation to have me back somewhat more often, or maybe not
after you hear what I have to say today.
Members of the Committee, the American economy through
yearend continued to perform in an outstanding manner. Economic
growth remained solid and financial markets, after freezing up
temporarily following the Russian default, are again channeling
an ample flow of capital to businesses and households. Labor
markets have remained quite tight, but, to date, this has
failed to ignite the inflationary pressures that many had
feared.
To be sure, there is decided softness in a number of
manufacturing industries, as weakness in many foreign economies
has reduced demand for U.S. exports and intensified competition
from imports. Moreover, the underutilized production capacity
and pressure on the domestic profit margins, especially among
manufacturers, are likely to rein in the rapid growth of new
capital investment. With corporations already relying
increasingly on borrowing to finance capital investment, any
evidence of a marked slowing in corporate cash flow is likely
to induce a relatively prompt review of capital budgets.
The situation in Brazil and its potential for spilling over
to reduce demand in other emerging market economies also
constitutes a possible source of downside risk for demand in
the United States. So far, markets seem to have reacted
reasonably well to the decisions by the Brazilian authorities
to float their currency and redouble efforts at fiscal
discipline. But followthrough in reducing budget imbalances and
in containing the effects on inflation of the drop in value of
the currency will be needed to bolster confidence and to limit
the potential for contagion to the financial markets and
economies of Brazil's important trading partners, including the
United States.
While there are risks going forward, to date, domestic
demand and hence employment and output in the United States
certainly has remained vigorous. Though the pace of economic
expansion is widely expected to moderate as 1999 unfolds, signs
of an appreciable slowdown as yet remain scant.
But to assess the economic outlook properly, we need to
reach beyond the mere description of America's sparkling
economic performance of 8 years of record peacetime expansion
to seek a deeper understanding of the forces that have produced
it. I want to take a few moments this morning to discuss one
key element behind our current prosperity--the rise in the
value markets place on the capital assets of U.S. businesses.
Lower inflation, greater competitiveness, and the
flexibility and adaptability of our businesses have enabled
them to take advantage of a rapid pace of technological change
to make our capital stock more productive and profitable. I
will argue that the process of recognizing this greater value
has produced capital gains in equity markets that have lowered
the cost of investment in new plant and equipment and spurred
consumption. But, while asset values are very important to the
economy and so must be carefully monitored and assessed by the
Federal Reserve, they are not themselves a target of monetary
policy. We need to react to changes in financial markets, as we
did this fall, but our objective is the maximum sustainable
growth of the U.S. economy, not particular levels of asset
prices.
As I have testified before the Congress many times, I
believe, at root, the remarkable generation of capital gains of
recent years has resulted from the dramatic fall in inflation
expectations and associated risk premiums, and broad advances
in a wide variety of technologies that produced critical
synergies in the nineties.
Capital investment, especially in high-tech equipment, has
accelerated dramatically since 1993, presumably reflecting a
perception on the part of businesses that the application of
these emerging technological synergies would engender a
significant increase in rates of return on new investment.
Indeed, some calculations support that perception. They
suggest that the rate of return on capital facilities put in
place during recent years has in fact moved up markedly. In
part this may result from improved capital productivity, that
is, the efficiency of the capital stock. In addition, we may be
witnessing some payoffs from improved organizational and
managerial efficiencies of U.S. businesses and from the greater
education, in school and on the job, that U.S. workers have
acquired to keep pace with the new technology. All these
factors have been reflected in an acceleration of labor
productivity growth.
Parenthetically, improved productivity probably explains
why the American economy has done so well despite our oft-cited
subnormal national saving rate. The profitability of investment
here has attracted saving from abroad, an attraction that has
enabled us to finance a current account deficit while
maintaining a strong dollar. Clearly, we use both domestic
saving and imported financial capital in a highly efficient
manner, apparently more efficiently than many, if not most,
other major industrial countries.
While discussions of consumer spending often continue to
emphasize current income from labor and capital as the prime
source of funds, during the nineties, capital gains, which
reflect the valuation of expected future incomes, have taken on
a more prominent role in driving our economy.
The steep uptrend in asset values of recent years has had
important effects on virtually all areas of our economy, but
perhaps most significantly on household behavior. It can be
seen most clearly in the measured personal savings rate, which
has declined from almost 6 percent in 1992 to effectively zero
today.
Arguably, the average household does not perceive that its
saving has fallen off since 1992. In fact, the net worth of the
average household has increased by nearly 50 percent since the
end of 1992, well in excess of the gains of the previous 6
years. Households have been accumulating resources for
retirement or for a rainy day, despite very low measured saving
rates.
The resolution of this seeming dilemma illustrates the
growing role of rising asset values in support of personal
consumption expenditures in recent years. Economists have long
recognized a ``wealth effect,'' a tendency for consumption to
rise by a fraction of the capital gains on existing assets
owned by households, though the magnitude of this effect
remains difficult to estimate accurately.
We have some evidence from recent years that all or most of
the decline in the saving rate is accounted for by the upper
income quintile where the capital gains have disproportionately
accrued, which suggests that the wealth effect has been real
and significant. Thus, all else equal, a flattening of stock
prices would likely slow the growth of spending, and a decline
in equity values, especially a severe one, could lead to a
considerable weakening of consumer demand.
Some moderation in economic growth, however, might be
required to sustain the expansion. Through the end of 1998, the
economy continued to grow more rapidly than can be currently
accommodated on an ongoing basis, even with higher, technology-
driven, productivity growth. Growth has continued to shrink the
pool of workers willing to work but without jobs. While higher
productivity has helped to keep labor cost increases in check,
it cannot be expected to do so indefinitely in ever tighter
labor markets.
Despite brisk demand and improved productivity growth,
corporate profits have sagged over recent quarters. This is
attributable in part to some acceleration in labor
compensation, but other factors have been pressing, especially
intensified competition and lower prices facing our exporters
and those industries competing with imports.
In these circumstances, businesses will feel under
considerable pressure to preserve profit margins should labor
costs accelerate further, or should the falling prices of
commodity inputs, like oil, turn around. But to date,
businesses' evident pricing power has been scant. Either that
will change and inflation could begin to mount or, if costs
could not be recouped, capital outlays might well be cut back.
The recent behavior of profits also underlines the unusual
nature of the rebound in equity prices and the possibility that
the recent performance of the equity markets will have
difficulty in being sustained. The level of equity prices would
appear to envisage substantially greater growth of profits than
has been experienced of late.
Moreover, the impressive capital gains of recent years
would seem also to rest on a perception of relatively low risk
in corporate ownership. Risk aversion and uncertainty rose
sharply over the late summer and fall of 1998 following the
Russian default in mid-August, as evidenced by widening spreads
among yields on debt of differing credit qualities and
liquidity. The rise in uncertainty increased the discounting of
claims on future incomes, and that reduced stock market prices
even as the long-term earnings growth expectations of security
analysts continued to rise. As risk aversion subsided after
mid-October, stock prices returned to record levels.
Markets have doubtless stabilized significantly after the
turbulence of last fall, but they remain fragile, as the
repercussions of the recent Brazilian devaluation attest.
Moreover, our chronic current account deficit has widened
significantly, in part reflecting the strength of domestic
demand that has accompanied the further accumulation of capital
gains. The continued increase in our net external debt and its
growing servicing costs clearly are not sustainable
indefinitely.
In light of the importance of financial markets in the
economy, and of the volatility and vulnerability in financial
asset prices more generally, policymakers must continue to pay
particular attention to these markets. The Federal Reserve's
easing last fall responded to an abrupt stringency in financial
markets and the effects that the consequent increased risk
aversion was likely to have on economic activity going forward.
We were particularly concerned about higher costs and
disrupted financing in debt markets, where much of consumption
and investment is funded. We were not attempting to prop up
equity prices, nor did we plan to continue to ease rates until
equity prices recovered, as some have erroneously inferred.
This has not been, and is not now, our policy or intent. As
I have discussed earlier, movements in equity prices can play
an important role in the economy which the central bank must
take into account. And, we may question from time to time
whether asset prices may not embody a more optimistic outlook
than seems reasonable, or what the consequences might be of a
further rise in those prices followed by a steep decline. But
many other forces also drive our economy, and it is the
performance of the entire economy that forms our objectives and
shapes our actions.
Nonetheless, in the current state of financial markets,
policymakers are going to have to be particularly wary of
actions that unnecessarily sow uncertainties, undermine
confidence, and interfere with the efficient allocation of
capital on which our economic prosperity and asset values rest.
It is important not to undermine the highly sensitive ongoing
process of reallocation of capital from less to more productive
uses.
For productivity and standards of living to grow, not only
must capital raised in markets be allocated efficiently, but
internal cash flow, including the depreciation charges from the
existing capital stock, must be continuously directed to their
most profitable uses. It is this continuous churning, this so-
called creative destruction, that has become so essential to
the effective deployment of advanced technologies by this
country over recent decades. In this regard, drift toward
protectionist trade policies, which are always so difficult to
reverse, is a much greater threat than is generally understood.
It is well known that erecting barriers to the free flow of
goods and services across national borders undermines the
division of labor and standards of living by impeding the
adjustment of the capital stock to its most productive uses.
Not so well understood, in my judgment, is the impact that fear
of growing protectionism would have on profit expectations and
hence on the current values of capital assets. Protectionism
was a threat to standards of living when capital asset values
were low relative to income. It becomes particularly pernicious
in an environment, such as today's, when that is no longer the
case.
In sum, Mr. Chairman, it has been the ability of our
flexible and innovative businesses and work force that has
enabled the United States to take full advantage of emerging
technologies to produce greater growth and higher asset values.
Policy has facilitated this process by containing inflation and
by promoting competitiveness through deregulation and an open
global trading system. Our task going forward, at the Federal
Reserve as well as in the Congress and administration, is to
sustain and strengthen these policies, which in turn have
sustained and strengthened our now record peacetime economic
expansion.
Mr. Chairman, I have excerpted from my full text and would
ask that the text be included in the record.
[The prepared statement follows:]
Statement of Hon. Alan Greenspan, Chairman, Board of Governors, Federal
Reserve System
The American economy through year-end continued to perform
in an outstanding manner. Economic growth remained solid, and
financial markets, after freezing up temporarily following the
Russian default, are again channeling an ample flow of capital
to businesses and households. Labor markets have remained quite
tight, but, to date, this has failed to ignite the inflationary
pressures that many had feared.
To be sure, there is decided softness in a number of
manufacturing industries as weakness in many foreign economies
has reduced demand for U.S. exports and intensified competition
from imports. Moreover, underutilized production capacity and
pressure on domestic profit margins, especially among
manufacturers, are likely to rein in the rapid growth of new
capital investment. With corporations already relying
increasingly on borrowing to finance capital investment, any
evidence of a marked slowing in corporate cash flow is likely
to induce a relatively prompt review of capital budgets.
The situation in Brazil and its potential for spilling over
to reduce demand in other emerging market economies also
constitute a possible source of downside risk for demand in the
United States. So far, markets seem to have reacted reasonably
well to the decisions by the Brazilian authorities to float
their currency and redouble efforts at fiscal discipline. But
follow through in reducing budget imbalances and in containing
the effects on inflation of the drop in value of the currency
will be needed to bolster confidence and to limit the potential
for contagion to the financial markets and economies of
Brazil's important trading partners, including the United
States.
While there are risks going forward, to date domestic
demand and hence employment and output in the United States
certainly has remained vigorous. Though the pace of economic
expansion is widely expected to moderate as 1999 unfolds, signs
of an appreciable slowdown as yet remain scant.
But to assess the economic outlook properly, we need to
reach beyond the mere description of America's sparkling
economic performance of eight years of record peacetime
expansion to seek a deeper understanding of the forces that
have produced it. I want to take a few moments this morning to
discuss one key element behind our current prosperity--the rise
in the value markets place on the capital assets of U.S.
businesses. Lower inflation, greater competitiveness, and the
flexibility and adaptability of our businesses have enabled
them to take advantage of a rapid pace of technological change
to make our capital stock more productive and profitable. I
will argue that the process of recognizing this greater value
has produced capital gains in equity markets that have lowered
the cost of investment in new plant and equipment and spurred
consumption. But, while asset values are very important to the
economy and so must be carefully monitored and assessed by the
Federal Reserve, they are not themselves a target of monetary
policy. We need to react to changes in financial markets, as we
did this fall, but our objective is the maximum sustainable
growth of the U.S. economy, not particular levels of asset
prices.
As I have testified before the Congress many times, I
believe, at root, the remarkable generation of capital gains of
recent years has resulted from the dramatic fall in inflation
expectations and associated risk premiums, and broad advances
in a wide variety of technologies that produced critical
synergies in the 1990s.
Capital investment, especially in high-tech equipment, has
accelerated dramatically since 1993, presumably reflecting a
perception on the part of businesses that the application of
these emerging technological synergies would engender a
significant increase in rates of return on new investment.
Indeed, some calculations support that perception. They
suggest that the rate of return on capital facilities put in
place during recent years has, in fact, moved up markedly. In
part this may result from improved capital productivity--that
is, the efficiency of the capital stock. In addition, we may be
witnessing some payoffs from improved organizational and
managerial efficiencies of U.S. businesses and from the greater
education--in school and on the job--that U.S. workers have
acquired to keep pace with the new technology. All these
factors have been reflected in an acceleration of labor
productivity growth.
Parenthetically, improved productivity probably explains
why the American economy has done so well despite our oft-cited
subnormal national saving rate. The profitability of investment
here has attracted saving from abroad, an attraction that has
enabled us to finance a current account deficit while
maintaining a strong dollar. Clearly, we use both domestic
saving and imported financial capital in a highly efficient
manner, apparently more efficiently than many, if not most,
other major industrial countries.
