Confessions of a One-Armed Economist

Article excerpt

I am not here to present any grand new vision of the role of economics and of economists. Rather, my purpose today is to show how useful it can be to combine some modest amount of economic analysis with lots of experience and application. I try to keep in mind the legendary plea of President Harry Truman: "I'm tired of economists who say, 'On the one hand ... and then on the other hand.' Send me a one-armed economist."

The key economic questions that bedevil our fellow citizens are of longstanding. I will try to deal with some of them today: How can we improve the performance of the economy? How can we simplify the tax system and reduce waste in government? Can we do something about the explosion of health care costs? How can we reform corporate governance? Can we say something new and useful about government regulation? How much defense can we afford? Should we worry about the trade deficit? Is globalization a boon or a bane?

Let us now take up each of these issues.

Innovations in Economic Policy

Effective economic policy must go beyond conventional monetary and fiscal measures, important as they are. We need to improve the basic structure of the economy so that it can function better in good times as well as bad. We must remove the structural barriers that prevent us from achieving a pace of economic expansion that is both more rapid and more durable than our customary experience.

Many of these structural defects arise from the operation of federal government policies and programs. Let us focus initially on two major categories: the composition of government spending and the structure of taxation. As we will see, reforms in both groupings can be designed to further more fundamental economic objectives. The array of government programs that affect the economy is staggering--and also a basis for serious budget cutting.

Five guidelines can be helpful for improving the way that government spends our money:

(1) Focus budget cuts on the large consumption part of the budget (what the public accurately calls handouts) rather than on the small investment portion. Investments in schools, roads, airports, libraries, and fire stations raise the efficiency of the economy in the years ahead. Transfer payments (that is, handouts) do not generate such a future flow of benefits.

(2) Target for cutback the subsidy programs that benefit limited groups of the society. I favor equal treatment of farm subsidies, labor subsidies, and business subsidies--cut them all out.

(3) Avoid spending programs which merely offset problems caused by regulation. The sensible alternative is to correct shortcomings in regulation directly.

(4) Privatize all those activities that are properly the responsibility of the private sector. There is no good reason why the Government Printing Office should compete against Rand McNally in selling maps to the public.

(5) Use economic efficiency as a basic factor in deciding what programs should be in the budget and which should be out. The constant question facing the governmental budget reviewers should be, "Is there a better way of achieving the public objective?"

There is one aspect of government activity that warrants special attention--the relationship to the pace of research and development (R&D), which is what generates technological progress and innovation. Most federal expenditures for research and development (R & D) are not motivated by the desire to promote R & D per se. Rather, they are designed to support a specific program objective which may or may not have a high technology content--energy, commerce, health, agriculture, etc. All of the expenditure approaches possess a basic shortcoming: the government chooses which firms are to do the R & D and the specific fields to which the money is to be devoted.

In contrast, a tax incentive for business firms to finance and perform R & D is the private sector approach to fostering innovation. …