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A Legacy of Failure

Raised in unrivaled prosperity, we inherit an economy that is still the world's strongest, but is weakened by business failures, stagnant wages, increasing inequality and deep divisions among our own people.

Bill Clinton

The election of 1992 was a mandate for change and no wonder. Twelve years of neglect have left America's economy suffering from stagnant growth and declining incomes. They have left the average American family worried about its future, working harder, and getting less in return. The specter of rapidly rising health care costs threatens every family and business. They have left a mountain of debt and a Federal Government that must borrow to pay more than a fifth of its current bills. Perhaps most sadly, they have left the great majority of our people no longer dreaming the American dream. Our children's generation may be the first to do worse than their parents.

Such is the sorry legacy of 12 years of short-sightedness, mismanagement, and protection of the privileged. All of this must be changed.

Anemic Recovery from Recession

The U.S. economy grew very slowly in the late 1980s and slid into recession in the summer of 1990. Sales and profits fell. Unemployment rose. The National Bureau of Economic Research says that the recession ended in March 1991. For most Americans, however, the recession has not ended. The great American job machine has ground to a halt, and the unemployment rate is higher than it was at the recession's official end (Chart 2-1). The fraction of the unemployed who have permanently lost their jobs is near its record high (Chart 2-2).

The 1991-93 recovery has been called a "jobless" recovery a description that is all too apt (Chart 2-3). The reason is simple: few new jobs have been created because production has grown so slowly (Chart 2-4). Until the last two quarters, this was not a recovery worthy of the name. That is the first thing we must change.

In a strong, durable recovery, people go back to work in great numbers, and are able to earn the incomes they need to buy the goods and services that economic growth produces. The increase in sales stimulates investment, and thus generates still more jobs. The process sustains itself until the economy is producing at its full capacity and the labor force is fully employed.

Recently, however, recovery has been slowed by powerful forces that are reducing the numbers of jobs. Key industries are laying off workers to become leaner and more competitive. The defense sector is downsizing to reflect the new realities of the post-Cold War world.

Already we have seen the recovery process begin twice, only to sputter when early signs of growth were not followed by solid gains in employment. Now, once again, the long-dormant American economy seems to be waking up. This time, we must be absolutely sure that the recovery is strong enough and durable enough to put Americans back to work. The stimulus component of the Clinton economic program is an insurance policy designed to make sure that the recovery does not falter again. It is also a downpayment on the long-term investments that will encourage lasting economic growth.

Stagnating Productivity and Living Standards

But mere recovery from recession is not good enough if we return to the trickle-down policies of the 1980s. America's economic problems are deeper than a temporary lull in economic activity. We must aim not only for more jobs, but also for better jobs at higher wages. We must aim not only to produce at our current capacity, but also to add to our economy's capacity to create a better life for all.

The productivity of American labor what an average worker produces in an hour has been growing at an agonizingly slow pace for about two decades. In turn, real wages have stagnated (Chart 2-5) and family incomes have advanced at a snail's pace. These developments, more than anything else, explain why the American dream is fading for the average worker.

Even a small improvement in a nation's productivity growth rate can yield much higher standards of living in the long run. Had real hourly compensation grown at 2.0 percent a year since 1973, instead of the actual 0.7 percent gain, average American workers would make almost $5.00 per hour more (Chart 2-6). Increasing productivity growth will have a direct and positive impact on living standards. We simply must do better.

Underinvestment and Slow Growth

The slowdown in productivity growth is partly mysterious, even to experts who have studied it for years. But no one doubts that part of the cause is that as a nation we have underinvested: in private business capital, in public capital, and in "human capital" the skills and capabilities of the American workforce.

Chart 2-7 shows that the United States devotes a smaller fraction of gross domestic product (GDP) to business investments than do the other major nations with whom we compete in the international marketplace. Chart 2-8 shows that American governments at all levels have been spending a decreasing share of our total resources on civilian public investment including both physical investment and the research and development that underpins future growth. Studies indicate that additional investment in private and government R&D, and in public infrastructure, could yield substantial economic benefits.

We have also underinvested in education and training. American students routinely score far below their counterparts in other industrial countries on tests of mathematical competence and scientific knowledge. Moreover, recent evidence also suggests that the demand for more highly trained, better-educated workers has been outrunning the supply. Chart 2-9 shows that the wages of college graduates have advanced far faster than those of high school graduates since 1978; similarly, the wages of high school graduates have risen faster than the wages of nongraduates. These growing wage gaps indicate that the financial returns to education have been rising.

