E L E C T R O S P H E R E    Issue 2.03 - March 1996

The New Economy, Stupid

By John Heilmann

On a chill winter night in northwest Iowa, in a town so small the local inn can call itself The Hotel with-out fear of confusion, Phil Gramm is preaching to the converted. "Friends," he says, "I know some people hear me talk about what America can achieve, and they say, 'That sounds like a Norman Rockwell painting'. Well, to those people I say, 'Why not?' As I travel around Iowa and around America, many of the families I meet look a lot like the families in Norman Rockwell's paintings.

"I believe we can bring back the American dream for those families," Gramm continues, his eyes bugging and and his drawl thickening as he builds up to what has become the signature line of his one-size-fits-all campaign speech. "But I also believe something else. If we don't dramatically change course, in 20 years we won't be livin' in the same America we grew up in."

For almost two decades now, Gramm's formulation has been at the heart of the Republican message: that going forward would mean going backward; that the future is a foreign country, while the past - well, the past feels like home. By strategically deploying their nostalgia for the 1950s, conservative politicians have sought, often successfully, to exploit the anxieties of voters about social and cultural decay, from violence in the streets to sex in the media (or is it the other way round?).

Sometimes, though, you can't go home again. When Gramm talks about the golden years, he's talking about the post-war economic boom. And since that boom ended in the 1970s, the economy has changed fundamentally. From Bill Gates and George Soros to the Web and the Net, from derivatives and fractal finance to Turbo Tax and ubiquitous e-mail, information technology and globalisation are changing the ways in which wealth is created. This looks like good news for America; its companies dominate leading edge industries; its economy is, by common consensus, the most competitive in the world. But the distribution of wealth has changed, too. For most Americans, incomes are stagnant or worse. And the gulf between those riding the crest of the wave and everyone else is widening fast.

All of which raises obvious questions for Gramm - questions I get the chance to ask him after his speech, in a car on the way to a nearby airstrip. Questions like: Isn't it true, in economic terms, that we're al-ready not "living in the America we" - or at least he - "grew up in", and we never will again? That the transitions from an industrial to an information age and from national to global markets are causing huge upheavals in the way people work and how much they earn? And if so, doesn't the government need to redefine its role to adapt to this new economy?

To which Gramm replies, "Awww, I'm not gonna get caught up in a bunch of buzzwords."

A few minutes and a few more cranky comments later, Gramm gets around to answering. He does, it turns out, believe that the American economy went through a "profound restructuring" in the 1980s, when "foreign competition forced us into a big re-trenchment." But that phase, he says, is over, having given way to the less earth-shattering "information revolution," the main impact of which, he argues, is "the elimination of a layer of white-collar middle managers." As for a new sort of relationship between government and economy, he says, "I don't see it."

As the car rolls to a stop, so does Gramm. "Look, old economy, new economy, the solution's the same: less government, more freedom. I am not worried about the ability of Americans to deal with change."

Four years ago, George Bush adopted a strikingly similar attitude - and suffered one of the most humiliating defeats ever. The incumbent lost to the philandering, draft-dodging, dope-smoking, liberalish governor of a small, poor, obscure southern state. Bill Clinton told the voters that America's economy was in the throes of a once-a-century structural transformation; a new economy (a term that Clinton introduced into the national conversation) was being born, full of enormous promise but posing real challenges. To Bush, it was all - to borrow a phrase - a bunch of buzzwords.

But the voters liked it. Clinton was convincing, Clinton won and Clinton was right: the transformation he talked of has since accelerated at mind-bending speed. For all that, Republicans like Gramm, or front runner Bob Dole, still seem baffled at best. They offer the same policies they've been running with for 50 years.

You might think that looked good for the president. But for the past four years he hasn't really engaged with the topic, either. He understands the new economy as well as any politician alive. But his responses to it have been all over the map - at times visionary, at times retrograde - while his political failures have left him defending some of the least forward-looking positions imaginable. As Rob Shapiro, top economist at the Progressive Policy Institute, a centrist think tank in Washington, DC, puts it, "Both parties are mired in the old paradigm, with this prepostmodern view of the economy ... that leaves neither party with much to say about the issues that really count."

