Private Debt Private debt increased substantially during the expansion. From 1982 to 1988, household borrowing almost doubled, growing nearly twice as fast as personal income, and corporate borrowing surged. By the end of the expansion, consumers and businesses faced relatively high levels of debt. Although the value of assets grew as well-a point often ignored when the growth of debt is discussedthe high ratios of household debt to income and corporate debt to profits probably were not sustainable. A period of slower consumption and investment naturally results as households and corporations restructure their balance sheets. The largest asset for most households is the equity in their homes. After rising rapidly in the 1970s and 1980s, residential real estate values flattened and even fell in many areas. When consumers' expectations for a continued increase in wealth were dampened, growth of consumer spending tapered off. Defense Spending Increases in defense spending were an important contributor to growth in the 1980s. By the end of the decade, fiscal constraints and shifting spending priorities led to cuts in defense spending; real defense purchases of goods and services surged between 1979 and 1987, but fell somewhat from 1987 to 1990. A much larger defense downsizing has already begun to affect employment in defense industries as firms adjust to expected changes. The United States has accommodated reductions in defense spending before. But the transition is never easy and, in fact, is costly in the short run, as people retrain and industrial resources are retooled for other purposes. Moreover, local economies where defense industries are a primary source of employment can experience significant disruption. Despite these difficulties the long-run potential dividends to the United States that come from turning military capacity to civilian endeavors is large. Obviously, the benefits to the world of the end of the Cold War transcend these economic factors. FOUNDATIONS FOR RENEWED GROWTH Fundamentals that promote growth are beginning to fall into place. Declining real and nominal interest rates should help boost interest-sensitive spending. Inflation, too, is expected to remain near its current, relatively low levels. Imbalances in international accounts have been substantially reduced, and exports should continue to grow as the Nation's international competitive position strengthens. Some structural imbalances are being righted: Households and corporations are reducing their credit burdens, and banks are improving their capital positions. It will take time to correct all the imbalances, but a start has been made. With the exception of a few industries, there does not appear to be a widespread inventory imbalance that would foreshadow further cuts in production. Increases in domestic and foreign demand will therefore be met mainly from new production and not from drawing down existing stocks. New production will generate income, increase consumption, and lead to further gains in production, employment, and income. The international competitive position of the United States has improved. After adjusting for exchange rates, the pattern of unit labor costs in manufacturing has been favorable relative to that of the Nation's major trading partners. As foreign economic growth rebounds, U.S. exports should increase. A particularly positive factor is the reduced inflation rate. Although special factors in agriculture, energy, and excise taxes may cause an occasional temporary blip in, for example, the consumer price index, underlying inflation is widely believed to be down. The economy currently is operating well below full capacity. Thus, during a moderate recovery, resource constraints that could rekindle inflationary pressures are unlikely to emerge. Furthermore, a credible and systematic monetary policy that is designed to reduce inflation gradually has ample room to accommodate a healthy expansion. Nominal interest rates generally are at their lowest levels in two decades. Real rates may not be as low as they have been around the trough in some other cycles. But the lagged effects of lower interest rates already in the pipeline should help the economy in 1992. The lowest mortgage rates in almost 20 years should spur housing starts and sales. Low rates also allow households to refinance mortgages, improving their balance sheets and providing a foundation for consumption growth. For many businesses, lower interest rates reduce the cost of borrowing to finance new investment. They also increase corporate cash-flow. Some corporations are using the strong stock market to issue equity and repay debt, thus improving their financial position and freeing funds for investment. There is some offset to the expansionary effect of these factors because lower interest rates reduce interest income and the consumption based on it. Because their capital positions have improved greatly, banks should be in a better position to lend than they have been for some time. Furthermore, the Administration, under the leadership of the Treasury Department and in conjunction with banking and thrift regulators, has been working to ensure that lenders make prudent loans and that examiners perform their reviews in a balanced, sensible manner. Still, bank lending remains tight; many banks are in vesting in Treasury securities rather than making loans. A combination of slack demand, due to the soft economy and the need to rebuild balance sheets still further, and skittishness, in response to regulatory overreaction, is preventing the banking system from playing its normal role in financing economic expansion. POLICIES FOCUSED ON GROWTH Economic growth is not just an abstract concept; it is the key to ensuring America's future. Growth will raise our standard of living; it will create a legacy of prosperity for our children; it will enable us to afford nontraditional goods and services, such as a better environment. It will provide new employment opportunities for those seeking upward economic and social mobility, and it will allow the United States to maintain its leadership role in the world. The Nation must choose between sound policies that promote long-term growth and those that stifle the flexibility of the economy, stunt incentives to work, save, invest, and innovate, and place our economic future at risk. If the proper choices are made today, the Nation's long-run growth potential will improve and a crucial step will be taken toward improving the current performance of the economy. Policies that promote short-term growth can and should be made consistent with medium- and long-term goals. This is one of the fundamental