While discussions of consumer spending often continue to
emphasize current income from labor and capital as the prime
sources of funds, during the 1990s, capital gains, which
reflect the valuation of expected future incomes, have taken on
a more prominent role in driving our economy.
The steep uptrend in asset values of recent years has had
important effects on virtually all areas of our economy, but
perhaps most significantly on household behavior. It can be
seen most clearly in the measured personal saving rate, which
has declined from almost six percent in 1992 to effectively
zero today.
Arguably, the average household does not perceive that its
saving has fallen off since 1992. In fact, the net worth of the
average household has increased by nearly 50 percent since the
end of 1992, well in excess of the gains of the previous six
years. Households have been accumulating resources for
retirement or for a rainy day, despite very low measured saving
rates.
The resolution of this seeming dilemma illustrates the
growing role of rising asset values in supporting personal
consumption expenditures in recent years. It also illustrates
the importance when interpreting our official statistics of
taking account of how they deal with changes in asset values.
With regard first to the statistical issues, capital gains
themselves are not counted as income, but some transactions
resulting from capital gains reduce disposable household income
as we measure it, while having no effect on consumption. As a
consequence, as capital gains and these associated transactions
mount, published saving rates are decreased. For example,
reported personal income is reduced when corporations cut back
payments into defined-benefit pension plans owing to higher
equity prices; however, such reductions do not diminish
anticipated retirement income and thus should not lower
consumption. And reported disposable income is decreased when
households pay taxes on capital gains realizations that would
not have been so large in less ebullient markets. However,
capital gains tax payments also are highly unlikely to be
associated with lower spending because the cash realized from
the sale of the asset exceeds the tax, and in most cases the
typical household presumably does not perceive of this
transaction as reducing available income or financial
resources. Together these two effects probably account for an
appreciable portion of the reduction in the reported saving
rate.
But beyond these statistical issues, there is little doubt
that capital gains have increased consumption relative to
income from current production over recent years. Economists
have long recognized a ``wealth effect''--a tendency for
consumption to rise by a fraction of the capital gains on
existing assets owned by households--though the magnitude of
this effect remains difficult to estimate accurately. We have
some evidence from recent years that all or most of the decline
in the saving rate is accounted for by the upper income
quintile where the capital gains have disproportionately
accrued, which suggests that the wealth effect has been real
and significant. Thus, all else equal, a flattening of stock
prices would likely slow the growth of spending, and a decline
in equity values, especially a severe one, could lead to a
considerable weakening of consumer demand.
Some moderation in economic growth, however, might be
required to sustain the expansion. Through the end of 1998, the
economy continued to grow more rapidly than can be currently
accommodated on an ongoing basis, even with higher, technology-
driven productivity growth. Growth has continued to shrink the
pool of workers willing to work but without jobs. While higher
productivity has helped to keep labor cost increases in check,
it cannot be expected to do so indefinitely in ever tighter
labor markets.
Despite brisk demand and improved productivity growth,
corporate profits have sagged over recent quarters. This is
attributable in part to some acceleration in labor
compensation, but other factors have also been pressing,
especially intensified competition and lower prices facing our
exporters and those industries competing with imports. In these
circumstances, businesses will feel under considerable pressure
to preserve profit margins should labor costs accelerate
further, or should the falling prices of commodity inputs, like
oil, turn around. But, to date, businesses' evident pricing
power has been scant. Either that would change and inflation
could begin to mount or, if costs could not be recouped,
capital outlays might well be cut back.
The recent behavior of profits also underlines the unusual
nature of the rebound in equity prices and the possibility that
the recent performance of the equity markets will have
difficulty in being sustained. The level of equity prices would
appear to envision substantially greater growth of profits than
has been experienced of late.
Moreover, the impressive capital gains of recent years
would seem also to rest on a perception of relatively low risk
in corporate ownership. Risk aversion and uncertainty rose
sharply over the late summer and fall of 1998 following the
Russian default in mid-August, as evidenced by widening spreads
among yields on debt of differing credit qualities and
liquidity. The rise in uncertainty increased the discounting of
claims on future incomes, and that reduced stock market prices
even as the long-term earnings growth expectations of security
analysts continued to rise. As risk aversion subsided after
mid-October, stock prices returned to record levels.
Markets have doubtless stabilized significantly after the
turbulence of last fall but they remain fragile, as the
repercussions of the recent Brazilian devaluation attest.
Moreover, our chronic current account deficit has widened
significantly, in part reflecting the strength of domestic
demand that has accompanied the further accumulation of capital
gains. The continued increase in our net external debt and its
growing servicing costs clearly are not sustainable
indefinitely.
In light of the importance of financial markets in the
economy, and of the volatility and vulnerability in financial
asset prices more generally, policymakers must continue to pay
particular attention to these markets. The Federal Reserve's
easing last fall responded to an abrupt stringency in financial
markets and the effects that the consequent increased risk
aversion was likely to have on economic activity going forward.
We were particularly concerned about higher costs and disrupted
financing in debt markets, where much of consumption and
investment is funded. We were not attempting to prop up equity
prices, nor did we plan to continue to ease rates until equity
prices recovered, as some have erroneously inferred.
This has not been, and is not now, our policy or intent. As
I have discussed earlier, movements in equity prices can play
an important role in the economy, which the central bank must
take into account. And, we may question from time to time
whether asset prices may not embody a more optimistic outlook
than seems reasonable, or what the consequences might be of a
further rise in those prices followed by a steep decline. But
many other forces also drive our economy, and it is the
performance of the entire economy that forms our objectives and
shapes our actions.
Nonetheless, in the current state of financial markets,
policymakers are going to have to be particularly wary of
actions that unnecessarily sow uncertainties, undermine
confidence, and interfere with the efficient allocation of
capital on which our economic prosperity and asset values rest.
It is important not to undermine the highly sensitive ongoing
process of reallocation of capital from less to more productive
uses. For productivity and standards of living to grow, not
only must capital raised in markets be allocated efficiently,
but internal cash flow, including the depreciation charges from
the existing capital stock, must be continuously directed to
their most profitable uses. It is this continuous churning,
this so-called creative destruction, that has become so
essential to the effective deployment of advanced technologies
by this country over recent decades. In this regard, drift
toward protectionist trade policies, which are always so
difficult to reverse, is a much greater threat than is
generally understood.
It is well known that erecting barriers to the free flow of
goods and services across national borders undermines the
division of labor and standards of living by impeding the
adjustment of the capital stock to its most productive uses.
Not so well understood, in my judgment, is the impact that fear
of growing protectionism would have on profit expectations, and
hence on the current values of capital assets. Protectionism
was a threat to standards of living when capital asset values
were low relative to income. It becomes particularly pernicious
in a environment, such as today's, when that is no longer the
case.
In sum, it has been the ability of our flexible and
innovative businesses and work force that has enabled the
United States to take full advantage of emerging technologies
to produce greater growth and higher asset values. Policy has
facilitated this process by containing inflation and by
promoting competitiveness through deregulation and an open
global trading system. Our task going forward--at the Federal
Reserve as well as in the Congress and Administration--is to
sustain and strengthen these policies, which in turn have
sustained and strengthened our now record peacetime economic
expansion.
Chairman Archer. Without objection, the Chairman's entire
statement will be printed in the record.
I think you have given us a lot to think about. Certainly a
very, I think, solid analysis of where we are, and perhaps a
few little guidelines in nuance form as to where we might go or
what we might do.
I would like to ask your opinion of a major part of the
President's proposal for Social Security last night, where he
proposed letting the government invest the Social Security
Trust Fund surplus in private financial markets. You testified,
I believe, last July before the Senate Committee on Banking and
Financial Services and were asked about such a proposal in
generalities. I believe you said that you thought that would be
very dangerous, and added, ``I don't know any way you can
essentially insulate government decisionmakers from having
access to what will amount to very large investments in
American private industry.''
And so my question to you today is whether you still feel
the way you did when you testified before the Senate Committee
on Banking and Financial Services as to the wisdom of
government-controlled investments in the market?
Mr. Greenspan. Mr. Chairman, let me just say first that the
notion that the President brought forth last night to
effectively keep a very large part of the unified surplus in
place in the years ahead is something which I have supported in
the past. What I do not support and did not support previously
was the investment of government funds, especially Social
Security Trust Funds, in private securities, especially
equities.
There are really two reasons for that. One is that despite
the Herculean efforts of a number of very thoughtful people to
try to find ways to insulate the use of those Trust Funds,
which would be extraordinarily large--in the trillions of
dollars--the ability to insulate that, in my judgment, is
virtually impossible.
The political process of which we are all aware, and I
would certainly expect that those on the panel know far more
about this than I, makes it very difficult not to try to create
some form of direction in the way those funds are invested.
Indeed, our experience with State and local pension funds very
graphically exhibits that.
Indeed numerous studies over the years have shown that the
average rate of return on State and local funds is usually 2,
maybe 3 percentage points lower on average than private pension
funds of comparable nature. There are also studies which
suggest that the greater the proportion of trustees who are
political appointees on those pension funds, the lower the rate
of return. And indeed, I don't think it is very difficult to go
through example after example of the endeavors on the part of
the political system to employ those funds in ways which are
other than what the private market itself will adjust to.
The reason this is important is in fact a reason similar to
what I was discussing with respect to the allocation of capital
generally. Our extraordinary performance in this country, our
ability to adapt to the new technologies in such an effective
way, has enabled us to use our capital in an extraordinarily
efficient manner, and that flows through directly into higher
productivity, higher real wages, and a higher standard of
living.
If we are going to take a very substantial part of our
savings, and that is what would occur if a substantial part of
Social Security Trust Fund was employed in that manner, in my
judgment we will lower the capital efficiency of this country.
We will lower the thrust of productivity growth and standards
of living. So it is not a mere financial accounting issue. It
gets down to real goods and services and real standards of
living.
Because I do not believe that it is politically feasible to
insulate such huge funds from governmental direction, I am
fearful that we will use those assets in a way which, one, will
create a lower rate of return for Social Security recipients;
but of even greater concern, that it will create suboptimal use
of our capital resources and those assets which create our
standard of living.
Now, to be sure, the President's recommendation is only a
small part of Social Security. Had he eliminated the particular
private investment characteristic of that program, I would have
found what he said with respect to Social Security last night
quite important and, in a sense, a definite factor in improving
the underlying savings rate in this country, which because of
the demographic changes that are occurring, is going to be
required if we are to get an overall retirement system, both
public and private, functioning in a manner which we have been
accustomed to.
Chairman Archer. I thank you for that comment. I must say
that I don't think any of us fully understands the technical
details of the President's proposal yet.
Mr. Greenspan. Actually, he did not give any. What he
basically stipulated, which was, in my judgment something
important, is essentially that rather than allow the surpluses
to be dissipated, they are going to be employed of necessity,
because that is what will happen if you run a significant
unified budget surplus, to reduce the debt to the public. And I
am one of those who believes that if we are looking at the
long-term stability of capital investment and productivity in
this country, if we can significantly reduce the outstanding
debt and indeed, in the current environment, create unified
budget surpluses, in my judgment that is all to the good.
I do not believe the President said that the surpluses are
going to be used to increase benefit payments or anything else
of that nature, although he did refer obviously to the use of
the non-Social Security part of it. But it is important to
distinguish between allowing these surpluses to run and observe
their impact on the borrowing from the public, which I think
will be very important and positive, and realize that that is
an important aspect of trying to increase the national savings
rate, which is important.
And I don't want to comment on other aspects of the
President's program, but I think we ought to recognize that
what this is is not a detailed Social Security program. What it
is is a statement that the Social Security system, whether it
is privatized or not, ought to move far closer to full funding,
because pay-as-you-go Social Security, because of the
demographic changes that are in the process of emerging, is not
something which can continue to function in the years ahead as
it has done so well in the past.
Chairman Archer. Well, I certainly agree with that.
Let me state that my position relative to a Social Security
solution is that I will oppose government-managed investment in
the private sector, for the very reasons that you mentioned and
others, although you articulate it probably better than I do.
But I will welcome any suggestions that the President might
have relative to the establishment of personal security
accounts that will create advanced savings to reduce the drain
on the Social Security fund in the outyears. There is a very
big difference, in my opinion, between giving individual
workers the power to invest their money and having the
government control investments.
Let me ask you this question, just as a followup. If in
fact we take money out of the Social Security fund, and we
don't know yet what percentage the President is going to
recommend, and we invest it in the private sector, will we not
then be investing in--will we not then fail to invest in
government bonds, which means that that debt will have to be
owned by the public or the private sector rather than within-
house? So we don't change the amount of debt that the Federal
Government has as an obligation, do we?
Mr. Greenspan. Mr. Chairman, maybe the best way to explain
this is to start with the presumption that there is no
investment in private securities, and all that is done is allow
the unified budget surplus to spill over into the Social
Security Trust Fund. That is a bookkeeping, intragovernmental
bookkeeping, transaction which has no effect on borrowing from
the public, no effect on national savings, and no effect on
government savings.
If, however, you use part of those funds to invest in
private securities, in effect you are borrowing from the public
and investing those funds in private securities. The effect of
that is clearly to increase the total debt to the public, but
it is offset, presumably dollar for dollar, with new assets
that the government has accumulated. So in one sense it doesn't
affect the savings rate overall, but it does affect the
relationship between private and public savings. But you are
quite right, it does require that the debt to the public be
higher than it would otherwise be, because of the way our
system is set up.