If that sounds kind of theoretical, consider some facts and figures. The information economy has arrived. More Americans make computers than cars; more make semiconductors than construction machinery; more work in data processing than oil refining. Since 1990, US firms have been spending more on computers and communications gear than on all other capital equipment combined. Software is the country's fastest-growing industry. World trade in information-related goods and services is growing five times faster than in natural resources. And world trade in everything is growing fast. Imports and exports have tripled as a proportion of America's GNP since the 1950s.

But this has not translated into real economic wellbeing for all. During the 1950s and 1960s the old economy provided growth rates of 4 per cent. Since the '70s the average has been 2.3 per cent. Adjusted for inflation, the typical worker's hourly wages have fallen substantially. Gauging what's happened to family incomes has long been the bloodiest battle in the political wars over official statistics, but by 1995, one conclusion was so unduckable that even most conservatives had reluctantly accepted it. Over the past 20 years, the top fifth of American earners have done swimmingly, the middle classes have barely kept afloat and the working class and the poor have sunk like rocks. That is why, despite three years of steady economic growth, record stock market levels and the lowest "misery index" (the sum of the unemployment and inflation rates) in a quarter century, a vast swath of the electorate remains as anxious as ever.

These people want a clear vision of how government can encourage the new economy to flourish while ensuring all Americans an opportunity to partake of its benefits. A switched on Republican party and a switched on Democratic party would offer different sets of policies, both plausible, based on such visions. Yet for either side to devise such a platform would require getting beyond its old economy identity and constituents. So far, no dice. Democrats remain the party of big labour and Republicans the party of big business.

The attraction of Clinton in 1992 was that he offered a "third way." In this year's race, though, none of the mainstream candidates can make that claim. They can't offer the clear vision needed. So voters look like getting a choice between the discredited and the disconnected, the muddled and the mean, the hopeless and the clueless.

Outsider insights

As it happens, there are two candidates who understand what's going on. They're both Republicans; they're both from outside mainstream politics. And neither has a hope in hell of being elected president.

I spent last Labour Day with Pat Buchanan. From a bandstand in the middle of a small lake at a park in central Florida, Buchanan shared his vision of the new economy with the workers at the Townley Manufacturing Company's annual Labour Day barbecue. "Bill Clinton has sacrificed the American worker at the altar of his New World Order," he exclaimed. "This New World Order is being constructed not for the benefit of you and other American families, but for the benefit of a corporate and financial elite that has no loyalties except to the bottom line of a balance sheet. While the profits of multinational corporations are soaring, the real incomes of working Americans have been falling steadily for almost 20 years."

Later, Buchanan assured me he was aware of the new economy's benefits. "The medical breakthroughs, the computers, my 37 varieties of shirts," he listed. "But we're paying a price for all these consumer goods. The social fabric is tearing. Sure, there are winners: knowledge workers, stockbrokers, people like me. But there are even more losers: men who work with their hands, with tools, machines. They're alienated from this go-go, turbo-charged, two-tiered global economy. They want the old America back."

There's a lot of truth in what Buchanan says. Economists have offered a range of suspects on which to pin the blame for America's low growth in wages. There are the forces of globalisation, which lock American workers into competition with low-wage immigrants at home and low-wage labourers abroad. There's the shift from manufacturing to the service sector, where there tend to be lots of "bad" jobs and precious few "good" ones. And there are new technologies that push up demand for the skilled and the sophisticated while pushing the less savvy down the wage scale or out of their jobs entirely.

"It's like Murder on the Orient Express," says Gary Burtless, an economist at Washington's Brookings Institution. "There were 12 suspects, and it turns out they were all guilty of putting the knife in." All of these forces have combined to produce the source of the resentment that drives the Buchanan campaign. Burtless calls it the fundamental characteristic of the new economy: "the widening disparity in people's earning capacities depending on the level of skill and education they bring to the labour market. Not only is the gap growing between winners and losers, but for those people with limited education and skills, there has been an accelerating erosion in how much they can earn, leaving us with lots of families in the United States who are worse off, or no better off, than they were 20 years ago, and lots for whom the prospects for the future are only getting dimmer."

