Economic Policy for the New Administration and Congress

Remarks for the Boston Economic Club
Dean Douglas Elmendorf
March 8, 2017

Thank you. I am delighted to have this chance to talk with you today. And I am delighted to talk about economic policy, which is a subject of tremendous importance for people’s material well-being, for their social well-being, for the cohesiveness of our society, and for our international leadership. I feel very fortunate to have been engaged in economic policymaking at the national level for the past 25 years, and I look forward to being similarly engaged for many years to come.

National economic policy is potentially on the cusp of a dramatic transformation. We have a new Administration and a partly new Congress. Moreover, the President, a majority of Senators, and a majority of Members of the House of Representatives are all Republican for the first time in a decade. One might expect a clear and sharp turn in a conservative direction.

However, at a panel of conservative policy wonks that I hosted at the Kennedy School two weeks ago, the speakers expressed far more pessimism than optimism about what lies ahead. Why are they pessimistic? I heard two main reasons: First, the President and his closest advisors appear to hold a set of views that are traditionally conservative in some ways but not traditionally conservative in others. Second, the Administration and Congressional leaders may not be very effective at moving policy in the directions they prefer, because changing policies is always difficult and is especially difficult with inexperienced leaders and followers---in this case, an inexperienced Administration and many Republican Members of Congress who are practiced at resistance but inexperienced at cooperation. I would add a third factor of my own: Americans have roughly split their votes at the federal level between Democrats and Republicans for more than a decade, so control of the government can be quite transitory if one does not broaden one’s base of support.

For all of these reasons, predicting the economic policy that we will see in the next two years is very difficult. If you are interested in my predictions, you can ask during the question-and-answer period, and I will be happy to tell you. But I want to focus now on what I think should be done in economic policy.

What Should Be the Goal of Economic Policy?
The starting point for any discussion of policy should be: What goal are we trying to achieve? In my view, the principal goal of economic policy should be to raise living standards for lower- and middle-income people.

Here is why: According to official statistics, between 1979 and 2013, real gross domestic product (GDP) per person in this country increased 72 percent, while household incomes before accounting for taxes and government benefits rose 18 percent in the bottom quintile of the distribution, 12 percent in the middle quintile, and 85 percent in the top quintile. Those specific numbers, which come from the Commerce Department’s Bureau of Economic Analysis and from the Congressional Budget Office (CBO), understate the true increases in people’s incomes because the data do not fully capture quality improvements or the introduction of new goods and services. Moreover, the measurement of household incomes is fraught with many other challenges. But even if we do not put much weight on those specific figures, it is clear that the market incomes of people across most of the distribution have increased by a relatively small amount during the past few decades.

A lack of economic opportunity for many Americans can be seen in other measures as well. For example, over the past 50 years, the rate of labor force participation for men between the ages of 25 and 54—so-called “prime-age” men—has slipped from about 98 percent to about 94 percent for men with college degrees but has tumbled from about 97 percent to about 83 percent for men with only a high school degree or less. Various factors are at work here, but one important factor is a shortage of desirable jobs for less-skilled men.

Moreover, underlying economic forces will probably make these problems worse over time. For example, there are roughly 3½ million drivers of taxis, buses, and delivery vehicles in this country. Many of those drivers are men without college degrees, and many are earning enough to put them in the middle class. But the rise of self-driving vehicles will probably cut the number of those jobs substantially over the next few decades. Similarly, manufacturing jobs will not increase to any great extent in this country, regardless of our policies on international trade, because the primary cause of the decline in those jobs has been technological advances in manufacturing. Unless those advances stop, there will be further downward pressure on compensation for less-skilled people in this country.

Slow income growth and a lack of economic opportunity for lower- and middle-income people are clearly harmful for the material well-being of those people. That situation is also harmful for those people’s social well-being, because good work and good pay are integral to people’s sense of self-worth and to their ability to engage fully in our society. We can see the social consequences of the economic challenges facing less-skilled workers in, for example, the frightening rise of opioid use, the growing divergence in out-of-wedlock birth rates by education level, and the sharply different trends in life expectancy by education level. This situation is damaging to our social cohesion and political process, because many lower- and middle-income people feel a growing distance from higher-income people and a growing frustration with our country’s policies. And the situation weakens our country’s international leadership because it casts doubt on the desirability of our political and economic system and because people’s frustration hampers our ability to adopt policies that would enhance our position in the world.