Chairman Archer. Well, I learned in 1982, along with you, a
lot about Social Security when we served together on the
Commission President Reagan created. Based on your overall
expertise, as well as your knowledge of Social Security, do you
have a preferred approach as to how we should attempt to solve
the Social Security problem?
Mr. Greenspan. Well, Mr. Chairman, I have always been
strongly in favor of a private approach. And the reason I have
been is not because of the increased rates of return on private
securities, which unless you increase the national savings rate
when you do that, is a zero sum game. It merely reduces the
rate of return in private pension funds. The reason I favor
private funds is that I believe we have a far greater chance of
creating full funding and hence higher savings rates through
that vehicle than we would through the political system, which
I regret exhibits a far higher propensity to spend than to
save.
Chairman Archer. Given a choice between spending the
surplus on more government programs and using it to provide
growth-oriented tax cuts, would you have a preference?
Mr. Greenspan. Well, as I have said previously, my first
preference is to allow the surpluses to run for a while and
unwind a good deal of the debt to the public which we have
accumulated over the years. Failing that, meaning if my
concerns about the propensity to spend are more real than not,
I would clearly prefer that if we can't run the surpluses, if
we have to get rid of the surpluses, I would far prefer
reducing taxes than increasing spending. And, indeed, I don't
think it is a close call.
Chairman Archer. Thank you very much.
Mr. Rangel?
Mr. Rangel. Thank you, Mr. Chairman.
We are fortunate that the President was not arrogant enough
to give us a bill with details. He recognizes that that
responsibility is in the hands of the Congress, and he did what
many of us demanded. He gave a framework for us to review and,
in a bipartisan way, which I think he stressed last night, to
come together with some type of plan that is not a Republican
plan nor a Democratic plan, but one that responds to the aging
of the baby boomers and longer life expectancy.
You advocate, if we cannot reduce the public debt, that
rather than spending more, that we have a tax cut. And there is
a lot of talk, especially last night, about a $600 billion tax
cut that may be recommended to this Committee.
Given the option of taking the surplus for a tax cut, or
following the suggestion that we better prepare the Social
Security system for its future obligation to the growing aging
population, as well as Medicare, what is your recommendation:
follow the framework of the President, to shore up the Social
Security system and the Medicare system with the surplus, or
move now toward a $600 billion tax cut?
Mr. Greenspan. Well, Congressman, as I said before, I
prefer letting the surpluses run. And the reason I do is that
we have been used to a really quite highly supported pay-as-
you-go Social Security system and indeed, a Medicare system.
And the reason that the popularity has been really quite
impressive is that until very recently the rates of return to
individual recipients, meaning the amounts of money that they
received as benefits, far exceeded the amount of taxes plus
interest they and their employers put in.
As the ratio of workers to retirees decreases, in part
because of increased longevity, the ability to continue that
process is rapidly diminishing, short of a very large increase
in immigration which would offset the retiree-worker ratio.
But if that is not forthcoming, then instead of retirees
effectively getting a reallocation of physical resources from
current workers, they will have to be able to put in place
investments which will return the real resources that they need
for retirement because they will not be available from workers
in the outyears. There will be just too few of them.
So the only way you can do that, short of an immigration
bulge, is to find a way to get increased productiveness in the
economy. And the way that we know which is most assuredly going
to do that is increased savings effectively invested in real
capital-productive assets which will produce the goods and
services that the retiree will need in, say, the year 2010,
2030, or thereafter.
So as far as I can see, if one is looking at the long-term
focus of the American economy, we do not have any choice but to
find a means to replace the pay-as-you-go system, because
demographics are immutable and effectively irreversible. And
what that tells us is that we cannot go on the way we are. The
arithmetic becomes impossible sooner rather than later.
And I might add, that is the reason why our younger
generations are turned off on Social Security, because what
they see, correctly, is that the rate of return that they will
achieve on their payments of taxes and their employers' taxes
is very low, especially compared to what you could now get even
in a U.S. Treasury bond. That compares with what their parents
were able to get, which was really a quite impressive above-
market rate of return.
We have to focus on that phenomenon. We have to adjust to
it. The fact that we are looking at 10, 20 years out does not
mean we can delay, because it is none too soon to start to take
action. And, therefore, to keep the savings in place as is
being recommended, is the right decision.
Mr. Rangel. I can see us thinking that way if we had your
leadership and that of President Clinton. But in some of our
past economic experiences, the market really hasn't responded
as positively as recently. What type of guarantees could the
individual beneficiary have that the market will be there for
them when they retire?
Mr. Greenspan. Well, I am not referring so much to the
question of whether the market is there. I am talking about the
amount of saving that has to be put in place in order to
achieve the capital investment. What I am basically saying is,
at the current rate of saving and the current expected benefit
payments which are embodied in the Social Security legislation,
that we will rapidly run into a dilemma where there will be
inadequate resources to meet the benefits.
Indeed, that is part of the so-called 2.2 percent gap in
the Social Security system that currently exists, or 3.6
percent on a fully, more than 75-year basis. And it is that
problem which has got to be addressed sooner rather than later,
and it has got very little to do with whether the funds are
invested in equities, bonds, government bonds or anything else.
Mr. Rangel. Well, the President certainly has given us
something to work with, that we have been asking for in a
bipartisan way. But the bottom line is that you would rather
see the surplus used to reduce our debt, rather than to do the
political thing, and that is rush now into a gigantic tax cut.
Mr. Greenspan. I don't know whether it is political. I am
just telling you what the economics are. The economics, as best
I can judge, are best served by moving as quickly as we can to
much closer to full funding for our retirement systems. We
obviously have it, by definition, in the private sector. We
need to now move in that direction in the public sector,
because the demographics are making any alternative impossible.
Mr. Rangel. Thank you.
Chairman Archer. Mr. Crane.
Mr. Crane. Thank you, Mr. Chairman.
Chairman Greenspan, we are honored with your presence here
today. I have been a longtime admirer from the beginning of my
acquaintance with you. I am in awe that you can sit here before
us and articulate responses when even a casual comment from you
can have international repercussions, so we appreciate
profoundly your willingness to do this. I think if I were in
your shoes, I would put it all in writing and insist that that
is the only way I will respond.
Mr. Greenspan. I am willing to do that.
Mr. Crane. I would like to shift gears just a little bit
and ask you about something that is also a major component of
our economy and our worldwide economics. I am referring to
trade. I am wondering if you could give us an estimate of what
portion of the annual growth of our economy do you attribute to
international trade?
Mr. Greenspan. While it is just a straight statistic where
we can try to make judgments as to what the division of labor
across the world does to overall standards of living, it is
very difficult to put a specific number on it. What we do know
with a reasonable degree of certainty is that the dramatic
increase in trade worldwide since the end of World War II,
which has been far faster than domestic gross product
increases, has been instrumental in rising standards of living
everywhere.
I think it has been a major factor in the United States,
where the open markets have for many, many decades been a major
source of business for our exporters, and the imports that
press in on us have done two things: First, have given us goods
and services at much lower prices than we would otherwise have
gotten them, which is the nature of the division of labor; but
second, it has also pushed us to a competitive edge which I
don't recall seeing in my long career as an economist, and our
ability to compete is really impressive.
Like all of us who are involved in business over the years,
we don't particularly like competition. I did not like my
competitors particularly when I was in the private sector. But
I must admit to you that their pressing on me made me do things
a lot better and a lot more efficiently. I worked harder and I
think I turned out a better product.
That probably is a pretty good description of what this
country has become, and I must say to you, it is really
something which is impressive in very many ways. The opening up
of trade around the world has, in my judgment, been a very
important factor in contributing to that impressive
performance.
Mr. Crane. Would you concur, then, that the renewal of the
President's fast track negotiating authority is absolutely
essential to advancing into the future a healthy economy here
at home, but that it has positive consequences worldwide?
Mr. Greenspan. I can't comment on whether it is essential,
but it is very important. And that one should support it, I
have no question whatever. It is all to our advantage to do
that.
Mr. Crane. One other question, since the light is turning
yellow already. I think that with the problems that Brazil has
most recently experienced, that there are potential parallels
to what Mexico went through right after we launched NAFTA. I
mean within 6 months of their peso devaluation, as you recall,
they had turned that around in Mexico. And I would argue that a
big part of that was having that trade relationship with the
United States and the prohibition against putting the tariff
walls up around their country as a response.
I am wondering if you see parallels between that experience
in Brazil, or what do you anticipate might happen down in South
America?
Mr. Greenspan. Each situation is different. The Brazilian
problem is largely a fiscal problem. The Brazilian private
economy is a very impressive entity. They have really built up
a productive structure and a very sophisticated financial
system, but as a consequence of 20 years of military
authoritarian rule, they have produced a constitution in 1988
which effectively, in most people's judgment, probably swung
the pendulum too much in the other direction, and created
innumerable benefits embodied in the constitution which
doubtless exceeded the underlying productive capacity of the
system to produce.
Ever since then there has been a major endeavor to unwind
those excesses, and indeed they are still working on it, and
there is an important one that is to be debated and, I believe,
voted upon in the Brazil legislature today. So that it is an
ongoing process, but it is terribly obvious that there are
fiscal problems, largely the very large payrolls in their state
governments and a pension fund system, which is what they are
voting on today, as well as what turns out to be a very short
average maturity of their government debt, which means that
marked increases in short-term interest rates flow through to
very large increases in interest payments, and that has created
a vicious cycle.
They are clearly coming to grips with that issue. It has
been very difficult. It has been tough, and it certainly has
not been helped by the international financial system, which
has run into trouble in the last couple of years, so that the
Brazilians are fighting not only their own problems but they
have to do it in the context in which the external environment
is less beneficent than it was a couple of years ago.
Mr. Crane. My time has expired. Again, I thank you for
sharing so generously your time with the Committee.
Chairman Archer. Mr. Thomas.
Mr. Thomas. Thank you, Mr. Chairman.
Thank you for being with us, Chairman Greenspan.
I have never heard it quite put that way, but it is exactly
the situation where you talk about current and especially past
retirees getting a return on their investment greater than
market return, and part of the problem is we don't have as many
people paying in, more people taking money out.
I also agree with your response to the Chairman in regard
to the Social Security portion of the President's speech last
night because of the unified budget and where the money would
be transferred.
My focus for the very short time I have would be on
Medicare. As a cochairman of the Medicare Commission we had the
pleasure of your presence on April 20, 1998, and it
corresponded almost exactly to the comments that you made today
about the concerns that you are worried about, one, the
interference with the efficient allocation of capital and that
it is important not to undermine the ongoing process of the
reallocation of capital from less to more productive uses. Your
thrust was in commenting about the current Medicare system and
that perhaps the incentive structure is not there to do the
kinds of productive things that we need to do and that we need
to look at structural change.
My concern would be that the President's speech, as opposed
to Social Security, was very specific on Medicare taking
general revenue sources and proposing to expand benefits--not
just try to control the current structure which is going
bankrupt but to expand benefits through the addition of the
prescription drug argument out of the general fund, increasing
the portion of the general fund that goes to Medicare without
any of the structural reforms that perhaps would make it a more
competitive model, moving from administered prices to more
competition.
Do you have some concerns that if the money from the
surplus was spent for the Medicare purposes the President
outlined that it would not be nearly so conducive as the Social
Security portion because we really need to revise structurally
Medicare to make it more efficient at the same time that we
make sure that money is there for future beneficiaries?
Mr. Greenspan. The Medicare issue is a far more complex one
than Social Security is. As difficult as we think Social
Security is, Medicare is a multiple of complexities. Indeed, as
Chairman Archer probably remembers, in the 1982 Social Security
Commission we were given the mandate of looking at Medicare if
we wanted to, and I thought we disposed of that one as quickly
as anything ever has been done. And the reason is it is very
tough.
As you remember, the discussion in the Medicare Commission
the issue of technology is a terribly crucial one, and it is
very difficult to forecast technology. And if you can't
forecast technology, it is very difficult to forecast what the
actual real dollar burden of the Medicare system is going to
be.
So I agree with you in the sense that if you are going to
spend funds out of the surplus, you reduce the flexibility of
the overall governmental system, if I can put it that way, to
address unforeseen Medicare expenses and requirements.
Mr. Thomas. Do you think that perhaps what we need to do is
to examine ways in which we can create a self-corrective
mechanism within Medicare to deal with market forces? And
certainly, as prices go up, at least you have the comfort that
it is a less political administered structure than it is a
response to the real needs of the health care marketplace and
then it would be a policy decision for us to make as to whether
we want to put assets into it at the rate that it would
require.
Mr. Greenspan. I would agree with that.
Mr. Thomas. Thank you very much.
Chairman Archer. Mr. Stark.
Mr. Stark. Thank you, Mr. Chairman.
Mr. Greenspan, I admire the work that you are doing to
ensure a strong economy, but I keep looking at the boats that
this tide hasn't lifted. I would like to focus on those who
have not benefited from this great, growing economy.
A New York Times article this week said that median family
incomes haven't risen since 1970. The average housewife is
working 15 more hours a year--15 more weeks a year than she did
back in the seventies. Ninety percent of the great stock market
gains have gone to the top 10 percent of our households. Sixty
percent of Americans don't own any stock. In 20 percent of our
counties, unemployment exceeds 8 percent. Fifteen million
children live in poverty, even including their participation in
social programs. And families headed by females in two out of
five quintiles have incomes that have declined markedly since
1983.
So my question is, what must be done to change or improve
the private sector or the economy to help the majority of
Americans who are observing this economic strength from the
sidelines--not participating in it?
While we know, I think, what social programs we can
entertain, those are not supported by the majority. What
private sector initiatives or changes in the economy could help
this portion of the American public?