A few months on, Steve Forbes begs to differ. "The economic transformation that we're on the threshold of will unleash an expansive future for America, a future far greater than anything we've ever seen before," Forbes predicted (aptly enough) via cellular phone. "The industrial machine age was about hierarchies, moving assembly lines, big companies, big unions, big cities and big government. The thrust of this new economy is more Jeffersonian. It gives power to individuals. It gives power to people to do things regardless of any physical presence. And we're just at the Model T stage of it. Eventually, everyone will benefit."

Here, again, experts agree. There are few who would go quite as far as Michael Rothschild, leader of the "bionomics" movement, does when he writes: "Information technology is just beginning to stimulate the most powerful tsunami of economic growth in human history. For many decades the 'economic pie' will grow faster than the population, and the widespread rise in living standards will make appeals to class warfare sound increasingly absurd." But more respected and more sober voices think Rothschild has at least half a point.

Paul Krugman from Stanford University notes that the first effects of the industrial revolution in Britain were declining real wages for most workers and a leap in inequality; it took a half-century before technological progress produced widespread middle-class affluence. Stephen Roach, the chief economist at Morgan Stanley, and a bit of a fetishist about productivity, points out that something similar happened in America after Whitney's cotton gin hit the fields - first "profound shocks to the entrenched way of life," then a "renaissance in worker productivity." Both men consider a repeat of that pattern likely.

Unelectable influences

Despite the fact that they are deeply opposed, Forbes and Buchanan are at some level kindred spirits. Alone among the candidates they understand the new economy and its importance. It's just that while Forbes sees only the up side, Buchanan sees only the down; Forbes's optimism is unbounded, Buchanan's pessimism pristine.

Their other similarity is that neither can win. Americans are as unready for an unvarnished plutocrat in the White House as they are for a former TV pundit with ardent backing from the clenched-fist-and-camouflage crowd. But that doesn't mean they don't matter. Quite the opposite. Both of them appeal to substantial blocks in the party, and that means that their presence in the campaign influences the positions and the rhetoric of more mainstream candidates such as Dole and Gramm.

Buchanan's sway has been pernicious. On the basis that native-born Americans are suffering from competition with low-paid immigrants and foreign workers, he proposes a five-year ban on legal immigrants, a vigilant effort to keep out illegals and a trade war. Buchanan would like to dismantle the North American Free Trade Agreement (NAFTA) between the US, Canada and Mexico and repudiate the worldwide GATT accord of 1994. He would slap a 10 per cent tariff on all Japanese goods, a 20 per cent tariff on Chinese goods and a tariff of unknown size on goods from developing countries.

"And that's just the start," he told me. "Once we get a toe in the water, then we swim out. My plan would be to gradually transfer the tax burden away from the taxing of American income and savings, and toward the [taxing of] consumption of foreign goods."

No other Republican espouses a protectionism this naked. Gramm decries it as "a dagger aimed at the heart of everything we stand for." Yet Gramm panders to economic isolationism on the stump. He happily trashes the American-led rescue of Mexico's crisis-hit financial system, asking crowds, "Who's gonna bail us out when we go broke?"

Bob Dole, once an unflinching free trader, has made an egregiously opportunistic move in a generally Buchananward direction. After backing NAFTA in 1993 he waffled on GATT, emitting strikingly Buchananite noises about the new World Trade Organisation and the possibility of it impinging on American sovereignty. Now he says "we're choking on free-trade agreements," and argues that there should be a "cooling-off period" before any more - extending NAFTA to Chile, say - are formulated. Bob Lighthizer, a member of the senator's inner circle and a likely chief of staff in a Dole White House, contends that, although Buchanan's proposal to "impose across-the-board tariffs is probably a little radical," his "analysis of the problem is fundamentally right." In general - and not least because of its gains in the South, home of the avidly pro-tariff textile industry - the Republican party is moving back towards its pre-World-War-Two protectionism. And on top of this, most candidates echo Buchanan's call to curtail legal immigration, if in softer tones.

Waning Republican faith in (relatively) open borders and open trade are the most ominous signs of what the party's ascendance might mean for the new economy. Though Buchanan may have diagnosed the issues correctly, his cures leave a lot to be desired on grounds of efficacy, let alone anything else.

