Today's date:
FALL 2001


The Terror Recession

Laura D'Andrea Tyson headed the Council of Economic Advisers for US President Bill Clinton and is now dean of the Haas School of Business at the University of California, Berkeley.

NPQ | Does this terror attack threaten to push a weakening United States economy into recession?

LAURA D'ANDREA TYSON | Yes, it certainly does. The likely effect of this kind of attack is to undermine consumer confidence. That is what we saw with the Gulf War. Americans felt patriotic but, at the same time, lacked confidence. Confidence then, too, was on the way down, as it is now. The immediate impact of the terror attacks will be to push the US into negative growth. It doesn't take much since we were almost there already. This is the short-term issue.

In the longer term some of the recovery spending being talked about can reverse negative growth. That will be next year.

NPQ | What is the impact on the world economy?

TYSON | It was the slowdown in the US economy that rippled out into the rest of the world that caused the weakening of the global economy. Since Japan has not been able to operate as a source of growth for the global economy, the US was taking that on. There was a hope that Europe might be an alternative demand, but that hasn't happened. If we tip fully over into recession, then that will increase the downward pressure on the rest of the world.

To reverse this will require a multilateral effort. The European Central Bank has reduced rates. If Europe joins the multilateral effort against terrorism, it can introduce more demand into its economies. Some states have been looking for a way to get out of the tight Maastricht fiscal caps. This emergency might provide them with a good excuse that will ?y politically.

NPQ | What is different now from when the United States went to war with Iraq?

Tyson | Then, the US had a real deficit problem and couldn't run a stimulative fiscal policy. In fact, what the previous Bush administration had to do then was work out a deficit-reduction package and tax increase that broke George Bush's campaign promise of "read my lips, no new taxes." He had to fund that war in a fiscally contractionary condition. This time around we have a large surplus. It is true that the majority of that surplus is currently earmarked for Social Security. But it makes eminent sense that, since the economy is weak and we have this pressing need to rebuild and reinforce our security infrastructure, we dip into that surplus. The American economy has the room to both stimulate the economy and do the right thing for security. One of the reasons not to have a deficit is so that discretionary spending is available when it is needed.

NPQ | What, specifically, would you recommend?

Tyson | An immediate, emergency appropriation to infuse additional spending into the US economy. We have an additional tax cut coming in. Putting $40 billion into the economy for reconstruction and to help the victims is the right thing to do. I would advise that we monitor the economy in the coming months, perhaps determining that this is a down payment to be supplemented when appropriate.

Some of this might be conducted in conjunction with salvaging the airline industry. The damage to the airline industry and air traffic-a major infrastructure of our modern, mobile economy-needs to be addressed as a national policy. An emergency loan or compensation package to help the airlines is essential. On a large scale, money must be spent on airport security. All of this stimulates the economy as a national law enforcement effort.

NPQ | Doesn't all this imply a new level of government intervention in the economy that the Bush team is not sympathetic with?

Tyson | It has long been a proposal for the government to fund airport security, but that proposal has gone nowhere because it was supposedly going to be up to the private-sector airlines to handle that. The fact that this is necessary now brings up a larger question. The US has underinvested in many of the public infrastructure mechanisms on which the marketplace rests-including in security and the modernization of intelligence. US government discretionary spending as a percentage of GDP is at its lowest level ever.

NPQ | Can a weakening American economy afford the kind of war President Bush is talking about?

Tyson | If we are about to enter a war that requires sacrifice and long-term commitment, then we have to recognize that wars must be paid for. That means something must be given up. Coming out of the Great Depression into World War II, we did not have to give up much because we had a huge amount of underutilized resources and capacity. Today's economy in the US, even though we've been focusing on its weakness of late, is a heavily employed economy. There is not a lot of slack. If we are going to wage a war over many years while also rebuilding our security system, that is going to have to be paid for. We are going to have to rethink whether we can have a $2 trillion tax cut over the next 10 years.

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