This evidence suggests that more investment is vital to raising the growth rate of productivity and boosting living standards. We must invest more in business capital, in public infrastructure, and in the skills of our people. Our future has been shortchanged for too long. We owe it to our children to change course now. The Clinton program will do precisely that.

The Alarming Rise in Inequality

Throughout the 1980s, slow growth in living standards was accompanied by growing inequality. The rich got richer while the middle class paid more in taxes and fell further behind. In fact, income gains were so concentrated that people at the bottom of the income scale actually lost ground: measured in inflation-adjusted dollars, their incomes fell between 1977 and 1991. The rising staircase in Chart 2-10 depicts a simple but doleful message: During this period, the richer you were, the better you did.

Behind these statistics lay very real problems. Middle-class families grew disillusioned and cynical while they worked longer hours but had trouble making ends meet. Tens of millions of families lived in fear of losing their health insurance; 37 million had none at all. The working poor were forced to choose between feeding their children and heating their homes. Hopelessness bred violence in America's inner cities. The nation drifted.

It is time to reverse that drift and reorder our priorities. It will require those who have profited to bear the greatest burdens and do right by the people who work hard and play by the rules. Our economic plan will redress the inequities of the 1980s.

A Government That Doesn't Pay Its Way

For more than a decade, the Federal Government has been living well beyond its means spending much more than it takes in, and borrowing the difference. The annual deficits have been huge, both in dollars and as a percent of GDP (Chart 2-11). As a result of all this borrowing, the Federal debt has grown as a percentage of GDP since 1981, reversing three decades of decline (Chart 2-12).

The Federal deficit is currently swollen by two temporary factors. One is the recession, which has reduced revenues and increased expenditures to aid those adversely affected; the other is increased borrowing for the savings and loan cleanup. Even when these temporary factors are behind us, however, a large structural deficit will remain. The structural deficit the deficit that would be there even if the economy were producing at full capacity and the savings and loan cleanup were complete was 3.4 percent of GDP in 1992. The really bad news is that the structural deficit not only will remain but will grow even faster than the economy unless the Government changes course.

The problem of the structural deficit is rooted in the early 1980s, when we cut income taxes and massively increased defense spending. Subsequent tax hikes in particular, large increases in regressive payroll taxes and a slower growth of defense spending during the second half of the 1980s temporarily halted the growth of the structural deficit. Nonetheless, the structural deficit remained huge by historical standards, and it once again began to climb relative to GDP by the early 1990s. Without a real deficit reduction program, the structural deficit will exceed 4 percent of GDP by 1997, rivalling the highs of the mid-1980s, and it will grow at an accelerating rate as a percent of GDP.

At first glance, slowly growing revenues and rapidly rising outlays, both aggravated by the economy's slowdown during the last two years, appear to be responsible for our deficit problem. Correcting for these recession effects, the share of Federal revenues in GDP is 0.5 percent less than it was at the beginning of the 1980s, while the share of Federal outlays has increased by 1.1 percent. These trends in total revenues and outlays, however, mask some important changes in how the Government raises its revenues and spends its money.

Major reforms of the Social Security system in 1977 and 1983 sharply raised taxes, stabilized benefits as a percentage of total Federal spending and caused an accumulation of large surpluses in the Social Security trust fund. But taxes to support the rest of the Government's activities have been cut by as much as Social Security taxes have been raised.

Adjusting for cyclical effects, the share in GDP of revenues to support the Government's other spending programs has actually shrunk by about 1.5 percentage points since 1980. And the surpluses in the Social Security fund have been used to fill the gap. Instead of adding to national savings to fund the retirement of the baby boom generation early in the next century, these surpluses have camouflaged the true imbalances in the Government's revenue and spending streams. Consequently, if we do not change course and revitalize our economy, redeeming the IOUs held by the trust funds will require major tax increases when the baby boom finally retires.

While Government spending has increased, its composition has changed. After a sharp increase in the first half of the 1980s, defense spending currently accounts for about 22 percent of total Federal outlays, down slightly from its 1980 share. Spending on non-defense discretionary programs has fallen sharply, from about 24 percent of total spending in 1980 to about 17 percent today. During the same period, public investment by the Federal Government measured as the sum of outlays for non-defense physical capital, non-defense R&D, and education and training has fallen from 8.2 percent to 6.3 percent of total outlays.

