[Joint House and Senate Hearing, 109 Congress]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 109-790
 
                  THE ECONOMIC REPORT OF THE PRESIDENT

=======================================================================

                                HEARING

                               before the

                        JOINT ECONOMIC COMMITTEE
                     CONGRESS OF THE UNITED STATES

                       ONE HUNDRED NINTH CONGRESS

                             SECOND SESSION

                               __________

                           FEBRUARY 16, 2006

                               __________

          Printed for the use of the Joint Economic Committee



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                        JOINT ECONOMIC COMMITTEE

    [Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]

HOUSE OF REPRESENTATIVES             SENATE
Jim Saxton, New Jersey, Chairman     Robert F. Bennett, Utah, Vice 
Paul Ryan, Wisconsin                     Chairman
Phil English, Pennsylvania           Sam Brownback, Kansas
Ron Paul, Texas                      John E. Sununu, New Hampshire
Kevin Brady, Texas                   Jim DeMint, South Carolina
Thaddeus G. McCotter, Michigan       Jeff Sessions, Alabama
Carolyn B. Maloney, New York         John Cornyn, Texas
Maurice D. Hinchey, New York         Jack Reed, Rhode Island
Loretta Sanchez, California          Edward M. Kennedy, Massachusetts
Elijah E. Cummings, Maryland         Paul S. Sarbanes, Maryland
                                     Jeff Bingaman, New Mexico

               Christopher J. Frenze, Executive Director
                  Chad Stone, Minority Staff Director


                            C O N T E N T S

                              ----------                              

                      Opening Statement of Members

Statement of Hon. Robert F. Bennett, Vice Chairman, a U.S. 
  Senator from Utah..............................................     1
Statement of Hon. Carolyn B. Maloney, a U.S. Representative from 
  New York.......................................................     3

                               Witnesses

Joint statement of Dr. Matthew Slaughter and Dr. Katherine 
  Baicker, Members, Council of Economic Advisers.................     4

                       Submissions for the Record

Prepared statement of Representative Jim Saxton, Chairman........    22
Prepared statement of Senator Robert F. Bennett, Vice Chairman...    23
    Together with editorials from the Washington Post entitled:
        ``The End of Europe''....................................    23
        ``The Fears Under Our Prosperity''.......................    24
Prepared statement of Senator Jack Reed, Ranking Minority Member.    26
Bar chart, submitted by Representative Carolyn B. Maloney, 
  entitled, ``The Bush Economy: The Distribution of Earnings Has 
  Become More Unequal,'' Bureau of Labor Statistics, Department 
  of Labor.......................................................    28
Prepared joint statement of Dr. Matthew Slaughter and Dr. 
  Katherine Baicker, Members, Council of Economic Advisers.......    29


                  THE ECONOMIC REPORT OF THE PRESIDENT

                              ----------                              


                      THURSDAY, FEBRUARY 16, 2006

             Congress of the United States,
                          Joint Economic Committee,
                                                     Washington, DC
    The Committee met, pursuant to call, at 10:40 a.m. in room 
2322, Rayburn House Office Building, the Honorable Robert F. 
Bennett, Vice Chairman of the Committee, presiding.
    Representatives present: Representatives Maloney, Paul, and 
Cummings.
    Senator present: Senator Bennett.
    Staff present: Chris Frenze, Nan Gibson, Colleen Healy, 
Brian Higginbotham, Bob Keleher, John Kachtik, Frank 
Sammartino, Jeff Schlagenhauf, Chad Stone, Rachel Thomson, and 
Katie Jones.