Mr. Greenspan. Mr. Stark, the best way to describe the
phenomenon which you are observing is there is just no question
that the dispersion of income growth or the dispersion of
income distribution has clearly widened quite significantly in
the last decade. The last year or two it stopped widening, but
there has been a very appreciable change in the income
distribution which appears to be highly correlated with
technical skills. It is fairly evident that there is a one-to-
one correspondence between abilities to interface with this
new, advanced technology and the real income that one can earn.
As a consequence of that evident observation, a remarkably
large number of people have gone back to school. Indeed, the
average age of undergraduates in school full-time has gone up
several years. It is really one of the more startling
statistics that one can find. Community colleges have burgeoned
in size, and on-the-job training has gone up very
substantially. The major thrust of this is coming from all
income groups pressing one way or another for increased
education because what has clearly been the case is that the
obverse of this extraordinary churning in the capital stock to
which I was referring is that people who are dealing with that
capital stock, which means just about everybody, feel insecure;
that is, things are changing in a very rapid way, and you get a
sense that it is tough to deal with the new technologies, and
so they are pressing very hard for higher levels of education
and capacity and ability. In my judgment, that is by far the
most effective means to bring all of our population into the
high-tech age and the high-tech values.
Lacking education I don't see how we can do it, and, as a
consequence, education, especially on-the-job training, is
important. There are even in many of the technologically
advanced corporations little universities in which they take
the lower skilled people and teach them exactly how to function
in that complex arena. It has induced a really significant
increase in their incomes, and I would suggest that anything
you can do to enhance that is clearly the most effective way
that I know of to bring a not insignificant part of our
population which is not doing all that well into the mainstream
of the high-tech area.
Mr. Stark. Would the economy be able to absorb a lot more
people who would acquire such skills?
Mr. Greenspan. Absolutely. There is no doubt that if those
people gained increased skills, you create a change in the
capital structure. You change incentives so the type of capital
equipment you purchase to take advantage of the fact that those
skills are there.
Mr. Stark. Thank you.
Chairman Archer. Mr. Shaw.
Mr. Shaw. Thank you, Mr. Chairman.
And, Chairman Greenspan, I am very pleased that you spent
so much time this morning in your dialog and in the question
and answer period in talking about the future of Social
Security. I was not aware that you were on that special
Commission some years ago back in the early eighties with
Chairman Archer, but that certainly makes you a tremendous
resource in our trying to wade through the ways of saving
Social Security.
Looking at Social Security on a global basis in other
countries, I would say there is a meltdown going on. There is a
global crisis in other countries, even though there are a few
that are doing better than we are. Overall, I think there is a
global crisis on the question of Social Security and our
various retirement programs all over the globe and especially
in Europe.
In trying to develop some of the ideas for solutions, I was
pleased to see that you do favor some type of privatization,
although you do not support the President's plan. In fact, I
don't see a lot of support for what the President put out last
night. However, I would give the President high marks for
having opened up the dialog on privatization, because I think
that was a very necessary step that he took, and I think it is
going to be very useful.
But what I want to question you on for just a moment is the
effect that it would have on the markets, assuming that we set
it up in a situation, maybe not exactly as the Chilean model
but somewhat, so that the management of these programs is far
divorced from and removed from the Federal Government but run
by the private sector under some very strict guidelines set
forth by the Congress. What effect will this type of investment
have upon the marketplace? And if you could expand your answer
into what effect would it have when people start pulling their
assets out of those programs, such as the baby boomers which
will come in large quantities at a future date to buy annuities
or to come up with some other device for distribution for
retirement income?
Mr. Greenspan. Mr. Shaw, it really gets down to the
question of the impact on equity prices. I assume you are
talking about the level of stock prices?
Mr. Shaw. Yes, sir.
Mr. Greenspan. That occurs as a consequence of who holds
the claims because if you think in the broadest sense the
overall market value of stocks in this country should be a
reflection of the productive capabilities of the assets that
companies have for which there are claims. While one can make
arguments that who holds the stock may affect the value of the
overall structure of American industry, as a first
approximation, it does not. The technological capability of
American industry does not depend upon who the shareholders
are. If that is the case, then you have to get to the question
as to what is it about the nature of the shareholding that will
somehow alter what the stock values are.
One of the things we do know is that if there is less
volatility in stocks, whatever the capital value capability of
the corporations are, if stocks fluctuate less and are more
stable and appear less risky, leaving out their trend, that
would assume, other things equal, stock prices would be higher.
The issue of what would happen if a significant part of our
equities were held by the Social Security Trust Funds is
indeterminate on the question of their impact on stock prices,
even leaving aside the issue I raised before about the
possibility that would be misallocation of capital if you did
that. The reason I say this is, on the one hand, clearly a
constant flow of funds from the Social Security Trust Fund
would be an element of support in the short run and, with other
things equal, would tend to probably balance out some of the
fluctuations.
But it is not clear that other areas of holdings would not
accelerate volatility, in part because of the types of issues
that you raised, and I don't think there has been enough
thought given about that particular phenomenon. I am reasonably
sure that the general presumption is that a significant amount
of holdings of equities in the Social Security Trust Funds will
significantly increase the level of stock prices. I am
reasonably sure that notion is false.
Mr. Shaw. Thank you, Mr. Chairman.
Chairman Archer. Mr. Houghton.
Mr. Houghton. Thank you, Mr. Chairman.
Thank you, Mr. Greenspan. I am delighted to have you here.
I have two questions. First of all, about the current
account deficit, trade deficit, how serious do you think that
is? And then, second, you talked about the objective--your
objective as the maximum sustainable growth of the U.S.
economy. And I worry about the delicate balance between
international sources, commodity prices, savings, what the U.S.
Government does, what business does. What are these things we,
as Members of the House, ought to worry about when you talk
about promoting flexibility and competitiveness and the
atmosphere of churning and creative destruction?
Mr. Greenspan. With respect to the current account balance,
the problem we have there is the fact that because the American
dollar has been held in such high esteem and because it has
become the major currency that is held in the private sector as
well as in the public sector as a reserve balance, it means
that we can run a chronic significant current account deficit.
Because the other side of the accounting for the fact that
imports of goods and services exceed exports of goods and
services is an inflow of capital, and if that capital is not
coming in, you cannot maintain the gap. That it has come in for
years now is an indication that our perceived policies are
sound and that the dollar is sound and that it is a stable,
noninflationary system in which foreigners are effectively
investing.
The problem that we run into, unfortunately, is that, as
our net foreign debt rises, that the amount of interest we must
pay, and indeed dividends as well, continues to rise and that
process itself creates a type of situation that if at some
point foreigners stop wanting to continue to accumulate dollars
it creates a major reverberation back on the American economy
which has to adjust.
We have seen no evidence of that phenomenon arising. We
know it as a problem only in the abstract and the arithmetic of
the issue is that the rise in the net debt cannot continue
indefinitely. The question is, what does that mean? Where is
the end of that rise? It is a question we have addressed
ourselves to in some considerable detail. We have not yet been
able to answer it effectively.
Mr. Houghton. Well, it is important, isn't it, that we
maintain our position of having the world's premiere reserve
currency?
Mr. Greenspan. It is important. It is not essential. In
other words, there is a great deal of discussion as to whether
the new euro will make significant inroads into our share of
the overall reserve assets held by both private and public
sectors abroad. My suspicion is that unless they find that they
run into more problems than it seems at this stage they are
about to run into, some erosion of our undisputed huge share
has got to occur.
My own suspicion, and I must say I am speaking with very
little evidence because I don't know how you fully answer this
question, is that it is only going to be modest.
Mr. Houghton. Thank you.
Chairman Archer. Mr. Matsui.
Mr. Matsui. Thank you, Mr. Chairman.
Thank you very much, Chairman Greenspan, for being here. We
appreciate your testimony.
I was brought back about 17 years when you were chair of
the Greenspan Commission, and it required a lot of leadership
in the spring of 1983 to solve that problem. Because you came
up with some rather difficult things: Deferral for 6 months,
the CPI for senior citizens which picked up $40 billion, as I
recall, and obviously a small payroll tax increase at that
time. After you had come up with your report, there was some
tentativeness because you didn't have unanimity at that time.
And the Chairman then, Chairman Dan Rostenkowski, and
obviously Speaker O'Neill and Jim Baker got together and you
and Senator Dole and, I believe, Senator Moynihan got together
and they all committed not to trash the proposal that was
coming out. They all said, let's step back and see if we can
resolve this. Because everybody understood how difficult this
issue is. And I would hope we would learn by that experience.
I just want to mention two things. You mentioned two
reasons why we shouldn't be in the equity market. One was the
lower rate of return for beneficiaries and, obviously, the
misallocation of capital issue. Those are two major,
significant issues. It is my understanding, however, that
public pension funds--public pension funds are about 10 percent
of the market. And you agree.
At this time, the President's proposal is just about 4
percent of the market, 25 percent of the 60 percent of the
surplus or 62 percent of the surplus, that is significant from
some perspectives. Others have suggested that is probably not
enough. You can get a greater rate of return.
It is my understanding that in the public pension programs
you do get a greater return than you do through Social Security
by the government bond. Is that correct?
Mr. Greenspan. That is correct.
Mr. Matsui. Even though it is 3 percent lower than the
private investment in the equity markets, it is still greater
than Social Security?
Mr. Greenspan. Yes, it certainly is.
Mr. Matsui. And so that it does provide some level of
benefit for Social Security recipients even though it is not as
great as if it were in the market on an individual basis.
Second, the misallocation of capital, that is very
important, I think, because obviously public pension programs
are creating some disruption in the marketplace. Certainly if
the Federal Government went in, it could create disruption in
the marketplace, but I suppose whenever government programs get
into the market or the economy, there is another purpose.
For example, we spent trillions of dollars over the last
decade or two on the defense budget. And I supported the
defense budget over the years, particularly in the eighties
through President Reagan because we were seeing the Soviet
threat, the East-West conflict and, obviously, it provided some
level of benefit. And the Berlin wall dropped in 1989, so we
actually won the cold war. So those expenditures actually
provided a big benefit.
But if you go back to the Michigan study and you go back to
other studies, if one put aside that goal of our confrontation
with the Soviet Union, one would come to the conclusion that
perhaps that effort was a misallocation of capital. Is that
correct? Because, after all, you could have used those
trillions of dollars in the R&D market, you could have used it
for productive pursuits, perhaps through consumer technology
advances.
Mr. Greenspan. In that particular context it is important
to separate certain aspects of a society. I would scarcely
argue that our military programs were market efficient. I think
that the Congress has gone over them in great detail and----
Mr. Matsui. If I could understand--I don't mean to
interrupt, but you are saying they were not efficient?
Mr. Greenspan. They were not.
Mr. Matsui. You said it the other--I just wanted to make
sure I understood it.
Mr. Greenspan. I am sorry. On the contrary, government
procurement is a centrally planned system. It may exist in a
private market, in a free, democratic system, but it has got
all the characteristics of Gosplan. And Gosplan, the Soviet
system of central planning, was allegedly a very efficient
means which they thought would function.
You have got to put the policing power aside. You do not
endeavor to apply market efficiency criteria to that particular
function of a society except in a more general way. I might say
it is a necessary condition for the market system to function.
I would never argue that it should be integrated with it.
Mr. Matsui. If I could just conclude, and perhaps you can
respond to this.
There is no question in my mind that much of government
spending--Federal, local, State--creates a misallocation of
resources. Because, obviously, if you have a free-peer market,
you are probably going to get the greatest efficiency. The
problem is that for Social Security we perhaps have a different
goal. We have an additional goal besides market purity, and
that obviously is to protect the safety net.
I believe that 40 percent of the American public currently
is in the market, but 60 percent is not in the market. And you
recall that Mr. Levitt said that you have got to be somewhat
cautious about this because there may be some difficulties
regarding that 60 percent in terms of investment risk. You saw
what happened in Great Britain. And certainly other forms of
government will have to come in if, in fact, those folks misuse
their Social Security benefits in the equity market.
Mr. Greenspan. I don't deny there are problems there, and I
agree with Arthur Levitt on a number of the issues but not all
of the issues he raises.
But let's remember that, unless savings increase, the mere
fact of getting a higher rate of return from equities in the
Social Security Trust Funds of necessity means that there will
be comparable losses and returns in the private sector, very
largely in private pension fund rates of return. And if you
think of the total retirement system, public and private, the
use of equities in the public system in lieu of U.S. Treasury
securities is a zero sum game. It does not increase the overall
rate of return to the system as a whole. And unless and until
one can demonstrate that the net national savings increases,
the form in which it is invested becomes irrelevant.
And my argument is with the problems that it creates for
corporate governance and for capital allocation questions. It
strikes me that there is really no strong evidence to suggest
any positive aspects of moving Social Security funds into
equities. And I find it very difficult to find rational
arguments taking into consideration the whole system for that
particular initiative.
Mr. Matsui. Thank you.
Chairman Archer. The gentleman's time has expired.
Mr. Herger.
Mr. Herger. Thank you, Mr. Chairman.
Mr. Greenspan, I would like to follow up on some comments
you made earlier; and to make sure I understand you. You have a
very strong concern, as I do, about one of the proposals of the
President last night in which he would take part of the Social
Security surplus and invest it in the stock market and under a
situation in which the government, the Federal Government,
would own those investments within the stock market and the
potential detriment that that can do as opposed to perhaps
taking a portion of this and having individuals be able to own
those investments.