Therefore, as I said, the primary goal of economic policy should be to raise living standards for people of modest means. I realize that my explicit focus on a distributional objective may be unsettling to some listeners. People often talk about overall economic growth and give less weight to distributional issues on the presumption that a rising tide will lift all boats. But the rising tide in this country in the past few decades has not lifted all boats to anything like the same degree, so we need to face distributional issues head-on.

I want to be clear that I do not view economic policy as a zero-sum activity and I do not like setting people against each other. Many of the policy recommendations I will make today will raise overall GDP as well the incomes of lower- and middle-income people. But sometimes in making policy, we face tradeoffs between maximizing the size of the total pie and increasing the size of pieces for certain people. When that happens, I think we should reject policies that would boost total income but reduce living standards of lower- and middle-income people, and support policies that would diminish total income but raise living standards of lower- and middle-income people.

What Economic Policies Should Be Adopted?
If one accepts the goal for economic policy I have offered, what policies should we adopt? Many policies might be helpful, but I will focus on six types of policies that I think are especially important. Here are my six recommendations.

First, we should empower people to be effective in well-paying jobs by increasing public investment in education and training for people who do not have good access to education and training today. When the development of new tools and techniques in farming put agricultural employment on a downward trend in this country, we moved toward universal high school education. Now that manufacturing employment has fallen to only 10 percent of total employment, and jobs for less-skilled people in the services sector are under pressure, we should improve the education people receive through high school and significantly increase the education and training they receive after high school.

We should focus that investment on people who do not have good access to education and training today. That focus is important both because the overall economic return would generally be higher and because we would enhance economic opportunity for people whose opportunities are currently limited. That means more preschool education, more support for primary and secondary education in low-income areas, more slots at community colleges, and more mid-career training. For primary and secondary schools, we should ensure that we are getting our money’s worth---something that the evidence suggests can be facilitated, in part, through greater competition that is managed by local school districts (such as charter schools that meet certain requirements but not through unrestricted vouchers). For community colleges and mid-career training, we should invest in education that is linked to specific jobs and prepares people for those jobs, because that approach is usually more effective than general education.

We should also encourage less-educated men to enter professions they have traditionally been reluctant to enter but are of growing importance in the economy. For example, a friend recently sent me a speech where he said that we should “make work in the caring professions acceptable and desirable to … working class white males”; I agree.

Second, we should develop mechanisms that help people with jobs that are not well paid or are temporary to build retirement savings, obtain health insurance, and receive other non-wage benefits. Low-wage workers who are employed on a long-term basis by large businesses often participate in those firms’ pension plans, health insurance, and other benefit programs. And because those programs have been developed for businesses’ entire workforces, they generally provide substantial benefits. However, fewer low-wage workers receive such benefits today because of increased outsourcing of low-wage work and growth of alternative work arrangements such as temporary help, on-call, and contract work. Many of those benefits are difficult to generate on one’s own, because they require financial and legal expertise or involve insurance in which many people need to participate.

Therefore, we need to develop alternative mechanisms for people to accumulate retirement savings, invest those savings effectively, withdraw those savings at a sensible pace, obtain health insurance, pay for health insurance, and so on. For example, we can create saving vehicles that encourage saving for retirement and make savings portable as one changes jobs. We can create markets for health insurance in which people who are not long-term employees of large businesses can buy health insurance even if they develop health problems. And more.

Third, we should help people find good jobs by keeping the demand for workers strong through monetary and fiscal policy. Strong growth in employment in the past few years has helped many people find jobs and receive higher pay. It has also kept in the labor force people who otherwise would have left out of discouragement: Relative to the trend decline in labor force participation, we have seen an increase in participation during the past 3 years amounting to roughly a million people. Thus, the return to full employment has been very important in both economic and social terms.

But maintaining full employment will be difficult. In each of the past 3 recessions, the Federal Reserve has cut the federal funds rate by more than 5 percentage points. With equilibrium interest rates now exceptionally low by historical standards, the funds rate will not have reached 5 percent when the next recession hits, so the Fed will not have as much room to cut. The Administration and Congress should not object if the Federal Reserve again uses nontraditional methods for achieving expansionary monetary policy, such as quantitative easing.