In contrast, health care Medicare and Medicaid and interest payments on the debt have claimed increasing shares of total spending. Between 1980 and 1992, spending on Medicare and Medicaid rose from 7.8 percent to 13.3 percent of total government spending. To make matters worse, large annual deficits, together with high interest rates for more than a decade, have swollen net interest payments on the debt. Interest payments now amount to almost $200 billion a year. About three-quarters of the money the Government borrows this year will go to pay interest on the debt piled up from previous years.

Unless there are meaningful changes in policy, sharp continuing growth in health care costs and self-perpetuating growth of interest on the debt will overwhelm projected revenue growth and cuts in defense spending. The Federal deficit will continue to balloon out of control unless we change course.

Why Deficits Matter

Deficit reduction is not an end in itself. It is a means to the end of higher productivity, rising living standards and the creation of high-wage jobs. In short, it is about securing a better economic future for ourselves and, even more importantly, our children.

Huge structural budget deficits are harmful for a simple reason: when the economy is not in recession, each dollar the Federal Government borrows to finance consumption spending absorbs private savings that would otherwise be used to increase productive capacity. Large, sustained budget deficits mean that we must either reduce our investment at home or borrow the money overseas.

This drain on our savings has caused anemic domestic investment, especially in comparison with most other advanced industrial countries (Chart 2-7). It has retarded growth in productivity and living standards. Meanwhile, borrowing from the rest of the world to maintain investment at even today's depressed levels has increased interest payments to foreign lenders. In effect, we have signed over some of the fruits of today's productivity-enhancing investments to the children of Europe and Japan, rather than preserving them for our own.

Regardless of whether the debt is owed to foreigners or U.S. citizens, the interest obligation requires higher taxes. Moreover, our skyrocketing interest costs squeeze out revenues that would otherwise be available for other priorities. Since 1988, for example, net interest alone has risen by $50 billion, making interest payments the fastest growing Federal "program." This mounting interest burden mocks our efforts to fund token initiatives for pressing social needs: next year's projected increase in interest payments by itself could fully fund the Head Start program five times over.

As a result, the nation has suffered from another deficit the deficit in public investment in education, training, infrastructure, and civilian technology. Like private investments, well-chosen public investments raise future living standards. Deficit reduction at the expense of public investment has been and will continue to be self-defeating. The Clinton plan is explicitly and emphatically aimed at reducing the deficit while increasing much-needed public investment. One without the other will not work.

Beyond the quantifiable benefits of deficit reduction greater investment and economic growth are unquantifiable but no less important benefits.

First, deficit reduction could allay anxiety in financial markets. Large and growing structural deficits could destabilize global capital markets because of the growing drain of government borrowing on available funds. Such anxieties help explain why historically high long-term real interest rates persist despite a weak economy. The threat that the United States might ultimately inflate the dollar to depreciate its runaway debt obligations raises the specter of a spike in interest rates, a collapse of the dollar, or both.

Second, a credible effort to reduce our structural deficit will improve our ability to coordinate macroeconomic policies with our major trading partners, who are concerned about our deficit's drain on global capital markets. Putting our fiscal house in order will improve our leverage in international negotiations.

Finally, deficit reduction will help break legislative gridlock and reverse public cynicism about government. Large deficits have virtually assured that each legislative session has been dominated by the deficit debate, encouraging budgetary quick fixes that have shortchanged the nation's long-term public investment needs and created a deficit of trust.

Skyrocketing Health Care Costs

Another legacy of the past 12 years is the crisis of rapidly escalating health care costs a crisis that threatens the security of every American family and business. In 1992, Americans spent $840 billion on health care, or 14 percent of GDP compared with about 9 percent of GDP only a dozen years ago (Chart 2-13). At this rate health spending will reach an astonishing 18 percent of GDP by the year 2000: Americans will be devoting almost one dollar of every five they earn to health care, and the average family's health costs will rise to almost $10,000 a year.

Rising health care costs are straining the budgets of families, businesses, and government. They are eating up incomes and squeezing out other spending. Individuals are facing soaring insurance premiums and rising out-of-pocket bills. Skyrocketing premiums have forced many businesses to drop or curtail health coverage for their workers, swelling the ranks of the uninsured. More than 37 million people do not now have insurance coverage. Many are dependent on hospital emergency units for care.

