The Coming Bush Bust

Neoconomy: George Bush's Revolutionary Gamble with America's Future by Daniel Altman (PublicAffairs, 290 pages, $26.95)

Innovation and its Discontents: How Our Broken Patent System is Endangering Innovation and Progress, and What to Do About It by Adam Jaffe and Josh Lerner ()Princeton University Press, 256 pages, $29.95)

Running on Empty: How the Democratic and Republican Parties are Bankrupting Our Future and What Americans Can Do About It by Peter G. Peterson (Farrar, Straus and Giroux, 272 pages, $24.00)

Is there a Democratic view of economics? Under Bill Clinton, Democrats came to stand for fiscal prudence, welfare reform, and a fairly conventional view of foreign trade. Full employment was the main engine of a more equitable income distribution. Clinton also went along with the dismemberment of much of the regulatory state, some of which boomeranged when liberated financial markets erupted in scandals that are still reverberating.

The single most memorable policy of the Clinton era was Rubinomics -- the premise that balanced budgets would allow lower interest rates, steady growth, and high employment. Federal Reserve Chairman Alan Greenspan was a willing partner, though he lived to regret the low interest rates when they fueled a stock-market bubble that was also enabled by an excess of deregulation.

Today, Clinton's entire approach has been reversed by George W. Bush, the surplus is gone, and Social Security is at risk, along with the stability of the U.S. economy. With Congress in Republican hands, nearly all of the Democrats' economic battles have been defensive.

The Republican story is that the economy thrives when entrepreneurship is unleashed: Cut taxes, therefore, reduce regulations, and market forces will do the rest. In this view, increasing the debt is no problem because we will grow our way out of it. Nor is a falling dollar worrisome because the world's investors are still attracted to America's dynamism: A cheaper currency makes our products more attractive in world markets, which will eventually moderate the trade deficit (and in any case, the central banks of China and Japan will keep buying our bonds because they need us to buy their exports).

Today, the ostensible economic issues are the cause and cure of the budget deficit, the swooning dollar, and the burgeoning trade deficit. The deeper question, however, concerns the true dynamics of economic innovation and productivity and their relation to the social distribution of the economic product.

Yet the economic debate is often like the sound of one hand clapping. A return to Rubinomics might be salutary but it would hardly be sufficient. A more full-throated liberal economic agenda, based on a different conception of national goals and means, is largely outside the national discourse. Tellingly, there is a paucity of books spelling out a coherent progressive story. Instead, there are some interesting critiques of Bush's economic policy and of current economic conditions and assumptions.

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Daniel Altman, a young Harvard economics Ph.D. and former student of Martin Feldstein, has written editorials and columns for The New York Times. His first book, Neoconomy, is a useful synthesis of the intellectual muddle that is Bush's economic policy and the risks it is incurring. In 2002, in the wake of September 11, Bush himself sounded like a Keynesian, declaring, “I said to the American people that this nation might have to run deficits in time of war, in times of national emergency, or in times of a recession. And we're still in all three.” Bush liked the concept so well that he invoked it throughout the 2002 congressional campaign, calling this triple threat the “trifecta.”

But as Altman points out, Bush's “neoconomists” were not really after short-term stimulus. Their goal was to reduce taxes as much as possible because they believed that permanently lower taxes would increase the rewards to savings, investment, and hence growth. Incidentally and conveniently, the cuts would increase the after-tax income of a lot of Bush supporters. Altman has a scorecard listing the several taxes that the neoconomists hoped to drastically reduce or abolish: the estate tax, taxes on interest, the dividend tax, capital-gains taxes, and the tax on corporate income. As his story advances, one after another gets a little check mark.

In an attempt to give the narrative some dramatic tension, Altman proposes the dubious premise that Bush's real goals were concealed. At more than 20 points in the narrative, Altman throws in lines like, “The neoconomists hadn't tipped their hand yet, so it was hard to tell what their real plans were,” or, “Years had passed while the neoconomists stealthily but assiduously pursued their dream.” But as any newspaper reader knows, there was nothing stealthy about the supply-side project. The effort to reduce taxes on investment income and corporate profits has been a flagrantly open goal for nearly 30 years.