Even so, countercyclical fiscal policy will be even more important in the next downturn. Policymakers should put in place stronger automatic stabilizers---that is, cuts in taxes and increases in spending that would take effect automatically when the economy falters---and should be ready to provide additional fiscal stimulus if necessary. A rush to normalize fiscal policy was the biggest policy error during this past economic recovery, and we should not let appropriate concern about long-term fiscal problems prevent appropriate short-term fiscal stimulus in the next recession.

Fourth, we should put greater emphasis on buffering the adverse effects of immigration and international trade on some people’s incomes. Economists have known for a long time that greater immigration and trade generally raise a country’s average standard of living. We have also known for a long time that greater immigration and trade hurt some people’s standard of living. That second effect may or may not seem important if different people are being hurt at different times and if everyone’s income is rising briskly for other reasons. But it is surely important if the same people are being hurt over and over, and if those people’s incomes are also being hurt by technological change and other forces. That is what has been happening to less-educated workers in this country. In addition, we should acknowledge that concentrated job losses in certain communities and regions have particularly large social costs. And we should acknowledge that people value stability as well as growth: Keeping a job with which someone is familiar and in which they take pride may well matter more than incremental improvements in the person’s purchasing power.

We should also recognize that immigration affects not just the economic environment but also the social environment in ways that some people find understandably unsettling. People born outside the United States now represent a larger share of the population than at any time in roughly a hundred years, so we should not be surprised that some people think the country is changing in ways they do not control and do not like.

My colleague Dani Rodrik wrote 20 years ago that “the most serious challenge for the world economy [is to ensure] that international economic integration does not contribute to domestic social disintegration.” Half-a-dozen years ago, he added: “Countries have the right to protect their own social arrangements, regulations, and institutions. That’s more important than squeezing out the last bit of purported efficiency gains from trade.”

Therefore, as we set trade and immigration policies, we should make those policies good not only for the country as a whole but also for lower- and middle-income workers. That means giving extra support for mid-career retraining. It may also mean foregoing or at least slowing changes in immigration and trade that would help the country as a whole but be hard on people whose economic and social circumstances are already shaky.

Fifth, we should “do no harm” through changes in federal budget policy and should maintain the current amount of federal benefits for lower- and middle-income people. Some people assert that the safety net has become a generous “hammock” that has reduced work and been ineffective at reducing poverty, so cutting benefits might actually help beneficiaries. However, that conclusion is not consistent with the evidence.

According to estimates by CBO several years ago, nonelderly households in the bottom quintile of the income distribution receive about 3 percent of total income before accounting for federal taxes and benefits and about 7 percent of total income after including those taxes and benefits. For households in the middle quintile, the corresponding figures are 14 percent and 14 percent, and for households in the top quintile, 55 percent and 49 percent. Those estimates predate the benefit and tax increases in the Affordable Care Act, which increased the progressivity of the federal budget but did not change this basic picture. Thus, federal taxes and benefits provide substantial help for lower-income people but leave them notably worse off than people in other income groups, while being a wash (on average) in the middle of the distribution and reducing income higher in the distribution. That is the direct effect of the benefits and taxes, and it suggests that cutting benefits would make lower-income people worse off. But what about the effect of benefits on people’s work effort, the possibility that benefit cuts could enable reductions in budget deficits or tax rates that would spur the overall economy, and the disappointing outcome of the War on Poverty?

It is true that cutting benefits would probably increase work by the recipients, but the evidence suggests that the increases would generally be small. That is partly because weak demand for labor, as we experienced for several years in the wake of the financial crisis, frequently limits job opportunities for less-skilled people, and partly because family needs, drug problems, mental health issues, and physical limitations reduce people's willingness to work. Indeed, the labor force participation rate of both prime-age men and prime-age women is lower in the United States than in most other developed countries, despite those other countries’ more expansive safety nets, so benefits are not the dominant factor in determining participation.

It is also true that lower benefits would allow for a combination of smaller deficits and lower taxes, which would increase overall GDP. But there is no evidence that the income gains that might result for lower-income people would be large enough to offset the loss in their benefits.