And my specific question has to do with one of the
presenters in the recent White House Conference on Social
Security, Martin Feldstein, who has developed a reform plan
that combines an investment-based system of personal retirement
accounts with the traditional tax-financed Social Security
which he believes can eliminate the need for an increase in the
payroll tax or decrease in Social Security benefits. The
required personal retirement account deposit of 2 percent
covered earnings could be financed by the projected budget
surpluses and the future increases in corporate tax revenues
that result from the personal retirement account savings.
And my question, Chairman Greenspan, are you familiar with
this proposal and would you give us your thoughts about this
type of approach?
Mr. Greenspan. My recollection is that what makes his
system work is the mandatory 2 percent additional savings which
creates additional capital which in turn creates additional
assets and higher GDP. So, in effect, he is funding the
increase in his system.
There are a number of economists who would take an
exception with him on whether some of his assumptions about how
much productivity there would be are realistic or not, but I do
think that the general approach that he is taking is something
which is one that requires considerable detailed evaluation by
the Congress.
Mr. Herger. Thank you again.
And then, just to again follow up with the first part of my
statement, do I understand that you do have very serious
concern about the Federal Government actually taking money and
then owning stocks in the private sector?
Mr. Greenspan. Everyone is concerned about that. The
difference is whether or not it can be insulated from the
political system.
There are those who are arguing for a special type of board
which would be technically independent of the political system
in a way in which the Federal Reserve is supposed to be
independent of the political system. I guess I have been around
this town too long to seriously believe that, with that huge
pot of funds sitting out there, the pressure is there to find
means to employ it for means other than direct budgetary
expenditures. In other words, if you have a particular project
and you are restrained by budget caps, there are a lot of
alternate ways in which you do it by regulation, mandation of
actions on the private sector, and this would be an additional
one. This would be a means of obtaining funds without a
particular effect on unified budget, and hence PAY-GO and all
the other rules are not relevant.
Mr. Herger. Thank you again, Mr. Chairman. I share those
same concerns. I think they are well taken. And I also
appreciate your thoughts on the other--that perhaps it would be
very advantageous for us to begin considering at least taking a
portion of this money in which the individual taxpayer and
citizen would own these stocks as opposed to the Federal
Government owning them. Thank you very much.
Chairman Archer. Mr. McCrery.
Mr. McCrery. Thank you, Mr. Chairman.
Chairman Greenspan, here I am. Let me talk about some
specifics, as I understand it, as to what the President has
proposed, because I am interested in your thoughts on the
specific amount.
You stated earlier there are to be trillions of dollars
invested, but the way I read the publication that I presume is
from the White House, the President only proposes investing
directly from the government about $680 billion over the next
15 years in the stock market. So, given that number that is far
short of several trillion dollars, do you still have the same
concerns about investing by the government?
Mr. Greenspan. If we start down that road, I will venture
to say the number will turn out to be substantially larger than
the number the President is using.
Mr. McCrery. Well, I understand the slippery slope theory,
but let's assume----
Mr. Greenspan. Let me just go back and say even that number
I find is large. Let me say it is not so much a tradeoff of
benefits versus costs. I am, frankly, just hard-pressed to find
any benefits there are in doing it if indeed it is a zero sum
game in which, if you do not increase the national saving, the
mere investment of public funds in American equities does not
change saving. And all it would do would essentially imply a
swap of the U.S. Treasury issues held by the Social Security
Trust Fund with equities in the private sector. So that those
government low-yielding instruments must end up in the private
sector, probably in the private pension funds.
It is not a question of whether a small amount is good. I
am just not finding reasons to even say that a negligible part
is of value. I cannot find a logical reason to do it.
Mr. McCrery. Well, Chairman Greenspan, I am sure you could
find economic fault with many of the things that the Congress
does, but, unfortunately, we are constrained by politics and by
the desire of the public to have a sound Social Security
system. And the President's proposal, let's give it some due.
From an economic theory standpoint you are correct, but from
the standpoint of solving the immediate problem of money in the
Social Security system, it does help to solve that particular
problem. So--and I am kind of playing devil's advocate here
because I do want to get your frank reaction to what we will
hear from the President's side.
Let me move on now to your suggestion that we need to fully
fund Social Security, and you said that you think we have a
better chance to fully fund it through a private system rather
than a public system. We could fully fund it, couldn't we, by
just increasing payroll taxes? That would be fully funding it,
wouldn't it?
Mr. Greenspan. That is correct, Congressman.
Mr. McCrery. And you are opposed to that?
Mr. Greenspan. I would be opposed to it on the grounds that
doing it in the private sector is better. But if you ask me is
it feasible to fully fund the Social Security system by
increasing taxes and therefore increasing government savings
and which, in turn, would increase national savings, the answer
is yes.
Mr. McCrery. That would be one way to fund it, even though
you think it is not the most desirable way to do it.
Mr. Greenspan. Yes.
Mr. McCrery. Would you elaborate a little bit on how we can
fully fund the Social Security system privately?
Mr. Greenspan. Well, let's talk about the Social Security
system in the general sense of benefits that are now being
created under current law. The question of fully funding those
benefits is what the crucial issue is. And I agree with what
you just said, it can be done in a number of ways. It can be
done in the public sector. It can be done in the private
sector. It is my view that it is far more feasible to do it in
the private sector.
The crucial issue, however, is that we have to do that.
Now, I am not saying we need absolute full funding but a very
substantial increase in funding is required largely because the
arithmetic of the pay-as-you-go system against the demographic
changes in the population makes the system immediately
vulnerable to the types of problems which would require a huge
increase in taxes if we don't come to grips with it relatively
soon.
Mr. McCrery. Well, Mr. Chairman, my time is up. If we get
another round--you didn't answer my question. I wanted you to
elaborate on how it could be fully funded in the private
sector. So if you could give that some thought.
Mr. Greenspan. I would just basically--well, let me say
that is a 15-minute discussion.
Chairman Archer. The gentleman's time has expired.
Mr. Coyne.
Mr. Coyne. Thank you, Mr. Chairman.
Chairman Greenspan, thank you for your testimony here
today. And in your testimony you pointed out that it is well
known that removing barriers to free flow of goods and services
across national borders affects positively the standard of
living, and I don't think anyone would disagree with that, and
protectionism should be avoided as much as we can.
We have a situation in this country where Japan and Russia
and Korea are dumping their steel product in this country, and
I was wondering if your admonition against trade barriers
extends to the Commerce Department and our trade ambassador
taking actions to try to ameliorate that problem?
Mr. Greenspan. I am very chagrined about what has happened
to the steel industry. I was, in a sense as a youngster,
brought up in the industry. That was my major specialty. So I
know the industry exceptionally well. It has had a remarkable
record in this country.
The trouble, unfortunately, is that it has gotten smaller
and smaller, and, as you are probably aware, total employment
is now at probably a little over 200,000, when it was many
multiples of that 15 or 20 years ago.
There is just no doubt that increased imports have had a
significant impact. My recollection is that hot-roll sheet
prices have gone down really quite dramatically. It has not
gotten to the point yet where there are industrywide losses;
that is, many mills are still doing reasonably well although
their earnings are down, but they are still quite positive, and
they are not doing all that badly. U.S. Steel is still in the
black. Bethlehem Steel is not. So it is a tough situation for
them.
The dilemma that trade policy has is how do you help the
10,000 or so U.S. steelworkers who have been laid off as the
market has weakened? How do you help people who are confronted
with these very difficult types of problems?
My own view is that you need very generous, basic support
for the workers. You have to be very careful about imposing
quotas or other types of things which will create retaliation
and undercut our whole trading system. This is one of the
really very tough problems that any trade negotiator has to
recognize. You have real hardship, and there is no question
that it is there.
I remember once I went up to Homestead outside of
Pittsburgh, and I remember when it was really the biggest plant
in the world. It was really something to behold, and now there
is nothing there to speak of. And that is a real tragedy, and
we have to address that the best we can, but recognize that we
are dealing with a very small segment of the American economy.
We have to be very careful in addressing the problems of these
industries not to undermine the capacity of the broad system to
function.
So I am glad I am not in the position where I have to make
those types of choices. I think they are pretty tough.
Mr. Coyne. Well, Homestead is in my district; and, as you
point out, 10,000 steelworkers have lost their jobs as a result
of this dumping problem in the country; and the Commerce
Department has had an initial finding of violations.
And the only question I had for you, do you think we should
let other nations dump their steel in here at less than what it
costs to produce there or should we take some actions against
that kind of practice?
Mr. Greenspan. There is a very difficult problem of what
their cost structures are. For example, I defy anyone to tell
me what Russian steel costs. Their books cannot be in shape to
find out what their marginal cost is. I know enough about
pricing in the industry to know that the notion that you're
pricing under cost is a very tricky issue because the fixed
cost levels in producing steel are very high.
All I can say to you is that whatever it is we do, if we
start to block the free flow of goods and services, it doesn't
stop there. The consequences of introducing increased
protectionism in that area is very costly for the Nation as a
whole, and I suggest that we do everything we can to try to
assuage the real and serious problems that both the industry
has and the individual workers have but not beyond the point
where it creates a serious trade problem for us. That is a
shortsided view of the way the world should work, and I trust
we will not go in that direction.
Mr. Coyne. Thank you.
Chairman Archer. Mr. Camp.
Mr. Camp. Thank you, Mr. Chairman, for holding this
hearing; and thank you, Mr. Greenspan, for appearing before the
Committee today.
The Federal tax burden as a percent of GDP is the highest
it has been since World War II; and I would like to get your
comments on if you agree that the tax burden is too high and,
if you do, what types of tax cuts should we be considering and
what types of tax relief or tax cuts should we be staying away
from?
Mr. Greenspan. The issue of whether it is too high is a
tricky problem for an economist, but there are those who are
concerned about it. There is no question, however, that the
numbers are large--it is over 21 percent of the GDP at this
stage.
All of the change that has occurred in recent years shows
up in the individual income tax receipts, and even though we
don't yet have the statistics of income for 1997--I am not even
sure we have 1996 data yet--it appears, looking at the nature
of what we see in the tax receipt data, that a very substantial
part of it is related to the rising stock market in two ways.
One, there has been a substantial increase in capital gains
taxes, but probably far more important, as I think we are all
acutely aware, there has been a really major shift in the form
of compensation which exists mainly for management and middle
management in the way of stock options, in the way of bonuses,
and in the way of all sorts of things which relate to the value
of the stock of the company. And so even though it is not
capital gains, it is clearly a stock market related issue.
Second, there has been a fairly dramatic rise in the
turnover of existing homes which is not unrelated to the stock
market itself. The commissions that are involved in that area
are really bolstering taxable income, mainly at the higher
marginal tax rates, so that we clearly see a fairly substantial
stock market related directly and indirectly increase in
revenues, and it depends on where the stock market goes how
substantial those revenues will be. But remember that a goodly
part of that occurs as a consequence of a rise in stock prices;
unless they continue to rise at near the rate they have, one
must presume that the tax base is going to be lowered.
My own view with respect to taxation is the lower, the
better. I have always argued for lower marginal tax rates
because that is where the incentive structure is. I have argued
for lower capital gains taxes. Indeed, I have always been of
the presumption that capital gains taxes are a poor way to
raise funds because of their negative impact on capital
investment. These taxes have a greater negative effect than any
measure of the value of the receipts that you as a consequence
create. So I would say in some sense a marginal tax rate
reduction and capital gains tax reduction have always been in
my judgment what is useful in this country.
The question of whether the burden overall is too high is
difficult to make at this stage if we are getting such terrific
capital efficiency. I do think, however, that we could still
improve it further if we did move the marginal rates lower.
Mr. Camp. Thank you very much.
Thank you, Mr. Chairman.
Chairman Archer. Mr. Ramstad.
Mr. Ramstad. Thank you, Mr. Chairman; and thank you,
Chairman Greenspan, for being here today as well as the
masterful job you have done with monetary policy.
I just want to follow up the question my colleague from
Michigan asked. With inflation hovering around 2 percent--and
thank you for keeping inflation in check--and growth in GDP at
3 to 4 percent, we have seen about an 8-percent growth rate in
Federal tax revenues, and you certainly explained the reason.
As a follow up, some are suggesting a substantial reduction in
the rates. And, again, thank you for your advocacy, which you
reiterated today, for lower marginal rates as well as capital
gains cuts which we have done in part.
What would be your reaction? Would you support, say, the
proposal being touted currently for a 10 percent across-the-
board reduction in rates?
Mr. Greenspan. Congressman, as I said at the beginning, my
first preference is to allow the surplus to run, because I
think that the benefits to the economy through the effects on
increasing saving are a very important priority for this
country. If it turns out that that is politically infeasible,
then I would say that some form of tax cut is a far superior
way than spending the money, and a 10 percent across-the-board
tax decrease strikes me as a relatively simple way to do that.
Mr. Ramstad. Given the factors--the inflationary factor at
2 percent, the economy growing at an annual rate of 3 to 4
percent, from an economic standpoint, obviously, this would be
a sound move. And you don't see the two as being incompatible
certainly, that is, using x percent of the surplus projected,
10-year surplus, to apply to Social Security and at the same
time providing the tax cut that you responded to?
Mr. Greenspan. That is an issue the Congress has got to
make a judgment on. I don't think that there is any reasonable
amount of insight that economists can give you over and above
what we have just been discussing to make that judgment.
Mr. Ramstad. The insight you have just provided has been
very helpful, and we appreciate that.
I want to ask you with my remaining time about the year
2000 computer problem. Certainly we recognize that the Y2K
computer problem affects primarily the aggregate supply side of
the economy, and I know monetary policy affects mostly the
aggregate demand side, but is the Federal Reserve prepared--and
I think this is an important question--prepared in case of a
Y2K disruption in case it has feedback effects? Has the Federal
Reserve dealt with this adequately and are you ready if we
have, God forbid, a recession or a big hit to the economy
because of problems with the Y2K computer problem of the type
some are predicting?