Economists reckon that immigration is responsible for only a tiny percentage of the wage slowdown of the past 20 years; and although cheap foreign labour has had a greater impact, protecting workers in industries facing import competi- tion would likely lead to counter-tariffs that would cost American jobs in export industries. More to the point, even if a few workers felt better as a result of "tough" trade and immigration policies, such cures would cause a host of crippling new ailments. Among the information-based industries key to America's future, foreign mar- kets are critical. Microsoft rakes in nearly 60 per cent of its revenues from abroad - which is why Bill Gates and his fellow high-tech bosses lobbied hard for NAFTA and for the GATT, and why they (like virtually all mainstream economists) are avid supporters of extending such trade agreements as far and as fast as possible.

They are also boisterously pro-immigration. From famous names like Intel's Andy Grove to countless lesser-known figures, foreign-born workers have been central to the success of the high-tech sector; according to the writer George Gilder, fully a third of Silicon Valley's engineers are immigrants. No wonder an attorney from Microsoft recently testified to a congressional committee that immigration restrictions could render the information highway "stillborn."

Dole, Gramm and others in the field are not trying to wreck the new economy. But they appear willing to risk doing so in order to tap into the fears that propel Buchanan's campaign. Only one candidate stands out on these issues: Steve Forbes. Forbes yearns for more free-trade deals and welcomes immigrants. His ebullience about the prospects of the new economy is genuinely infectious, and his grasp of the underpinnings of the digital revolution is surprisingly firm. He is the only Republican who, when asked about the new economy, mentions the Internet. Jeff Eisenach, an adviser to Newt Gingrich and head of the Washington-based Progress and Freedom Foundation, deems Forbes "by far the most information-age-oriented candidate in the race."

Forbes's two main proposals are a rapid deregulation of telecommunications - "we need to open things up and let consumers decide" - and, at the core of his campaign, a plan to "scrap the tax code and replace it with a flat tax that lowers rates across the board to 17 per cent." By 'zeroing out' the capital-gains tax, Forbes contends, his plan would "spur the full power of technological invention and economic growth." On telecom reform, every Republican agrees with Forbes, at least in theory - but then, so do most Democrats. The question is what that means in practice. The history of telecom deregulation shows that constituencies always trump convictions. Whether a Republican party still wedded to big business, and therefore caught between warring entrenched monopolies, can alter that pattern remains to be seen.

What the 1995 telecom debate did show, however, is that there is one area where both Republicans and Democrats think excessive regulation is fine and dandy: content. Failing to comprehend the crucial connection between free expression and economic progress in a networked world, the two parties joined together for one of the more obscene acts of legislative fornication in memory, giving birth first to the Exon Amendment and then to its wretched sibling in the final version of the telecom bill. Has any Republican candidate, Forbes included, spoken out against censoring the Net? Be serious.

Instead, they speak incessantly of cutting taxes. Forbes takes the notion of a flat tax furthest. But virtually all the other candidates have embraced some version of what Dole refers to as "a lower, fairer, flatter tax system." Their theory: slashing taxes will re-ignite vigorous growth, both by leaving consumers with more money to save or spend, and, most important, by increasing the supply of capital available for businesses to invest in ways that make the economy more productive. It is high tax, they say, that has stifled growth and caused incomes to stagnate.

Saying the Republicans' history is skewed on this would be like saying Ronald Reagan is getting on in years. America's tax burden - federal, state and local, as a proportion of GDP - rose in the 1950s and 1960s. Since 1970, it has stayed roughly the same. Which is a bit awkward for the Republicans. As Burtless at the Brookings Institute puts it, "What you have is the most remarkable period of growth, the best productive performance in the history of the US, occurring when the tax burden was going up. The most it's ever gone up in history. Then the tax burden stops going up and ... well, the last 20 years have been pretty shabby. Unfortunately for the Republicans, the correlation goes in exactly the reverse direction of their theory."

If looking back in time makes one key Republican premise seem shaky, looking around the world makes another - that America is "overtaxed" in general - look silly. In fact, with Japan, the US maintains the lowest tax burden of any advanced economy. Forbes and his like-minded rivals claim that this isn't true where it counts: on capital gains, where US tax rates are quite high by international standards. Yet the idea that cutting capital-gains rates would turn out to be a boon to the new economy is questionable precisely because of the nature of the new economy.