          OPENING STATEMENT OF HON. ROBERT F. BENNETT,
            VICE CHAIRMAN, A U.S. SENATOR FROM UTAH

    Vice Chairman Bennett. The Committee will come to order. I 
am here for Chairman Saxton, who will be here later. I 
appreciate the indulgence of our witnesses and those who have 
been here on time. The Senate has just conducted a vote, and I 
had to be there to help save the Republic before I came to 
these particular hearings. Why are you all laughing?
    Today, the Committee will hear testimony from two of the 
members of the President's Council of Economic Advisers. They 
will be discussing the recently released Economic Report of the 
President, which is appropriate. The Council of Economic 
Advisers and this Committee were created by the same piece of 
legislation as to get economic advice into the Executive Branch 
and then provide a forum for economic discussions in the 
Legislative Branch. So we welcome you in this one legislatively 
sanctioned activity that we engage in.
    Now, the President has nominated Dr. Edward Lazear of 
Stanford University to serve as the chairman of the Council of 
Economic Advisers. We had his confirmation hearing in the 
Senate Banking Committee earlier this week. When he is 
confirmed by the Senate, he will replace Dr. Ben Bernanke, who 
has been in the news with other assignments. We heard from him 
in the Congress yesterday as the new chairman of the Board of 
Governors of the Federal Reserve.
    But we are pleased to welcome the Council's other two 
members, Dr. Kathleen Baicker--is that close enough?----
    Dr. Baicker. Close enough.
    Senator Bennett [continuing].--close enough--and Dr. 
Matthew Slaughter to the Committee.
    Now, as we look at the Economic Report of the President, we 
do so against the backdrop of a strong and growing economy 
which created 2 million new jobs over the past 12 months and 
more than 4.7 million new jobs since August of 2003. Core 
inflation remains relatively contained, and interest rates are 
historically low despite recent increases by the Federal 
Reserve.
    That does not mean that the economy does not face 
significant challenges in the future. Energy prices remain a 
concern, and, of course, the uncertainties of the global 
economy are always with us, and we face serious long-term 
fiscal challenges tied to the retirement of the baby boomers 
and the entitlement programs that have served us well in the 
past but that are threatened by demographic changes.
    I found it interesting that in this morning's paper there 
was an op-ed piece by Robert Samuelson that posed a very 
interesting question, which is, how can the economy be doing so 
well and people feel so insecure and industries, like Ford and 
General Motors, be in trouble while the entire economy has 
performed better over the last 20-25 years than it ever has in 
a similar period in our history. His answer is competition, 
that the power of competition has made individual industries 
and, therefore, their employees feel more uneasy about their 
economic status even as it has improved the overall economic 
well-being of the Nation as a whole. It is an interesting 
thesis, and I would like to get into that with you as we go 
into the question period.
    [The Washington Post editorial entitled, ``The Fears Under 
Our Prosperity,'' appears in the Submissions for the Record on 
page 24.]
    It is imperative that the Congress and the Administration 
work together to handle these challenges head on. We have to 
deal with entitlement spending. I have watched politicians, for 
the dozen years I have been here, all tell me, yes, Senator, we 
have to deal with that, and we will address it right after the 
election because both sides want to carry the election rhetoric 
to see if they can win just one more election on the past 
rhetoric, and then they will tackle the tough problems, and as 
we keep putting them off, the tough problems keep getting 
tougher.
    We all recognize the challenges that are essential for a 
strong economy: improving our education system, not the direct 
responsibility of this Committee but something we have to pay 
attention to; the issue that Robert Samuelson raises of 
international competitiveness; and we are finally recognizing 
that our present tax system, born in the 1930s, is no longer 
adequate to the challenges of a global economy in the 21st 
century, and at least among some of my colleagues in the 
Senate, we are beginning to have conversations about that.
    So I look forward to hearing our witnesses describe how the 
system, particularly the tax system, can be replaced, not 
altered, not tinkered with, not ``reformed,'' but I think we 
ought to start conversations about replacing it. Maybe you are 
not prepared to do that today, but I am giving you the warning 
that that is at least something that I am concerned with, and I 
understand, having had conversations with your new chairman, 
that he has an interest in that subject, too. That is a very 
great understatement.
    So we welcome you both to the Committee and look forward to 
your testimony. Mrs. Maloney, there being no ranking member 
present, why do not you assume that responsibility and give the 
opening statement from that perspective?
    [The prepared statement of Vice Chairman Bennett appears in 
the Submissions for the Record on page 23.]