It is further true that the War on Poverty has not succeeded in eliminating poverty. Some people point to the fact that the official poverty rate has declined only slightly over time despite federal benefits. However, that official measure excludes SNAP (formerly known as food stamps), Medicaid, housing vouchers, the earned income tax credit, and other programs that constitute the War on Poverty for working-age families, and measures that include those benefits show a marked decline in the poverty rate during the past several decades. Other people note that the percentage of people whose pre-tax-and-benefit income is below the poverty threshold has not fallen notably over time, so the War on Poverty has not eliminated the causes of poverty. However, one cannot realistically expect the amount of benefits we have provided to low-income working-age people---as distinct from the much larger benefits provided to people over 65---to have overcome the effects of technological change, globalization, and other forces that have depressed wages for less-skilled people. Moreover, there is a growing body of evidence that children in lower-income families that receive certain government benefits do better in the labor market when they grow up than children in families that do not receive those benefits. So, if we want children in lower-income families to have a stronger start in their lives, reducing benefits received by those families would be a mistake.

I am not arguing that safety net programs are perfect as they stand. We can and should make changes to improve them. Recent proposals by groups of experts from the American Enterprise Institute and the Brookings Institution provide valuable starting points. However, we should not pretend that those changes would reduce government spending significantly without hurting the people affected.

That includes, by the way, changes in the Affordable Care Act (ACA) that would significantly reduce the number of people with health insurance. The evidence is clear: There are no alternatives to the ACA framework that would achieve similar levels of insurance coverage at significantly lower budgetary cost or with significantly less restrictive insurance-market rules. If the Administration and Congress make changes that substantially reduce budgetary costs, many people will lose health insurance and be worse off. Moreover, because the ACA provided subsidies to lower- and middle-income working-age people without employer-provided insurance---the largest group of Americans that were not already receiving federal subsidies for health care---cutting those subsidies would hurt people we should be trying hard to help.

Sixth and last, we should support people’s incomes and strengthen social ties by increasing federal investment in infrastructure. Under the current caps on annual appropriations, federal investment in infrastructure---such as highways, mass transit, and water treatment facilities---will soon be smaller as a percentage of GDP than at any time in at least 50 years.

That is not forward-looking, growth-oriented policy. The evidence suggests that additional federal investment in infrastructure would raise future output and income. Just maintaining the traditional amount of investment relative to the size of the economy would require a substantial increase in the caps. Moreover, we should probably increase federal investment relative to its traditional amount, because interest rates are low and will probably stay low for an extended period. The yield on 10-year Treasury notes was 8 percent at the end of 1990 and 5 percent at the end of 2000, and it is only 2½ percent today even with the run-up of the past few months. That is a sea change in the economic backdrop for fiscal policy. The implications of low rates depend to some extent on the reasons why rates are low, and I explored this issue at length in a paper with a co-author at Brookings. The bottom line is this: With interest rates lower than in the past, the direct costs to the government of borrowing, and the indirect costs to the economy of government borrowing, are lower too. As a result, we should have more federal debt and do more federal investment than we would otherwise.

Public infrastructure can be especially important for the well-being of lower- and middle-income people because they are less able to use private substitutes for public services. Higher-income people can use private cars when mass transit is lagging, while many other people cannot; higher-income people tend to have more flexible work schedules and can arrange for more deliveries when roads are congested, and higher-income people can afford to buy private water when public water is unhealthy, which many people cannot. Thus, good infrastructure tends to draw citizens together, while bad infrastructure divides them. In our divided and polarized society, strengthening social ties is especially important.

When we invest public dollars in infrastructure, we should spend the money wisely. As we choose transportation projects, we should apply cost-benefit analysis more consistently, we should pursue projects that have benefits across the income distribution, and we should charge fees to users when we can so that our infrastructure is used efficiently.

That concludes my list of economic policies for raising living standards for lower- and middle-income people. Many other economic policies might be helpful as well, but I focused on ones that I think are especially important.

You have undoubtedly noticed that my list of recommended policies overlaps only in limited ways with the policies being developed by the new Administration and Congress. That limited overlap worries me greatly. The public rhetoric, at least, of our elected leaders on both sides of the aisle suggests that we have a broad consensus to make our economic system work better for Americans who feel left behind today. Unfortunately, I think that many of the policies in the headlines today will not succeed at that goal.

If our shared goal for economic policy is to improve the lives of people of modest means, as I think it should be, then we should evaluate proposed policies by whether they are advancing that goal, and we should ground those evaluations in evidence about the effects of different policies. If we do that, we can make real progress. Thank you.