"In an era of global credit markets," says Shapiro at the Progressive Policy Institute, "companies everywhere have access to the entire world's capital, from which they can borrow freely at home and abroad. Republicans are right that capital still matters. But given borderless financial flows, differences in the cost of capital reflect expected inflation rates, not differences in tax policy." Shapiro points out that although the capital-gains rate was cut four times between 1977 and 1985, the rate of growth of US net investment did not budge.

And then there is a more fundamental issue. Let's agree that a tax cut would, in the words of Bob Dole, detonate "an explosion of job creation and economic growth." What then? If one of the fundamental characteristics of the new economy is that it yields ever-greater rewards to the smart and the skilled while punishing less-endowed workers, then it's perfectly possible that even a burst in GNP would still leave much of the middle class and everyone below in the same bind they're in now. After all, the past 20 years may not have been terrific compared to the post-war ones, but the economy did grow - and so did income inequality.

With the exception of Buchanan, Republicans have nothing to say about this. Literally. Ask Phil Gramm about wage stagnation, and he tells you that the solution is to cut taxes - odd, considering that wages are stagnating before taxes. Ask Gramm about income inequality, and, after resisting the urge to declare you a Socialist, he launches into a lecture about how the poor need to get out of the wagon and start pulling the wagon like the rest of us and on and on until you realise he's just not going to answer. Forbes is more succinct. Worry not, he says, growth will deliver prosperity to all. But when you mention to him that even Adam Smith (who knew that his beloved invisible hand would usually fail to steer the economy toward the optimal amount of public investment) would probably make the case today for increased spending on, say, job training, Forbes retorts, "The best training comes not from a government agency, because bureaucrats are the last ones who know what to train for, but from employers or from - I know it sounds frivolous - temp agencies."

The comeback kid can't

It's a strange moment in politics when Bill Clinton's views are closer to Adam Smith's than Steve Forbes's are, but there you have it. In 1992, Clinton told voters that America was suffering from two deficits: the budget deficit, naturally, and a deficit in public investment. Taming the first was indisputably necessary. But taming the second - by spending vastly more on education, training, basic research, infra- structure, et cetera - was equally essential. Improving America's stock of "human capital" was the only way the country would remain competitive. And it was the only way all of America's workers would have a chance to share in the bounty of the new economy. The public-investment agenda was the soul of Clinton's cam- paign. He called it Putting People First.

In November of 1992, not long after his victory at the polls, Clinton's economic wizards went to work on a plan to make their boss's pledges real. Hopes ran high. The Democrats controlled both ends of Pennsylvania Avenue; Clinton's ambitions, like his intelligence and charm, seemed immutable. Then reality - and politics - set in. Three years into the administration, the public-investment agenda has disappeared, the Republicans have taken over Congress and balancing the budget has become the sole goal of fiscal policy. Sitting in his office last December, Robert Reich - old friend of Bill, Harvard academic, author of the key putting-people-first text The Work of Nations and now, as secretary of labour, putter-first-in-chief - is rueful. "I'm afraid that, even though voters seem to be shifting their allegiance back toward the Clinton administration, we're still left without much of a mandate for the kind of public policies that would help shift much of the population in the direction the economy is shifting." To Reich, the 1996 election will be a struggle for that mandate, with the vot- ers confronting a choice between three starkly divergent approaches to the new economy. The first, he says, is "Republican trickle-down economics," which holds that tax cuts will lead to growth and growth will benefit everyone.

The second is "protectionism/nativism/ xenophobia," personified by Buchanan but "emanating from Democrats as well as Republicans." The third option, Reich says, is "a strategy of adjustment and adaptation: embracing the opportunities of the new economy and investing in our workers so they can thrive in it; improving wages by upgrading skills; turning our social safety nets into springboards to better employment." Clintonism, that is.

Phrased like this - and you can bet this is just how the president will phrase it - the choice seems a no-brainer. The problem, as Reich's glumness suggests, is that Clinton has manifestly failed to implement Clintonism. "The administration has done very little," Paul Krugman says. "There is no large-scale human-capital program. There is no large-scale infrastructure program. There have been lots of trips by the commerce secretary to big emerging markets for the ostentatious re-signing of contracts that firms have already made there.... People ask me, 'What do you think of Clinton's economic policy?' And in the end, I always find myself saying, 'What economic policy?'"