         OPENING STATEMENT OF HON. CAROLYN B. MALONEY,
              A U.S. REPRESENTATIVE FROM NEW YORK

    Representative Maloney. Thank you very much, Chairman 
Bennett. I have appreciated your thoughtful comments today and 
always your sincere dedication to understanding and moving 
forward the American economy in a stronger position.
    Unfortunately, Senator Reed is not here right now. He will 
possibly be here later, and I request that his statement be in 
the record. Apparently, he is questioning Chairman Bernanke 
right now, the Financial Services Committee.
    [The prepared statement of Senator Reed appears in the 
Submissions for the Record on page 26.]
    Vice Chairman Bennett. Senator Reed has the same conflict I 
do, and that is where I will flee as soon as Chairman Saxton 
shows up, to go sit down with Mr. Bernanke and see if he is 
easier to understand than Chairman Greenspan.
    Representative Maloney. He is, and he actually answers 
questions. I am shocked. I think he is great. He is a former 
teacher, and it shows.
    I want to particularly welcome our two panelists, Dr. 
Baicker and Dr. Slaughter and mention that I am always 
delighted when competent women are appointed to policy 
positions. We are far underrepresented in our Government and in 
many industries in our country. I want to welcome our male 
friends, too.
    The statute that created both the Council of Economic 
Advisers and the Joint Economic Committee mandates that the 
Joint Economic Committee should review the Economic Report of 
the President, and I am pleased that you are here today to 
discuss this truly important report for every American.
    In its 11 chapters, this year's report covers a broad range 
of topics and reflects the talent and professionalism of you 
and the other economists on the CEA staff, but what concerns me 
is the disconnect between the policies that the Bush 
administration has been pursuing for the past five years and 
the policies that can be justified by sound economic analysis. 
I hope that you would agree that persistent, large budget 
deficits and debts are not conducive to long-term growth and 
our standard of living.
    I hope you would also agree that even if there is not a 
lockstep relationship between budget deficits and international 
imbalances, it cannot be good for our national savings and our 
trade deficit when the Federal budget moves from a substantial 
surplus in 2000 to an even larger deficit in 2004, especially 
when our personal savings rate has fallen and is now a 
negative. Nor can it be good for our economy or our society 
when workers are not seeing the benefits of economic growth in 
their paychecks, and the gap between the haves and the have-
nots is widening. I think this is a trend that every Republican 
and Democrat is deeply concerned about because that is a very 
bad trend for, I would say, the economic well-being and the 
spirit of America.
    Your report wisely avoids trying to justify the President's 
budget and tax policies, but I think it is important that we 
try to understand what is really happening in the U.S. economy 
and how the President's policies are affecting the economic 
well-being of all Americans.
    Foreign governments, as pointed out in the Financial 
Services Committee yesterday, are buying GSEs--Government-
sponsored entities--instead of Treasury notes. In fact, they 
now hold a third of our debt. What they are buying now, a third 
of it is now GSEs, and I am concerned. Is that a warning sign 
that we are getting near the edge, that foreign governments may 
not continue to buy our debt at the rate that is needed to 
sustain our spending?
    I am also concerned, since this is a shift that I have 
never seen before--possibly it has happened before, but I am 
not aware of it--where GSEs have become a major holding of our 
debt, and that, as you know, is a Government-private 
sponsorship that is moving to the private away from Government. 
What is the ramification, if any, on our economy?
    I welcome you today. I congratulate you on your 
appointments. Some very good people have come out of the 
positions that you hold and have continued to lead and play 
important roles in our Government. I thank you for your service 
today and your service and commitment to our Government. Thank 
you.
    Vice Chairman Bennett. Thank you very much. We will now 
hear from our panelists. Which one goes first?
    Dr. Slaughter. I believe I shall.
    Vice Chairman Bennett. Okay. Dr. Slaughter, and then we 
will hear from Dr. Baicker.

          JOINT STATEMENT OF DR. MATTHEW SLAUGHTER AND
           DR. KATHERINE BAICKER, MEMBERS, COUNCIL OF
                       ECONOMIC ADVISERS