Mr. Greenspan. We obviously are spending a considerable
amount of time and resources to make sure that, one, the
Federal Reserve System as a whole with all of our payment
systems, all of our interconnects to the individual banking
systems is what we call Y2K compliant, and we are pretty much
convinced that we are going to be OK.
We are also increasingly optimistic that the American
banking system is moving quickly in the direction of being able
to interface with us and with their clients in a manner which
will be, I would say, pretty much effective.
There clearly are going to be mistakes out there which I am
not able to anticipate largely because a computer program is
really unforgiving of mistakes. You could have 1,000 lines
which are perfect and then the next line has got a comma in the
wrong place and it is gone.
What we need to recognize is that while we probably have
got a believably good shot that the internal U.S. systems Y2K
problems are under control, we cannot be sure about our
interface with the rest of the world. As a consequence of that
and as a goodly part of the international flows that are
involved with automatic computer digital type of interfaces, it
is conceivable to us that some problems could emerge.
We have not only clearly tried to fix whatever we can see
in the current system but we are also increasingly beginning to
address the issue of what if, and the what if can come in many
different forms. I am reasonably certain that we will be about
as prepared as one can be prepared for the unknown, but it is
unknown. There is nobody I know who has the capability to know
precisely how this is all going to come out. We have never seen
anything like this, and all we can do is to try to think of all
the possible negative outcomes, both prior to January 1 and
subsequent, and at the moment I would say I personally am quite
impressed with what we and our colleagues at the Reserve banks
are doing in this regard.
Mr. Ramstad. Thank you, Mr. Chairman, Chairman Greenspan.
Chairman Archer. Mr. Chairman, I think in deference I
should ask you what your schedule is for the remainder of the
day so we can plan as to how we proceed from this point.
Mr. Greenspan. I can go on certainly for a half-hour to 45
minutes if you----
Chairman Archer. If that is suitable to you, we will just
continue for 30 to 45 minutes.
Mr. Levin.
Mr. Levin. Thank you. Thank you. You are a highly respected
figure. You deserve to be. I think one of the problems is that
you don't please anybody all the time and so people kind of
hear you selectively. If they like your advice, they take it.
If they don't, they can skip along.
Mr. Greenspan. I have observed that.
Mr. Levin. So let me be clear as to your advice. You said
your first preference is to let the surplus run. And that is a
higher preference, for example, as you see it than a
substantial, across-the-board tax cut?
Mr. Greenspan. That is correct.
Mr. Levin. You less prefer large spending increases.
Mr. Greenspan. That is not a preference.
Mr. Levin. All right. OK. That is clear.
Now, just quickly, where does Medicare--addressing Medicare
fit into your preference list?
Mr. Greenspan. Congressman, that is one of the most
difficult problems that we face. As I said before, one of the
reasons it is exceptionally difficult is that, one, we are so
increasingly technologically oriented in that area that we need
to get some judgment as to what the technology is doing, and
second, we are really quite limited in understanding what types
of new major advances in pharmacology and the electronic means
of surveillance of the human body and----
Mr. Levin. Let me ask you, where should we put this
preference?
Mr. Greenspan. I was about to get to another issue which I
think is really at the base of it. What we try to do in our
society is allow people to make judgments of how they wish to
allocate their real incomes, and the American people have very
clearly chosen increasingly to put it into medical services.
When I was very young, I remember the doctor used to show
up and he would give you two aspirin and say, call me in the
morning, and that was high-tech medicine. Now our capabilities
of doing things are just awesome, and if everybody got
everything that was technologically possible, we would probably
be eating up half the gross domestic product.
There is clearly an issue implicit in the way we handle
ourselves in the medical services area. The crucial issue is
that there is one form or another of rationing that goes on,
and rationing of medical services, I think, is anathema to the
average person. So we have this very crucial dilemma, granted
the capability of actually expending huge resources in a
positive manner. That is, we probably can improve the quality
of health of everyone to a certain degree, considerably more
than we do at this stage, with the expenditure of a huge amount
of resources.
I don't know the way in which one can properly make those
balanced judgments. Here the Congress has, in my judgment, the
most difficult of choices, because you are trading human life
against other values in life. If we knew a great deal more
about the technologies' future, you could probably be in a far
better position to make the----
Mr. Levin. Let me quickly ask you, on trade we hear you
caution. I don't think that is the same as inaction. But let me
ask you about the government investment of funds. By the way,
if it is done privately, I don't see how it increases the
savings rate any more than if the government does it.
Mr. Greenspan. It would do so only at this particular point
if the additional savings were mandated.
Mr. Levin. So let me ask you this, then: The Federal
Reserve Board is insulated from political pressures
considerably, is it not?
Mr. Greenspan. To an extent. The only thing that we are
insulated from is a countermanding of the decisions that we
make under law in the Federal Open Market Committee.
Mr. Levin. Why can't we do, I guess you have to answer this
quickly, the same in terms of a government investment?
Mr. Greenspan. Congressman, that is what people are
recommending. It is just that I find it very difficult to
believe that it is feasible. There are people whom I respect,
whose judgment I respect, who disagree with that. It is not an
economic judgment. I guess it is a political judgment. It is a
question of how our system works.
I guess I have just seen too many Presidents in my lifetime
who, when confronted with a problem in the Federal budget,
meaning a lack of resources and a huge pot of money sitting out
there, would be unable to resist moving in that direction. I
just don't believe they would. A majority of both houses can
create laws that can overturn anything that is done to set up
such sort of a Federal Reserve Board type related reserve fund.
Look, your judgment on this has got to be superior to mine.
You have been involved in all sides of the political process
for a good number of years. That is my judgment. If you think
it is wrong, clearly your judgment would be superior in that
regard.
Chairman Archer. The gentleman's time has expired.
Mr. Johnson.
Mr. Johnson of Texas. Thank you, Mr. Chairman. Welcome
again. In the past you have testified that you expect a
correction in the stock market, and I guess it hasn't happened
exactly like you had forecast. I wonder, since the prices of
high-tech stocks have really zoomed and there aren't any real
profits in those companies yet, especially the Internet ones,
what your forecast is now, and how is that going to affect some
private investment that we might formulate for fixing Social
Security?
Mr. Greenspan. I am not sure I want to get involved in
individual types of stocks and their valuation. As I said in my
prepared remarks, I made a few comments with respect to what I
think the historical relationship of values are, as best we can
judge them. I know of no one who would argue at this stage that
at minimum we are not at the higher levels of valuation.
I guess that is about as far as I want to go at this
particular stage. There are lots of ways in which markets can
evolve for lots of different reasons. I chose my words as
closely as I could in my formal remarks, and I would just as
soon not go beyond that.
Mr. Johnson of Texas. You mentioned the Y2K problem and the
fact that there is no assurance that internationally it is
going to work out. You are fairly confident that we are OK,
U.S.-wise, and yet our interrelationship internationally is
pretty intertwined at this point. How do you expect that to
affect--I mean, already you saw a bump when Brazil deflated and
it came right back up. And this morning even there was a bump
at 10:30. Believe it or not, when you started testifying it
went down and it is back up.
How do you account for that in the long term?
Mr. Greenspan. I would just as soon not try to.
Mr. Johnson of Texas. OK. You are pretty honest, as a
matter of fact. I appreciate that.
Do you think that our tax system sufficiently rewards risk-
taking and entrepreneurship? And if we lowered taxes, I think
you intimated it ought to increase the dollars available to
make the economy stay strong.
Mr. Greenspan. Our tax system relative to the rest of the
world is not bad, but there is no doubt in my mind that it
could be improved upon. I do think that lowering marginal tax
rates specifically and lowering the capital gains tax rate, in
my judgment, would enhance the ability to increase incentives
and capital investment in this country.
Mr. Johnson of Texas. Thank you very much.
Chairman Archer. Ms. Dunn.
Ms. Dunn. Thank you very much, Mr. Chairman.
Mr. Chairman, I want to stay on this track because I really
am intrigued with your comments on how the surplus should be
used. I wanted to ask you further, if a portion of the surplus
is returned to the people in the form of tax relief, and you
have talked about marginal rate reductions and capital gains,
could you discuss for me your analysis or your impression or
your thoughts on how lowering the death tax, the inheritance
tax, would affect the economy, the growth side of the economy?
Mr. Tanner and I are cosponsoring a rate reduction, 5 percent a
year, and I am interested in your thoughts.
Mr. Greenspan. Which tax are you referring to?
Ms. Dunn. What is your analysis of how lowering the rates
on the death tax or inheritance tax would affect the growth of
our economy?
Mr. Greenspan. I have seen a lot of studies on that and I
have found them all inconclusive, so I have nothing really
substantive to add. Clearly, when we had a very substantial
part of our population on the farm, the issue of inheritance
taxes was a really debilitating problem for the transfer of the
property from one generation to the next. The fact that our
inheritance taxes throughout a substantial part of our history
were either zero or very low, I thought enhanced a goodly part
of the development of this country.
I can't say that I feel as strongly currently as I would
have, say, in an earlier period. But my general view is, it is
not terribly obvious to me that the amounts of money which we
raise through the inheritance tax, which is really quite small,
is economically positive. In my own judgment, it is probably
otherwise, but I can't honestly cite evidence which I would
consider to be conclusive in that regard.
Ms. Dunn. What about your thoughts on corporate capital
gains reduction?
Mr. Greenspan. Well, I would put the capital gains tax
reduction on both individual and corporate earnings.
Ms. Dunn. Let me move to a different topic that affects my
State, Washington State, almost more than any other State in
the Union. That is the fact that our exports have been reduced
to Japan over 31 percent in the last year. We are very
concerned about this. As the second highest exporting State in
the Nation, it has a huge effect on us. Japan is seen as
driving the economy in Asia, and I would like to have your
thoughts on whether you believe that the Japanese, as they have
made their corrections in their own economy, if you think that
they are responding adequately to restore their economy and the
economy of Asia?
Mr. Greenspan. As I have said publicly, I am hopeful that
the Japanese will address the issue of their ailing banking
system with a great deal more alacrity than has been the case
of late.
The problem that occurred in Japan and still exists is a
very dramatic decline in the value of real estate assets when
the so-called real estate bubble burst in 1990. Real estate is
the major collateral for the banking system in Japan, and the
immediate result was a very major increase in nonperforming
loans, which could have been addressed very early on in a
manner similar to what we did with the RTC when the savings and
loan debacle hit us. Had they done that, in my judgment, they
would have cleared up a corrosive force that was spreading in
their banking system and they now would probably have an
economy which is doing a good deal better than it is.
The problem in Japan is that their financial intermediation
is very largely commercial banking, as differentiated from the
United States where we have a very significant capital market
as well. The result of that is the increasing problems within
the Japanese banking system have induced a major credit crunch
in Japan. The problem has gotten so bad that Japanese banks
have to pay a significant premium in the London market for
borrowing in yen relative to British and American banks, for
example, which tells you that it is a credit-risk problem of
very major dimensions and that unless and until they resolve
their banking problems, it strikes me that the economy's
ability to come back in a vigorous manner is going to be
delimited.
So I should say that there are lots of things that have to
be done to reinvigorate the Japanese economy, but unless they
address the nonperforming loan problem in a significant manner,
which I have always argued has got to be handled in a manner
similar to our RTC, I think that the credit crunch will
continue to hobble economic growth there.
Chairman Archer. Mr. Jefferson.
Mr. Jefferson. Thank you, Mr. Chairman.
You say in your testimony, among other things, that it is
important not to undermine the highly sensitive ongoing process
of reallocation of capital from less to more productive uses
through enactment of various policies that may sow
uncertainties, undermine confidence and so on. Do you have any
particular prospective policies in mind that might result in
that sort of problem, that the Congress should refrain from
being involved with?
Mr. Greenspan. I did not quite get the----
Mr. Jefferson. In your testimony, at the end you say that
it is important not to undermine the highly sensitive ongoing
process of reallocation from less to more productive uses. And
previous to that you say that policymakers are going to have to
be particularly wary of actions that unnecessarily sow
uncertainties.
So my question is, did you have any particular actions in
mind that you might see on the horizon, that the Congress might
be contemplating or policymakers might be contemplating, that
might cause this concern for you?
Mr. Greenspan. Let me just address the broad allocation
problem because the thing which has struck me about the way our
markets have evolved is that the technology has enabled us to
unbundle risks in a manner which it has never been capable
before. Individual consumers and investors have been able to
differentiate between various products.
For example, you now can go out to buy a car and you can
get all different types of special vehicles which we never were
able to get before. Remember, several generations ago Henry
Ford said, you know, ``I will give you any type of car you want
so long as it is black.'' And we have changed that. We have
gotten very sophisticated.
The technology has essentially created a major ability to
reallocate capital in positive ways. There are a number of
things that we can do to enhance it from the governmental point
of view. My major concern would be, for example, that we be
careful not to raise the minimum wage, and the reason I say
that is that all the evidence that I have seen suggests that
the people who are most needy of getting on the lower rungs of
the ladder of our income scales, developing the skills and
getting the training, are unable to earn the minimum wage and,
as a consequence, cannot get started.
We have to be very careful about thinking that we can
somehow raise standards of living by mandating an increase in
the minimum wage rate. As a consequence of that, the need to
keep our labor markets as flexible as possible and the ability
to get the training to move up the ladder has got to be
unimpeded because we cannot have a sophisticated capital market
or a sophisticated system overall unless we have a flexible
wage market.
