Today's date:
Fall 1987

Economic Hypochondria

George Gilder - Gilder, author of the controversial book Wealth and Poverty - a manifesto of supply side economics - remains one of the most colorful and persistent proponents of Reaganomics. He argues that the technological revolution and marginal tax cuts are producing an economic boom that makes debt worries insignificant.

The fact that total debt in the US - consumer, corporate and federal - is now 170% of GNP does not mean much. Our rising debt reflects the unexpected collapse of inflation in the early 1980s. This lowered nominal GNP compared to existing debt and unexpectedly raised real government spending. Moreover, the $264 billion we owe to foreigners is a good sign. It shows that the US economy continues to attract foreign capital.

Debt panic has been a perpetual pitfall for economists since the industrial revolution when Adam Smith and David Hume were alarmed by growing debt. Now, the Guernica howls over the debt spring from a lack of tenable complaints about the performance of the Reagan economy.

The basic problem is single entry bookkeepers who lovingly tally liabilities and ignore assets. What really matters is the growth we've had in assets, household net worth, manufacturing productivity, and in the economy at large. Technology and entrepreneurship are advancing explosively. And immigrants, our most important asset, keep coming in waves. These positive factors dwarf the debt.

Investment: The Problem Is the Solution
Debt is bad when it is spent unwisely. Debt is good when it is channeled into investments that lead to greater growth and, subsequently, to the ability to defray debt. The US is the only major industrial country that has substantially increased its investment share of GNP over the last six years. Starting in 1983, producers' durable equipment has risen more than 40% as a share of GNP Since 1980, even official data show business fixed investment rising from 11.5% to 12.4 % of GNP. Japan, on the other hand, has reduced its fixed investment share of GNP by 4.1%.

With all forms of investment rising as a share of GNP, consumption had to drop. Even so, this failing consumption was actually personal investment in durable technology like computers, software, cars and VCRs.

Some economists insist that US investment lags behind our rivals'. They don't measure correctly. "All government spending is consumption," they say, and fail to mention that all the other OECD countries, to which we compare ourselves, categorize a large share of their government spending as investment. Education, research and infrastructure all fit under the investment rubric.

So we shouldn't confuse consumption apples with investment Apples. Adjusting for the investment portion of government spending indicates that American investment as a share of GNP rose from 27.2% in 1980 to 31.7% in 1986.

Conventional economists make another significant mistake when they calculate "net" investment as a percentage of GNP. They don't grasp that the US is now massively investing in fast-depreciating high technology, or consider that although the new capital equipment used in the electronics industry takes up less plant space, it is far more productive.

For example, when a semiconductor firm moves from five inch to eight inch wafers, as IBM is doing, and from 100 thousand to nearly a million transistors on an average chip, the increase in productivity is tenfold. This productivity gain is what eliminates the need for a bigger, much costlier factory.

So, perhaps we are investing less in big capital-intensive plant facilities. But this is not important because we are investing more in capital-efficient new technologies. Again, it is the bookkeeping that confuses. To the extent that investment shifts from warehouses to just-in-time systems that require less space for manufacturing, investment will seem to drop.

So, the apparent "problem" of failing investment is really a part of the debt solution. Investment isn't dropping. The capital efficiency of investment is increasing. As a result, the US has witnessed a six year stretch of manufacturing productivity growth rates that are the postwar era's highest. These rates are almost 50% higher than Japan's. Manufacturing productivity growth has surely exceeded official estimates. For example, government statistics seldom measure software investment. And most economic analysis does not show that the productivity of new software products accounts for a steadily rising share of the value added in the computer industry.

The flat service sector productivity statistics simply do not accurately reflect the productivity advances in medicine, new drugs, the financial sector, credit cards, conveniences, retailing, software vendors, video shops and new forms of insurance. If new products cannot be compared to any other unit of output, how can we show productivity growth? That is the problem left unanswered by the official statistics.

A decrease in the savings rate doesn't matter when assets, real profits and investments are increasing. Household net worth has grown at a pace of 7.5% annually since 1980, compared to a 2.9% rate in the 1970s.

The value of corporate equity has risen $1.7 trillion since 1982. Compare this to the corporate sector's $600 billion loss over the previous six years when savings rates were higher.

Rising assets and foreign investment compensate fully for the reduction in savings as a share of GNP or household income.

The Trade Deficit
The US economy is much stronger than it was five years ago. However, the rest of the world, with the exception of Asia, has been in a virtual depression. What growth the rest of the world has achieved has largely derived from government consumption and exports to the US. In other words, we run a trade deficit chiefly because we are the only country that doesn't have the privilege of exporting to the American market.

We have to realize that everyone cannot run surpluses at once. Nothing would be worse for the US and the world economy than if the US were to balance its trade deficit. Only balancing the budget with tax hikes would be as bad.

Japan cannot possibly balance trade with the US while saving more than it invests. Japan's growth fate has dropped drastically, from an average of about 7 % a year to about 3 % a year. Thus, they have reduced investment rates and growth rates, but not savings rates. This situation has produced their huge capital surplus.

So, when looking around the world for investment opportunities, the Japanese choose the most competitive place - the US. Since they can't simultaneously invest in the US and buy our exports with the same dollars, their capital surplus - really an investment deficit - necessarily entails a US trade deficit.

In short, our debt to foreigners is a completely positive flow of investment into the United States. We attract this investment flow with our lower tax rates, better investment opportunities and deeper commitment to capitalist ideology.

Government Spending
The US budget deficit is not a particularly positive development. Between 1981 and 1986 government revenues increased 11% in real terms while spending increased 24%. But the deficit problem in no sense comes from the revenue side of the ledger. Government spending is the problem.

The government cannot continue to increase spending in real terms twice as fast as it takes in revenue. But the best single antidote to this problem is the Tax Reform Act which comes into play in 1988. It will reliably increase government revenues with collections from upper-bracket taxpayers.

Even in the period from 1981 to 1985, we increased federal tax revenues by $44 billion. Taxpayers with incomes over $100,000 per year paid for 86% of this gain. And during the first seven months of the current fiscal year, federal tax revenues were 13 % higher than last year. Moreover, the US federal deficit is expected to fail by 25% this year.

Economic Hypochondria
America is going into debt to invest in a future with extraordinarily promising opportunities. And we will be able to pay off our debts with growth stimulated by tax cuts and new technologies.

Those who think otherwise are part of a national outbreak of hypochondria. The trouble with hypochondria is that it often leads to iatrogenic illness. The real danger today is not the debt, but the likelihood that doctors of economics will administer real wounds in an attempt to correct nonexistent problems.

back to index