Krugman's assessment is a touch harsh. Clinton has been bold on some things. NAFTA , GATT and the foundation of the Asia-Pacific Economic Community have made Clinton the political leader most committed to economic internationalism in either party. But the boldness Clinton showed promoting trade has been sorely lacking on other fronts. Having turned the information highway into a flashy campaign issue, for example, Clinton and his cyberpol vice president, Al Gore, handed telecom reform over to the same hoary lot of Capitol Hill barons who'd made no progress on the issue for ages. Two years of futzing and fiddling produced a bill that died in the final days of a gridlocked Congress in 1994.

Most devastating, though, has been the evisceration of the public-investment agenda. In 1992, Clinton promised to pump $200 billion (£125 billion) into human capital (education, training, apprenticeships), technological capital (R&D) and physical capital (highways, bridges, the environment). In 1993, the promise melted away in the face of the demands of deficit-reduction and, crucially, the unwillingness of Clinton and congressional Democrats to attack entitle-ments and subsidies to make room for such new-style spending. What eventually emerged was a public-investment increase less than a fifth the size Clinton had pledged. Halfheartedly, Reich calls this "a modest foundation." Economists such as Burtless call it "trivial - it's like the Nile is having a once-a-century flood and your response is to put three rows of sandbags on the riverbanks."

As the presidential campaign begins in earnest, reviving the public-investment agenda looks hopeless. In the balanced-budget debate that occupied Washington in 1995 and 1996, the question of human capital was reduced to an abject irrelevancy. As this article went to press, the two sides were still haggling over a budget deal. Whether or not a deal gets done, it it's clear that balancing the budget will be a banner issue in the campaign - and that, because of this, Putting People First will not.

Balancing the budget is without doubt a prerequisite to prosperity in the 21st century. Even with the growth provided by a knowledge-based, information-driven economy, paying for the health care and pensions of aging baby boomers will be impossible if a deficit has to be serviced as well.

But at the same time, without massive investment in better education and skills, many workers face a bleak future in the new economy. That the two parties view a balanced budget and investment in hu-man capital as mutually exclusive is perhaps the most damning piece of evidence that neither has a grip on the needs of the new economy. Both matter, and both are achievable.

Government expenditure includes hundreds of billions of dollars in corporate subsidies and tax breaks. It includes a defence budget that gives the Pentagon 90 per cent of its average Cold War funding fully a decade after Russian defence spending fell by two-thirds. It includes a Social Security system that will go bankrupt anyway unless reformed. But, at the moment, cutting into any of that spend-ing is something that the old politics just can't do.

"It's amazing," says Matt Miller, a former Clinton budget aide and now econ- omics editor for The New Republic. "I can come up with a plan that balances the budget in five years, while also raising public investment six times as much as the president did in his first two years - $100 billion in public investment. Now, we can argue about the details. The point is that my plan would require a 10 per cent change in planned spending and taxes for five years. Just 10 per cent. And that, in the political discussion in the United States today, is regarded as being beyond the pale."

Ultimately, the new economy will not be stopped in its tracks by inept or inimical government. But it could be impeded or hastened, diverted or channelled. Trade and taxes, deficits, subsidies, regulations, immigration, infrastructure, education and training, research and development - all are areas where the state can do right or wrong by the new economy. The state's opportunity to do harm - by erecting trade barriers or imposing senseless regulations, for instance - is particularly obvious, and many of the candidates seem worryingly oblivious to it. But the whirl- wind of the new economy will also throw up consequences that government is well-placed to cope with. Even as optimistic a futurist as Alvin Toffler writes of the "immense social dis-locations that are likely to flow from a change as profound as the third wave." The sooner the political class acknowledges those dislocations and faces up to the choices they entail, the smoother the transition from an industrial to an information age will be. This is one reason the 1996 campaign could be so useful. If only its leading players weren't spending all their time either harking back to a past that can never be recovered, or preaching eloquently about a future they lack the courage to claim.

John Heilemann is National Affairs Editor of Wired US. His daily report from the campaign trail, Impolitic, can be found on Hotwired.