I would say in that respect if there is any single thing
that we could do which would help over and above a number of
other things that have been discussed today, I would say be
careful about moving the minimum up inordinately. My own
preference would be to lower it and in fact even eliminate it,
because I think it does more damage than good. But I recognize
I am in a significant minority on that question.
Mr. Jefferson. This issue of fully funding the Social
Security system, Mr. McCrery asked about it, and I was
intrigued by your comment in your testimony on that issue. He
talked about fully funding it through the public sector and you
intimated a preference to having it done through the private
sector. You also said it would take a long time to answer that
private sector question.
But nonetheless, I don't know what you had in mind, and I
would like to know if you could provide something of an answer
as to how the private sector might be an answer to fully
funding the Social Security retirement system?
Mr. Greenspan. It is going to be very difficult. The issue
I come at is that it needs to be done. That is statement number
one, and I infer that from the clear and growing evidence that
we are not going to be able to meet the demands of the goods
and services that retirees, who are going to be in hugely
increasing numbers, are going to require upon retirement.
So I start off with the proposition that we have no
alternative but to go to some form of increased funding or full
funding. The more difficult question is how to do that, and
clearly you can do it in a number of ways. You can raise Social
Security taxes, which I think would be a problem in the labor
market or you could significantly increase the average age of
Social Security entitlement to more effectively link it to life
expectancy. Indeed, I think what we should be doing is have the
number of years that one is in retirement remain proportional
to the number of years which one works and contributes to the
fund. As it stands now, the ratio of retired years to working
years is increasing and that is arithmetically unsustainable.
There are also a number of things we can do with bend
points in the benefit programs. There are a number of things we
could do to flatten out benefits without materially affecting
the levels of benefits in a large way, which would have a very
major effect on the underfunding that currently goes on. So can
it be done costlessly? The answer is absolutely not.
Mr. Jefferson. These solutions you talk about are all
within the public domain. The private sector domain is the one
which is the most confusing as to an obvious answer, and there
are some suggestions as to where an answer might be.
Chairman Archer. Will the gentleman suspend for 1 minute?
In deference to the fact that there are other Members that need
to try to get their 5 minutes in, perhaps the Chairman can give
you that in writing or in some other way. I hate to cut any
Member off, but I want as many Members as possible to be able
to inquire.
Mr. Greenspan. Write me a note and I will be very glad to--
--
Chairman Archer. I fear the answer might be rather lengthy.
Mr. Collins.
Mr. Collins. Mr. Chairman, thank you.
Chairman Greenspan, please bear with me. I am probably the
only one on this Committee that will speak at a slower pace
than you do. There are two areas that I want to refer to and
follow up with a question.
You mentioned Brazil and their economy and the fact that
government actions have led to a point that government
liabilities probably and do exceed potential revenues for the
Government of Brazil. I think you may be referring to some
programs that redistribute income. I see the United States as
having that same potential problem, based on government
entitlement programs that have been created over the years. One
in particular is Medicare. And I agree with you that Medicare
is a more significant problem for us to deal with than Social
Security.
But I want to refer to Social Security and the fact that we
have a pay-as-you-go system. In other words, the workers today
are paying the payroll tax to meet the benefits of those who
are receiving the Social Security checks. You mentioned current
retirees and how their returns on the investment that they made
from those payroll taxes over the years are much better.
Actually, many of them have received back in 3 to 5 years more
than they actually had reduced or deducted in payroll tax.
But then I want to go to my generation. I was born in 1944.
I thought I was the beginning of the baby boom generation but I
learned last night it was 1946. But at the White House in the
Social Security summit in December, information was shared that
my generation probably will have to draw benefits for a period
of some 19 years before we get to a point of breaking even,
based on increased taxes and the higher earnings limit that
have been put in place for Social Security taxes.
But then we look at the next generation behind me, the
younger people. You referred to the fact that they, as has been
said before, believe more in UFOs than they do that they will
ever receive a Social Security check, because the same
information that was shared with us at the summit on Social
Security at the White House was the possibility of younger
people never living long enough to even get a return on all of
their investment through the payroll tax.
That is the reason I think we need to focus on that
generation and generations behind them, as to whether or not we
are going to establish a true retirement program for them or we
can continue with this socialized insurance program we have
today called Social Security. I think we need to focus on the
fact that they need a true retirement program, and I think it
will do several things.
First, it will phase out the pay-as-you-go system that you
said needs to end. Second of all, I think it will increase
individual savings and overall savings rates. It will make more
funds available for capital investments. And I think that it
has the potential of reducing the payroll tax in the outyears,
which I think will be very important and significant to younger
generations, rather than having to increase the payroll tax to
meet the current socialized insurance program.
My question to you is very similar to what Mr. Jefferson
was leading into. When you talk about the importance of not
undermining the highly sensitive ongoing process of
reallocation of capital from less to more productive uses for
productivity and standards of living to grow, not only must
capital be raised and markets be allocated efficiently but
internal cash flow, including the depreciation charges for
existing capital, must be changed. Are you suggesting that we
revise the current depreciation schedules based on the new
current high-tech equipment that is used so much?
You mentioned the medical field. I am in the trucking
business. There is quite a difference today in the current
truck market than there was 20 years ago when I went into it. A
lot of it is high-tech. That is true throughout the industry,
computers and all. Should we revise the depreciation schedules
more in line with the life expectancy of that equipment and
usage of it than we currently do?
Mr. Greenspan. It is very difficult to get a depreciation
schedule which essentially replicates the economic lives of the
various different types of equipment that we have. Over the
years there has been considerable endeavor on the part of the
Congress to restructure depreciation schedules to be more
closely aligned to the expected average lives.
One of the troubles, however, is that because of this
continuous change in the structure of capital, it is hard to
keep up. I don't know at this particular stage, not having seen
any studies--but I am sure there are studies--of to what extent
the most recent set of depreciation guidelines as they exist in
the Internal Revenue Code, which go back a number of years now,
still apply to what the real world capital asset turnover is.
If indeed it turns out that it is a significant issue, I
would say that if you have a depreciation code which is
debilitating to the investment structure, you are going to
inhibit the appropriate allocation of capital. And indeed I
would say that should be addressed. I must say, though, I don't
know anything particular that I have seen which suggests that,
but I do think it is something worthy of study if it has not
been particularly done in some detail recently.
Chairman Archer. Mr. English.
Mr. English. Thank you, Mr. Chairman.
Chairman Greenspan, your testimony here is timely and
deeply appreciated. I want to follow up directly on Mr.
Collins' question. I am very interested in the remarks in your
testimony about the fact that growth has been fed, at least in
part, by investment in capital stock. I wonder, as a followup,
if Congress were to decide to scrap depreciation completely and
go to a system of expensing, what sort of impact would you
expect that to have on economic growth?
Mr. Greenspan. The first thing it would do is provide a
very significant tax cut, clearly, and increased cash flows
historically have always had the impact of increasing capital
investment. If you take a step back and say how did the system
work when we didn't have any corporate tax at all, clearly the
incentive structure was different from the way it is today.
I think the question you have to ask is, if you are going
to give a significant tax cut which would be implicit in that,
whether it is better focused in the depreciation area or at
marginal tax rates. At this stage I am not sufficiently up to
date on all of the discussions that have existed on this
question recently to be able to give you a thoughtful judgment
on it.
Mr. English. Then in that case, Mr. Chairman, on another
topic, recently the U.S. taxpayer has been called on, either
directly or through multilateral institutions such as the IMF,
to act as a lender of last resort to stabilize the rapidly
devaluing currencies around the world. These devaluations are
fairly clearly the result of failed micro- and macroeconomic
policies of the countries involved, and it seems that despite
tens of billions of dollars of lending, devaluations have been
occurring in any case, although admittedly in a much more
orderly fashion. These devaluations obviously put some of our
sectors, steel as an example, at something of a competitive
disadvantage.
Now setting aside for a moment the very real concern of
moral hazard with these lending policies, many of us are
concerned that our taxpayers have been put in the position of
subsidizing foreign economies which in turn subsidize our
competitors. Do you feel it would be appropriate to in some
manner to tie our loans to specific progress in receiving
countries opening their markets to U.S. exports and the
elimination of direct or indirect tariff barriers?
Mr. Greenspan. That is a goodly part of what the IMF has
been endeavoring to do. The issue of whether they have done it
successfully is another question. There is just no doubt that
it should be in the interest of the United States to open up
world markets because the other side of our protectionism is
other people's protectionism, and that should be as anathema to
us as any we engender ourselves. So anything which opens up
markets is to the mutual advantage of all trading partners.
I would think that that is our policy in the sense that in
all aspects of the foreign economic policy of the United
States, as I understand it, it is an essential goal. I don't
think that it has been compromised in a very significant
extent, though I do grant you that there are particular
instances when I would say that it is otherwise.
Mr. English. Thank you Mr. Chairman. I yield back the
balance of my time.
Chairman Archer. Chairman Greenspan has now generously
given us a little over 2\1/2\ hours of his time. The Chair is
going to suggest that, with Mr. Greenspan's permission, that we
will take one additional Member on the Minority side and one
additional Member on the Majority side and then conclude this
hearing this morning.
Mr. Doggett.
Mr. Doggett. Thank you for your very insightful comments.
Am I correct that if the choice is between letting the
surpluses buildup or enacting a tax cut, even a so-called
growth-oriented tax cut, that your belief is unequivocal that
we ought to build the surplus and reject the tax cut?
Mr. Greenspan. That is correct, Congressman. At this
particular stage, with the economy doing as well as it is and
with investment moving forward as facilely as it is, the need
for additional fiscal stimulus from the tax side, which we may
need at some future time--and I am very supportive of that--we
don't need as far as I can see at the moment. The advantages
that I perceive that would accrue to this economy from a
significant decline in the outstanding debt to the public and
its virtuous cycle on the total budget process is a value which
I think far exceeds anything else we could do with the money.
Mr. Doggett. There has also been, as you are well aware, so
much dissatisfaction with the Internal Revenue Code that some
have advanced the notion that what this Congress ought to do is
just set an arbitrary date and kill the sucker. My question is,
what economic consequences or reaction of the financial markets
should we as Members of Congress consider in deciding whether
to set a day, say, December 31, 2002 or 2003, and to declare
that the Internal Revenue Code is dead without having
previously enacted a replacement Code?
Mr. Greenspan. That is the toughest question I have been
asked all morning.
Obviously if you do not have a Code in place to replace it,
and I am one of those who have great sympathy for those who
want to make lots of changes in that Code, it is not a good
idea. That does not mean that one should not move in the
direction of significant alterations, but this is a process
question as to whether in fact, which is the reason it is a
tough question, you throw out the Code and you are going to
have to focus one's attention to get a new one by the effective
date. That concentrates the mind and probably is a great
incentive to doing that. Whether you want to take that risk is
not a judgment I am going to make.
Mr. Doggett. If we stay within the existing budget caps
adopted under the Balanced Budget Act, is more investment in
effective education and job training likely to produce
increased labor productivity and thereby our national economic
growth rate?
Mr. Greenspan. I agree with those who have difficulty
finding relationships between the quality of the education that
we engender in this society and the amount of cash that we
direct to it. Structural changes--indeed, some of the issues
that the President raised last night I thought were to the
point--are more relevant than the issue of cash.
Mr. Doggett. Thank you so much. I yield back.
Chairman Archer. The Chair is always pleased whenever a
Member yields back any time. Thank you so much.
Mr. Chairman, before I recognize Mr. Portman, who will be
the last inquirer, let me be sure to crystallize your responses
as I understand them. And frankly, I thought I understood them
before you even appeared today because you and I have talked
about this before.
Your number one preference for the surplus would be to let
it stay in place and neither spend it nor give tax reduction.
Mr. Greenspan. That is correct.
Chairman Archer. Because leaving it there effectively
reduces the national debt every year?
Mr. Greenspan. And has significant positive economic
consequences as a result.
Chairman Archer. And I understand that. But knowing the
proclivities of democracy and the Congress particularly, it is
very unlikely that that will happen, and I think history is a
pretty good barometer of that. And in the event that it does
not happen and you had to choose between a tax reduction and
simply new spending programs, what would you choose?
Mr. Greenspan. Tax reduction.
Chairman Archer. I just wanted to make that clear, because
I understood you to say that this morning.
Mr. Portman.
Mr. Portman. I want to commend Chairman Archer for holding
the hearing and for allowing not only the Members of this panel
but the public to hear your insights. I have found it
fascinating. We have learned a lot today.
Trying to summarize your prescription for the future, I
would say it is that net increased savings effectively invested
in productive assets should be our goal. On Social Security and
retirement savings generally, I would like to get your input.
You probably know more about it than anybody, having chaired
the Greenspan Commission and having thought about it now in the
larger perspective of our country's economic growth into the
next century.
Often we treat Social Security reform in isolation and
don't focus as much on the other two legs of the so-called
three-legged stool, personal savings, IRAs, and then employer-
sponsored plans. And in fact, last year and the year before
there were more benefits paid through the employer based
pension system than there were in Social Security benefits. So
it is an important part, critical part of our overall
retirement savings.
My concern is, retirement savings is not growing nearly
fast enough. In fact it is flat in many areas. Among smaller
businesses, as you probably know, with 25 or fewer employees,
only 19 percent now offer any kind of pension plan, 401(k),
profit sharing or any other vehicle. Congress has done a pretty
good job on the personal savings side, particularly with the
Roth IRA and some other vehicles. But we tend to focus on
Social Security in isolation, a bit on the personal savings
side, and we have left the employer-sponsored plans without
effective simplification and effective expansion that we should
indeed be providing.