Altman is at his best when poking holes in the supply-side premise about how the economy works. He cites several pieces of academic research demonstrating that government outlay is often a superior engine of growth to private investment -- not for Keynesian economic-stimulus reasons but because government provides many necessary inputs to greater productivity, from scientific advances to a well-educated workforce. “For around $50 billion a year,” Altman writes, “less than a third of the cost of the tax cuts -- the government could have paid enough to double first enrollment at the nation's four-year colleges.” Or Bush could have forgone the tax cuts and tripled scientific research.

Altman begins to tease out an important, and largely unargued, debate regarding the true sources of innovation -- and, in turn, of productivity and growth. On one axis of the debate that he addresses, the issue is whether tax cuts will truly produce more investment in innovation and growth than certain social outlays. A second axis of debate has to do with the ground rules of the innovation system.

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The original rationale for patent and trademark protection was to reward, and hence promote, innovation. Lately, industry has succeeded in lobbying Congress to increase intellectual-property protections. Patent and copyright terms have been extended. Procedures have been modified to make patents easier to get and “infringement” easier to litigate. Many research products that stayed in the public domain now end up being private property, and the science is balkanized. Corporations have also been more aggressive at limiting the freedom of scientists working on grants or contracts to freely publish their findings.

A recent literature suggests that excessive patent and copyright protection now has the paradoxical effect of retarding innovation. A good primer is Innovation and its Discontents, by Adam Jaffe, an economist at Brandeis University, and Josh Lerner, who teaches investment at the Harvard Business School. As Jaffe and Lerner tell the story, seemingly innocent legislative changes enacted in 1982 have made it much easier to obtain a patent and to harass other innovators for alleged infringement. “In short,” they write, “the reforms of the patent system have created a substantial innovation tax.”

Because future innovations are built on existing technologies, walling off those technologies retards innovation. Indeed, the owner of a patent has every incentive to discourage innovations not under his or her own control. So there is “an inherent tension,” the authors write, between protecting and promoting innovation.” The book offers a wealth of examples from the biotech, software, footwear, and other industries, and recounts hilarious stories of attempts to patent a peanut-butter-and-jelly sandwich and a “method of swinging on a swing” invented by a 5-year-old. In some cases, judges have intervened to compel cross-licensing agreements to serve the seemingly opposite goals of protecting patent holders while promoting general innovation.

Jaffe and Lerner are on to something very important. If anything, they understate the problem by focusing mainly on changes in the procedures for awarding and defending patents. During the same recent era, manufacturers such as Microsoft have tried to crush rivals and turn public goods into proprietary ones. Using the Bayh-Dole Act, the drug industry has taken publicly funded innovations and turned them into proprietary products, capturing a great deal of university-based science along the way. [See Jennifer Washburn, “Hired Education”] The erosion of antitrust enforcement and the excessive protection of patents are part of a common malady afflicting America since about 1980. There is an infant “copyleft” movement aimed at restoring balance and protecting the intellectual and scientific commons. However, the words “Lawrence Lessig” do not appear in Jaffe and Lerner's important but narrow text, and Microsoft is discussed only in passing.

It was the economist Joseph Schumpeter who pointed out the virtuous role of monopoly in capitalism -- up to a point -- because it is the exploitation of monopoly power that generates the profits that finance the next round of innovations. But as Schumpeter also pointed out, this can easily go too far. Getting the ground rules right for innovation is at least as important as getting the balance right between public and private investment, not to mention balancing the budget.

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Running on Empty is the fifth book Peter G. Peterson has written in two decades warning that entitlements are bankrupting America. Peterson is a Republican, but he breaks with most Republicans in criticizing Bush's rising deficits. Indeed, it is the Bush experience that gives Peterson a good reason to write yet another book. Yet his political thesis, embodied in his subtitle's claim that “the Democratic and Republican Parties are Bankrupting our Future,” is anachronistic bordering on intellectually dishonest.