    Dr. Slaughter. Thank you. Vice Chairman Bennett and other 
members of the Joint Economic Committee, we are very pleased to 
testify today about the 2006 Economic Report of the President. 
The report reviews the state of the economy and the economic 
outlook, and it discusses a number of economic policy issues of 
continuing importance. Across its 11 chapters, the report 
highlights how economics can inform the design of better public 
policy and reviews Administration initiatives.
    The performance of the U.S. economy continues to be strong. 
In 2005, the Nation's real GDP grew 3.5 percent for the year, 
above the historical average. Key components of demand that 
accounted for growth in 2004--consumer spending, business 
investment in equipment and software, and exports--continued to 
do so in 2005. Employment increased by about 2 million payroll 
jobs for the year, and the unemployment rate dropped to 4.7 
percent last month, well below the averages of recent decades. 
Real disposable personal income increased, and real household 
net worth reached an all-time high. This growth comes on top of 
an already strong expansion, the foundation of which has been 
exceptionally rapid productivity growth. The Administration's 
forecast, consistent with consensus private forecasts, shows 
the economic expansion continuing for the foreseeable future.
    Increases in investment spurred by the dividends and 
capital gains tax relief enacted in 2003 have played an 
important role in the strengthening of our economy. Since the 
Jobs and Growth bill became law, capital investment has 
increased by 25 percent, contributing to sustained job growth 
and directly benefiting workers in the broader economy. It is 
essential that this tax relief be extended.
    American productivity growth, and thus competitiveness, in 
the 21st century will rely upon American ingenuity, 
entrepreneurship, and labor force talent. The President's 
American Competitiveness Initiative aims to support these 
forces. Promoting a flexible and skilled workforce through 
improved access to high-quality primary, secondary, and post-
secondary education, through policies that attract the world's 
best and brightest to our shores, and through investment in 
research and development and the continuing education and 
retraining of our mobile labor force will help ensure that the 
United States remains a leader in this rapidly changing world 
economy.
    But maintaining this leadership will also require a 
continued commitment to competition in and flexibility of U.S. 
product, capital, and labor markets that help transform 
innovations into the new products and processes in the 
marketplace that ultimately support rising incomes for workers 
and their families. Innovation alone is not sufficient to 
guarantee rising prosperity. It also requires the dynamism of 
the marketplace, for which America is uniquely positioned.
    This continuing strength and competitiveness of the 
American economy in the global marketplace depends upon 
policies that open international markets to U.S. goods and that 
promote growth and investment at home. The performance of the 
U.S. economy depends on an effective financial services sector 
and on a tax system that promotes domestic growth and 
international competitiveness.
    Further opening of foreign markets to U.S. goods would 
yield great rewards for Americans. Over the past 70 years, 
policymakers across political parties have consistently 
recognized the importance of international commerce and have 
achieved major trade liberalization both here and abroad. The 
net payoff to America from these achievements has been 
substantial.
    The Administration's policies will make even greater gains 
possible. Support of the agricultural sector can be provided in 
ways that are less distortionary. We must work to eliminate 
further barriers to trade, especially in services, and to 
further open markets in global, regional, and bilateral 
negotiations. Americans will reap the greatest benefits from 
this trade when intellectual property rights are well defined 
and well enforced. The Administration continues to enforce 
vigorously the laws that protect the rights of American 
intellectual property owners.
    Dr. Baicker. The continued expansion of energy markets and 
diversification of energy sources can further increase our 
resilience to energy supply disruptions. Hurricanes Katrina and 
Rita demonstrated that competitive markets play a central role 
in allocating scarce energy resources, especially during times 
of natural disaster or national emergency. Policies that build 
on economic incentives and that spur our development of 
alternative fuel sources can further reduce U.S. vulnerability 
to energy disruptions and dependence on foreign oil, encourage 
energy efficiency, and protect the environment.
    Even as living standards rise, Americans are increasingly 
concerned about their retirement security and health care 
costs. Most working-age Americans are, in fact, on track to 
save as much as most retirees, but there are a number of risks 
to the retirement preparations of Americans. People today are 
living longer and can face higher health care costs in 
retirement than members of previous generations. In addition, 
both defined-benefit pension plans and Social Security suffer 
from fundamental financial problems that expose not just 
retirees but all U.S. taxpayers to risk of substantial losses. 
The Administration is focused on addressing these problems and 
protecting the Nation's retirement security.
    Rising health care costs are of concern to all Americans, 
young and old. All Americans deserve access to reliable, 
affordable, high-quality, high-value health care. Health care 
in the United States is second to none, but it can be better. 
Both public and private health care spending have grown much 
more rapidly than general inflation or wages, straining 
consumers, employers, and Government budgets. The cost of 
finding new health insurance locks some workers into their 
current jobs if they or someone in their family is ill or in 
less-than-perfect health. Frivolous lawsuits can raise health 
care costs for everyone. Perverse tax and insurance incentives 
have led to inefficient use of our health care resources.
    Promoting a stronger role for consumers can help create a 
health care system that is more affordable, more transparent, 
more portable, and more efficient. Health savings accounts 