I know that you are not necessarily in a position to talk
about specific legislation today, but I would like to hear from
you as to what you think about ideas to indeed expand the
pension system through simplification, so that smaller
businesses can get involved without the same cost burdens and
liabilities attached to the current system; and, second,
through increasing the ability of people to set money aside and
increasing the ability for employers to match those funds by
increasing contribution limits. I wonder if you would care to
comment on that kind of a proposal?
Mr. Greenspan. Congressman, I agree with you that basically
we tend to focus on Social Security as though it is independent
of the overall means of retirement incomes for the population
as a whole. Indeed, what we find is that retirees over a broad
segment of our society have multiple forms of resources to
carry them through their retirement, although there is not a
insignificant proportion of the elderly who have only Social
Security.
But I do think it is important to recognize that the same
forces which are creating problems for the public sector,
Social Security, are also the identical problems that are
focused on the private sector; namely, that we are going to
have to increase the aggregate amount of resources for our
retirement population because it is becoming so large and will
become larger. The presumption that it can all be financed
through the public Social Security system, I think, is a
mistake. We ought to look at all various segments of retirement
funding. I have no question that there is probably a
significant possibility for major improvements in our private
retirement system laws which so affect employer contributions
and employer capabilities of setting up various different types
of funds.
Mr. Portman. Thank you, Mr. Chairman. I yield back the
balance of my time.
Chairman Archer. The Chair regrets and apologizes to all
the Members who have not been able to inquire. At the same
time, Chairman Greenspan has been most generous with his time
today.
We are extremely grateful for your coming to visit with us
at the beginning of this new Congress. Again, my compliments to
you for the marvelous work that you have done over the years.
We expect nothing but the best from you in the years ahead.
Mr. Greenspan. Thank you very much Mr. Chairman.
Chairman Archer. Thank you. The Committee will stand
adjourned. We do have another hearing tomorrow morning.
[Whereupon, at 12:45 p.m., the hearing was adjourned.]
[A submission for the record follows:]
Statement of National Association of Manufacturers
Introduction
Over the last eighteen months, there have been a series of
shocks to the world economy. The main ones were the recession
in Asia, which started in the summer of 1997, followed by a
similar collapse in Russia. There is now a serious risk of the
same type of scenario in Latin America. Further, the world
economy will be hit by the Y2K problem in less than a year.
Through it all, the American economy has continued to hold
up. This reflects both some key underlying strengths--mainly
high productivity--and the fact that the Federal Reserve has
cut interest rates. So far, the United States seems to be
riding out the global storm, albeit at the expense of large
trade deficits. Given the threat that the recession overseas
will worsen, it would be a good idea to take out some
insurance, and cut taxes. To this end, we recommend a cut of 10
percent in personal and corporate tax rates.
Global Shocks
The 1997 recession in Asia was the largest shock that has
hit the world economy since the Gulf War. The crisis was
largely unanticipated, and involved a massive flight of capital
from the region. In 1996, net private capital inflows into the
Pacific Basin (South Korea, Indonesia, Malaysia, Thailand and
the Philippines) came to $93 billion. In 1997, the net private
capital outflow was $12.1 billion, a swing of $105 billion,
equal to 11 percent of the GDP of these countries. The collapse
was not only unanticipated, it was much deeper than expected.
The situation in Asia was worsened by the fact that Japan
underwent its second recession in a single decade. Japan's
initial slide into recession occurred in 1992-93, coming in the
wake of the collapse of the Nikkei and a decline in real estate
values. Macroeconomic policy was too tight at the time, slowing
the recovery. The government has been slow to enact stimulative
measures, relying more on public works, rather than demand-
expanding tax cuts. As a result, Asia is likely to remain in
recession in 1999, and emerge only slowly in the year 2000.
The second shock that hit the world financial system was
the collapse in Russia in the summer of 1998. The causes were
similar in some ways to Asia: there was a massive flight of
capital, leaving Russia short of foreign exchange. As a result,
Russia defaulted on its foreign debt and underwent a disorderly
devaluation.
The Threat in Latin America
The most serious threat at the current time is that a
similar crisis could take place in Latin America. The focal
point is Brazil, which was forced to devalue on January 13.
Last summer, Brazil was hit by the crisis in Russia, and began
to suffer the same kind of capital flight. In only two months,
Brazil's foreign exchange reserves dropped by nearly $30
billion (from $70 billion in July). This created the
preconditions for an Asia-style implosion. As of November 13, a
$42 billion IMF rescue package has been announced for Brazil.
However, this does not seem to have stabilized the situation.
One aspect of the problem is that Brazil still has a budget
deficit of more than 7 percent of its GDP. The size of the
deficit has led to fears that at some point it may be financed
by money creation, leading to a return to high inflation.
Fiscal restraint will be difficult because it will slow the
economy and lead to greater unemployment in the short run. A
further aspect of the problem is that Brazil's inflation rate
has been driven in part by a series of devaluations. This
country chose to try to stabilize its exchange rate in part to
be able to control inflation. However, the exchange rate could
not be maintained. In the short term, the United States and
other Western countries need to make additional credit
available to Brazil. In the long run, the success of the
Brazilian stabilization program will depend on whether they are
able to reduce their budget deficit, and keep devaluations
orderly.
If Brazil were to go into recession, this would inevitably
drag down much of Latin America. The Southern Cone countries--
Argentina and Chile--are currently stable, but would undergo
downturns if the Brazilian market contracted. Venezuela also
seems politically unwilling to retrench, and may try to
reflate. As a result, Latin America could be in for a period of
stagnant growth and possibly higher inflation.
This would not be favorable for the United States. Brazil
represents only 2 percent of the American export market, but
Latin America (less Mexico) represents more than 10 percent.
Adding in Mexico, the Latin American region comprises 20
percent of U.S. exports. Stagnant growth in Latin America would
further slow the American economy, particularly in trade-
sensitive manufacturing sectors that have already been hurt by
the recession in Asia.
It would also not be favorable in a geopolitical sense. If
Latin America were to collapse, this would leave North America
and Western Europe as islands of prosperity in a sea of
recession stretching from Japan, through the Pacific Basin,
Russia and South America. In other words, a large part of the
Third World would be in recession. A situation in which most of
the world's wealthy countries (excluding Japan) are prosperous
while most of the world's poor countries are in recession is
not desirable. This would lead to widespread resentment against
the West, and possibly lead to a backlash against free market
policies in other parts of the world.
Why the United States Should Avoid Recession
There are a series of underlying strengths that should keep
the United States out of recession. The most important is
steady growth in employment and incomes. Payrolls increased by
over $2 million in 1998. As a result, consumer demand should
remain buoyant in 1999.
A second factor was the Federal Reserve's astute response
to the global shocks. As the dimensions of the crisis became
evident in August, the Fed lowered short-term interest rates by
75 basis points in three stages. These demonstrated Chairman
Greenspan's commitment to containing the crisis. The rate cuts
are important for another reason. The world economy needs more
dollar liquidity. As monetary growth in the United States
speeds up, the trade deficit injects more of this liquidity
overseas.
A third factor has to do with a higher rate of productivity
growth. In the early 1990s, there was some debate as to the
rate of productivity growth that could be sustained. Pessimists
argued that this was only in the range of 1.1 percent per year.
In 1996, we forecast that the rate of productivity growth could
be sustained at 1.6 to 1.8 percent per year. This was based
primarily on a speed-up in the rate of technological advance.
One item of evidence supporting this was that national income
was growing faster than national product, indicating hidden
productivity growth.
Since then, revisions to the national income accounts have
largely validated the more optimistic forecast. In mid-1998,
the Commerce Department published benchmark revisions to GDP,
which demonstrated additional output growth and lower inflation
in 1995-97. Simultaneously, the Bureau of Labor Statistics
revised the 1996 productivity number up to more than 2 percent.
Moreover, the speed-up in productivity has been sustained. Over
the last four quarters, the average rate of productivity growth
in nonfarm business has been 1.7 percent. Productivity of
course does not operate only on the supply side. The path of
wages--or more specifically the corridor within which wage
increases do not raise inflation--depends on the rate of
productivity growth.
Elements of The Forecast
Here, we discuss selected elements of the forecast. For
1999, we project GDP growth at 2.3 percent for the year. This
represents a substantial slowdown from the 3.6 percent pace
that we probably achieved in 1998. However, even this rather
guarded scenario is contingent on at least one more cut in
interest rates by the Federal Reserve, and on a successful
resolution of the situation in Latin America.
The strongest part of the economy is consumer spending,
reflecting increase in incomes from higher employment and
wages. Lower interest rates lead to an improvement in household
balance sheets, due mainly to lower mortgage costs. The savings
rate essentially remains at zero, or slightly below. Consumers
spend all the income they take in, and continue to draw down
financial assets.
Business investment hands in a mixed performance. Despite
lower interest rates, residential construction declines, due to
excess capacity. Nonresidential structures rebounds slightly,
but this is largely a reflex response to the decline in 1998.
The level of investment in nonresidential structures in 1999
remains lower than it was in 1997. Business equipment also
slows down. This reflects excess worldwide capacity and a
narrowing of profit margins.
The trade deficit continues to deteriorate, although the
rate of deterioration is not as bad as in 1998. The exchange
rate falls, but the improvement in competitiveness is swamped
by the continuing shortfall in demand overseas. The effect on
balance is to reduce GDP growth by slightly less than a
percentage point.
The inflation rate remains low. High productivity growth
and the arbitrage of world prices into domestic prices keeps
the GDP deflator at only 1.5 percent.
Corporate earnings remain under pressure, primarily from
the lack of pricing power. Prices in some sectors are actually
declining, while in other sectors they are not rising as
rapidly as labor costs. With the economy essentially at full
employment (unemployment roughly at its natural rate),
corporate margins are being squeezed. As a result, corporate
profits decline slightly in 1998, and then achieve only a minor
increase in 1999.
If a collapse in Latin America were to occur, the situation
would be less favorable. We ran econometric simulations in
which we assumed that Brazil falls into a deep recession and
drags the rest of Latin America down with it. Even if the
Federal Reserve loosens interest rates further at this
juncture, it is too little, too late. As the experience of Asia
has demonstrated, it is difficult to bring countries out of
recession after they have already undergone financial
collapses.
In this case, the growth rate initially slows to 2 percent
in the first half of 1999, and to 1.6 percent in the second
half as the trade deficit climbs. The United States would not
actually go into recession, but instead would lapse into a
period of near-stagnation.
A final risk is the Y2K problem, which of course is outside
the range of the forecast. This is analogous to a natural
disaster. If the problem is pervasive, it would lead to supply
disruptions, forcing firms to divert resources into repairing
computer systems. The most likely outcome is that this will be
another in a series of shocks that have slowed the world
economy since mid-1997.
Policy Implications
The downside risks have two major policy implications. The
United States has to maintain a loose monetary policy in order
to provide adequate liquidity to the world. Further reductions
in interest rates are needed.
Congress, however, should provide additional stimulus by
enacting a tax cut. Specifically, we recommend a 10 percent
reduction in individual and corporate tax rates to raise
consumer demand and keep spending strong over the next two to
three years. Even in the event of a severe recession overseas,
or disruptions from the Y2K problem, the United States will be
able to maintain stable growth and full employment. At the same
time, faster growth will enable the United States to act as a
locomotive for the rest of the world economy, and for the
Western hemisphere in particular. This will speed up recovery
overseas.
To gauge the impact of this tax cut on the economy, we ran
econometric simulations in which the rate reductions were
assumed enacted in the second half of 1999. In the year 2000,
the growth rate of GDP increases by 0.9 percent, and in 2001,
it increases by 1.2 percent. The level of GDP increases by $130
billion (or 1.7 percent) in 2001, and shows a final gain of
$166 billion, or 2.1 percent in 2002. The static cost of this
tax cut is roughly $80 billion a year in 2000-01, but because
of higher growth, the dynamic revenue cost is smaller. We
estimate the dynamic revenue cost at $55 billion a year.
There are other reasons to cut taxes at the current time.
The burden of taxation is now at a post World War II high. The
ratio of total taxes collected to GDP is currently 32 percent,
compared to 25 percent in the late 1950s. We also estimated the
increase in the burden of taxation on workers, relative to
their incomes. From 1959 to 1997 the average tax burden
increased from 24 percent in 1959 to 36 percent in 1997.
Clearly, this situation calls for tax relief.
In recommending a cut in income tax rates, we do not of
course rule out cuts in other types of taxes. For instance, we
argue that converting the Social Security system to a new
system based on individual retirement accounts would also yield
substantial economic benefits. The FICA tax has lowered the
level of GDP, primarily by slowing growth in the labor force.
Our econometric analyses indicate that if the FICA tax had not
been raised, the level of GDP would be significantly higher
today. For instance, if the FICA tax rate had not been
increased during the period from 1984 onward, real GDP would
have been higher by over $80 billion in 1997, while employment
would be higher by 1 million. By implication, if Social
Security were privatized, the economy would emerge with a
higher level of GDP and employment in the early twenty-first
century.
Conclusions
The economy is slowing down, following three years of
strong growth in 1996-98. At the same time, there is a risk
that the recession overseas will spread to Latin America in
1999. Our policy recommendations are twofold. First, monetary
policy should be loosened through additional cuts in interest
rates. Second, taxes should be reduced through a 10 percent
rate cut. For the time being, the most important priority is to
enact tax relief to maintain economic growth, and take out some
insurance against the threat of a slowdown. Over the long run,
Congress should draft legislation converting Social Security to
a system of individual retirement accounts.