Inflation in health care costs is also robbing government budgets of scarce resources needed for critical investment in our future education, job training, infrastructure, and technology development. If current trends continue, by 1998 the Federal Government will spend one in every four dollars on health care (Chart 2-14). State and local spending for health will rise over the same period from 14 to 18 percent of total outlays. Exploding health costs threaten funding for other public priorities.

The rise in health care costs now projected will consume between 25 and 35 percent of total projected GDP growth for the rest of the decade and will account for over 40 percent of the total increase in Federal spending. In short, containing health care costs has become an economic imperative. Indeed, the potential "health dividend" is far larger than the peace dividend promised by the end of the Cold War. If America spent the same share of GDP on health as our main international competitors do, last year alone we would have had $230 billion more to invest in our people. Similarly, if spending by employers on health insurance had remained at the 1980 percentage of total compensation, cash wages for the average worker could have been $670 a year higher in 1991 without affecting corporate profits.

Despite these bleak statistics, widespread evidence suggests that we can control health care costs and maintain quality. Other advanced industrial nations have levels of health spending substantially below ours and have controlled cost growth more successfully even while providing care that matches and often exceeds our own. Their success offers a strong basis for hope as we step up to the challenge of fundamental change.

A Government That Doesn't Work Well

Finally, it is clear that the American people have lost confidence in their government. They believe that government has gotten too big, that it is out of touch with its citizens, that it wastes money, that it is ill-equipped for taking on the country's problems or, worse, that it causes those problems and hears only the voices of the privileged few.

In too many cases they are right. We cannot deny the evidence.

* Billions of taxpayers' dollars have been lost to fraud and abuse. The worst examples scandalous military purchases, sweetheart deals, the saving and loan debacle, and abuse of government perks have made headlines, but many remain hidden. We must crack down on these hidden scandals and catch problems before they occur, not after.

* Millions of Americans every year must deal with the maze called "Federal bureaucracy." The American people deserve a government that treats them like customers, by giving them more choices and stripping away unnecessary layers of management and red tape.

* The size and cost of the Federal Government has grown over the past twelve years. Despite many promises, administrative costs have increased and special perquisites for high-level officials have proliferated. That is why we have already made real cuts in the Executive Branch and will do so over the coming years.

Our political system has failed to address many of the most urgent problems facing the American people health care, declining incomes, job loss, budget deficits. A large part of the blame must go to the lobbyists and special interests who profit from the status quo. All too frequently they control the agenda or use their campaign contributions to dominate the debate. Even as government did less, the ranks of the special interests grew. By the decade's end, some 80,000 people will make their living pleading the causes of the special interests. To break the stalemate in Washington, we must attack the problem at its source: entrenched power and money.

The Clinton Administration is determined to meet a double challenge. First, we must cut the waste and make government operations more responsive to the American people. It is a time to shift from top-down bureaucracy to entrepreneurial government that generates change from the bottom up. We must reward the people and ideas that work and get rid of those that don't.

Second, we must restructure government to deal with new realities, both foreign and domestic. Our defense and foreign affairs agencies must be reorganized to reflect the new problems of the post Cold-War era and the global economy. We must also reinvent our domestic agencies to serve us more effectively in the twenty-first century.

Public cynicism about government is not merely a political problem. Making our government more responsive and improving the way it works is essential to the future of our children and our democracy.

The Price of Not Changing

Reversing the legacy of the last twelve years will not be easy. Nor will it happen overnight. But the cost of clinging to the status quo will be born by every family and by our children and their children. Consider:

(1) If we do not change, we could continue to have epidemics of measles and other preventable childhood diseases; if we find the courage to change, we could immunize every child.

(2) If we do not change, a college education could become the domain of the privileged; if we find the courage to change, hundreds of thousands of Americans could go to college in exchange for national service.

(3) If we do not change, health care costs will continue to terrorize our families. If we find the courage to change, all Americans can have affordable quality health care.

(4) If we do not change, the deficit will continue to grow and incomes will stagnate. If we have the courage to change, we can have a higher standard of living and a government that pays its way.

The stakes for every American's standard of living are enormous. From World War II to the early 1970s, we grew more productive year by year and our standard of living doubled. At today's anemic rate of growth, our standard of living will no longer double every generation but once every 100 years. If we do not summon the courage of change, our legacy will not be worthy of the nation we have inherited.

Continuing the failed policies of the past twelve years is a choice without a future. To restore our nation's economic vitality and reclaim our vision of America, we must change course. And we must do it now.