principles of the President's growth agenda. PRODUCTIVITY-THE KEY TO SUSTAINABLE GROWTH The major long-run challenge confronting the American economy is to increase the Nation's rate of productivity growth-that is, growth in output per worker. The United States still has the highest level of productivity, but other countries have had higher productivity growth in recent decades. After a quarter of a century of rapid advance following World War II, U.S. productivity growth collapsed between 1973 and 1981. It has only partially rebounded since then, although productivity growth in the manufacturing sector has improved much more than in the rest of the economy. Higher saving rates have helped Europe and Japan maintain higher productivity growth rates. Productivity depends on capital formation, workers' skills, and new technology. The Nation cannot be complacent about the fundamentals of economic growth and productivity. Quite simply, without adequate productivity growth, America's standard of living will neither keep pace with the expectations of our citizens, nor remain the highest in the world. 205 592 0-999 The Nation must increase its rate of saving to ensure that funds are available to finance job-creating investment and research and development leading to new technologies. Raising America's saving and investment rates to enhance future productivity growth is a key goal of the Administration's policies. The United States cannot remain the world's leading economy without the world's leading labor force. Competing in a rapidly changing international economy requires a skilled and flexible work force able to adapt to changes unforeseen today. Effective job training programs to retrain workers are a key to increasing productivity and remaining internationally competitive. The most important step the Nation can take to confront these long-term challenges is to restructure our elementary and secondary education system. By some measures, the United States spends more per pupil than any country in the world except Switzerland, but test scores reflect less than world-class performance. Another urgent priority for the Nation is to eliminate the scourge of crime and drugs. Not only is it costly to address the consequences of these problems, but the Nation is losing the potential contribution these people can make to economic growth. A key source of the U.S. economy's dynamism and resiliency is the flexibility it derives from reliance on markets. Of course, some markets are not perfect, and achieving certain desirable social goals such as a cleaner environment may require rules and regulation. Long-run productivity is enhanced if regulation does not unnecessarily hamper the efficient allocation of resources and reduce the economy's flexibility. Incentive regulation, which encourages firms to operate more efficiently while at the same time achieving the social objective, is an important innovation in this regard. In particular, regulation must not inhibit competition by discouraging technological innovation that would enable new firms to compete with those that are currently regulated. Just as improper regulation harms the economy, protection from foreign competition retards innovation, raises production costs, and decreases choices for consumers. Long-term productivity growth, therefore, depends on opening, rather than closing or segmenting, markets. THE ADMINISTRATION'S AGENDA TO MEET THE CHALLENGES The President has presented a comprehensive and coordinated growth agenda for the Nation. The agenda includes fiscal and other measures that will stimulate the economy in the short run, address the structural imbalances, and promote the Nation's long-term growth. The Administration's policies for raising long-run productivity growth and thus the standard of living are based on five principles: a pro-growth fiscal policy that enhances incentives for entrepreneurship, saving, and investment, and that continues to reduce the multiyear structural budget deficit; a trade policy that promotes growth through opening markets worldwide; a regulatory policy that avoids unnecessary burdens on business and consumers; a human capital investment policy that focuses on education, training, and preventive health care; and strong support of a monetary policy that keeps inflation and interest rates low, while providing adequate growth of money and credit to support solid real growth. The agenda focuses directly on increasing economic growth. The short-term agenda includes executive actions and proposed legislation that will stimulate economic growth immediately. Executive actions with immediate impact include a reduction in excessive personal income tax withholding and acceleration of previously appropriated Federal spending. Reinvigorated action to reduce the burden of unnecessary regulation and prudent measures to reduce the credit crunch will improve the environment for growth now. Proposed legislation focuses on spurring job-creating investment. The proposed 15-percent investment tax allowance and simplified and liberalized treatment of depreciation under the alternative tax, as well as the reduction in the capital gains tax rate, will stimulate business investment. The reduction in the capital gains tax rate will quickly raise asset values, improving confidence and encouraging spending. A $5,000 tax credit and penalty-free withdrawal from individual retirement accounts for first-time homebuyers, along with other incentives, will increase housing construction and sales. Bolstering the short-term agenda are proposals for the long term that invest in the Nation's future by increasing the productivity of people and business. Record Federal investment in research and development and infrastructure, and the extension of the research and development tax credit will help increase business productivity. Record Federal investment in Head Start, children, and education, as well as proposals that strengthen the war on drugs and improve the implementation of job training through Job Training 2000 will help increase labor productivity. The long-term growth agenda also includes continued efforts to expand international markets through multilateral, regional, and bilateral negotiations. Fiscal discipline has been a centerpiece of all of this Administration's budgets. Fiscal policy is designed to foster long-term growth by encouraging saving and investment as outlined in the Omnibus Budget Reconciliation Act of 1990. Controlling the growth of government spending and deficits so that resources are freed up for investment is but part of a more comprehensive fiscal program that, within proposed spending categories, shifts spending from current |