Peterson is a chum of Bob Rubin, but Clinton's fiscal revolution gets exactly one grudging sentence. To Peterson, Democrats are still equal offenders with Republicans in perpetrating budgetary excess. His book is emblematic of a media cliché holding both parties about equally responsible and blaming bipartisan gridlock for the looming fiscal catastrophe that Peterson invariably exaggerates. The combined “unfunded liability” of Social Security and Medicare, he writes, is $27 trillion. But, as Alan Blinder has pointed out, we don't consider our projected defense spending over the next 75 years an unfunded liability. We consider it a necessary outlay that future tax revenues will support.

The latest projection by the Congressional Budget Office puts the 75-year Social Security imbalance at just four-tenths of 1 percent of the gross domestic product. It would have been very useful to read a book on the actual fiscal dimension of the underlying Social Security and Medicare commitments, their relationship to the Bush deficits, and the relatively culpability of the two parties. Peterson's rehash isn't it.

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If economists have agreed on one proposition for nearly 200 years, it is the virtue of free trade. The basic proposition, dating to David Ricardo in 1817, has been that both trading partners realize net gains from trade thanks to the efficiencies of specialization. Economists have conceded that some individuals within nations might lose from the dislocations of trade, but this was a subject for redistribution policy and not an impeachment of free trade; nations as a whole benefited. No serious U.S. politician has questioned free trade for nearly a century. Yet this past summer, a revolutionary article was published in The Journal of Economic Perspectives. The dean of modern economists, Paul Samuelson, at age 89, questioned whether the theory still always makes sense in an era when two immense economies, India and China, can produce much of what is made in America with nearly the same efficiency but at a fraction of the wages. What made news was less what was being said than who was saying it.

In a December cover story headlined “The China Price,” BusinessWeek described pressure on U.S. producers to match prices of products made in China, sometimes below U.S. costs of production. Contrary to the usual story that China's production of low-wage goods simply invites American workers to move up to higher-valued processes, BusinessWeek made clear that all of manufacturing and many service industries are vulnerable.

When immense low-wage nations such as India and China are the trading partners, the Law of Comparative Advantage is overtaken by the Law of One Price. If productivity levels are roughly comparable thanks to equivalent production technology, wages need to roughly converge. For American workers, that means convergence downward.

In this new literature, there is belated acknowledgment of a real problem, but scant discussion of remedy. In a sidebar to the main BusinessWeek story, Paul Magnusson suggests a range of policies, from tougher enforcement of intellectual property and trade rules to U.S. budget balance. But none gets at the root of the U.S.–India-China problem, which is wages in exporting countries that lag far behind productivity growth. The only remedy that avoids downward convergence is some kind of global wage regime, to force faster increases in wages and living standards in export powerhouses, based on rising productivity, so that India and China would be more reliant on expanded domestic markets. That idea is on nobody's political radar screen.

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What is under intensified scrutiny, however, is the increasing size of the U.S. trade deficit, the falling value of the dollar, and the role of the Bush budget deficits. Catherine L. Mann, of the Institute for International Economics, writes of a “global co-dependency” in which the central banks of China and Japan buy U.S. debt and American consumers keep buying their exports. This strategy, she warns, is a “bargain with the devil” because “when their own currencies eventually do appreciate, not only will their exports fall but so, too, will the value of the U.S. assets in their portfolios.” Whether this adjustment will occur gradually or with a nasty thud is anyone's guess. But nobody doubts that the Bush fiscal policy is increasing the risk.

Reading these works, one glimpses pieces of a whole other strategy for the U.S. economy -- one that restores both fiscal balance and social balance by reclaiming a progressive tax system and public outlay. Growth would flow more from the fruits of social investment than from the market casino. More research would stay in the public domain, which would also be good for growth. The social product would be shared more equitably via -- what else? -- taxing and spending. International balance would improve as a consequence of the better fiscal balance, but there would also be pressure on exporters to raise their domestic living standards so that they did not depress ours.

I know of no single book proposing this model. More alarmingly, it is far from what is being offered by today's Democratic Party, traumatized as it is by successive election defeats, fiscal pillage, and counsels of economic centrism. Beginning with Barry Goldwater, the right recovered by thinking boldly, way outside the conventions of the day. Liberals would be well advised to do the same.

Robert Kuttner is co-editor of The American Prospect.

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