should be strengthened by allowing people to contribute enough 
to them to pay for all of their out-of-pocket expenditures tax 
free. Individual purchasers should have the same tax advantages 
as those who get insurance from their employers. We need to 
ensure that patients and their doctors have the information 
they need to use this control to get the health care that is 
best for them and that electronic health records are widely 
used to reduce costs and to improve the quality of medical 
treatment.
    The report provides an analytical backdrop for the 
President's agenda, which includes restraining Government 
spending, making tax relief permanent, making health care more 
affordable and accessible, creating an economic environment 
that encourages innovation and entrepreneurship, continuing to 
open markets to American goods and services, and reducing 
America's dependence on foreign oil by diversifying our energy 
supply. These policies will help maintain the economy's 
momentum, foster job creation, and ensure that America remains 
a leader in the global economy.
    Thank you all for this opportunity to discuss the 2006 
Economic Report of the President, and we would be happy to 
answer any questions you might have.
    [The prepared joint statement of Dr. Slaughter and Dr. 
Baicker appears in the Submissions for the Record on page 29.]
    Vice Chairman Bennett. Thank you very much. We appreciate 
your testimony and the hard work that went into the creation of 
the report. You have touched on a number of issues that I find 
fascinating, and let me just explore a few of them with you.
    The Samuelson column and the comments you have made 
demonstrate how changed this economy is from the one that I 
grew up in and, indeed, the one that many people thought was 
normal. ``Normal'' meant you graduated from high school or 
college, and you got a job. You went to work at Sears & Roebuck 
as a stock boy, and then you became a salesman on the floor, 
and then you became a standpoint manager, and if you were 
really good, you got to be an assistant store manager, and at 
the end of your career, you had been a store manager, and you 
got your pension and a gold watch, and life was good.
    If you graduated and went to work at Ford or Delphi or one 
of the giant companies, the unions negotiated on your behalf. 
Your wages were not only stable, but they rose with virtually 
every negotiation in both real terms as well as with respect to 
inflation. Your job may not have been all that stimulating, but 
you stayed on the manufacturing line, you did a good job, you 
were there for 40 years, and you retired with or without the 
gold watch but with a pension and lifetime health benefits.
    That world is gone, and it is never coming back, however 
much we in the Congress might want to legislate its return. The 
world in which we now live is a world of intense competition, 
and the emphasis is on the word ``world,'' a world of intense 
competition, and those who meet the competitive challenge 
thrive, and those who do not are almost ruthlessly left behind.
    I just came back, a few weeks ago, from a trip to the Far 
East, and we went to China, and the Chinese are very concerned 
about losing jobs to Vietnam, and, interestingly enough, the 
Chinese are worried about intellectual property rights because 
as their economy matures, and they begin to invent things of 
their own, they get very upset when somebody in some other 
country steals their patents without protecting their 
intellectual property rights. It was very interesting to hear 
Chinese officials say, we have to have tough international 
intellectual property right regulations, to which we could only 
say, hooray, we are glad you finally got the message.
    When we did go to Vietnam, the people in Vietnam said, ``Do 
not look to China as the place to go; look to us.'' And in both 
cases they said, ``We do not want an economy built on cheap 
labor. We are making sure that our economy is built on 
technological breakthroughs and high quality.'' That is not the 
image you get reading the op-ed pages of the New York Times, 
but that is the image that you get when you get out into the 
world.
    I think Samuelson is exactly right: People are doing better 
than they have ever done before, and they are more uneasy and 
feel more threatened than they ever have before, and I am not 
sure his analysis that that is due to competition is the right 
one, but that is certainly probably the place to start. However 
much we might want to not live in such a competitive world, the 
fact is we are there, and there is nothing we can do about it 
except accept it, compete, and be the ones that survive.
    I wish I had brought it with me. Again, a recent piece 
pointed out that Europe is almost in a death spiral and that 
the average European, within 15 to 20 years, will be half as 
wealthy as the average American because they are not 
competitive, they have tried to hang onto the model that I have 
described as the past as their view of the future, and the net 
result has been to say that Europe is dropping out of the 
global competition, and the countries that will survive and 
thrive in the future will be the United States, China, and 
India, and I am not so sure that China will, given their 
population problems and the demographic challenges they have.
    [The Washington Post editorial entitled, ``The End of 
Europe,'' appears in the Submissions for the Record on page 
23.]
    They were talking to us about the difficulties of what they 
call the ``one-two-four pyramid.'' They will have one worker, 
because of their one-child program, who will have to support 
two parents and four grandparents, and they have no safety net 
of the kind that we take for granted in that society. So the 
parents are looking to their child to support them, but the 
grandparents are still alive, and the economic burden of the 
one-two-four pyramid in China is something we can be grateful 
we do not face.
    All right. I apologize. I am making a speech here, and I 
should be asking a question, so let me do the standard 
senatorial thing. What do you think?
    Dr. Slaughter. I believe the answer is yes. I will offer a 
few reactions to that, if I may, Senator. You raise an 
excellent set of points.
    There is a famous labor economist named Richard Freeman who 
refers to the change in the nature of the global economy in the 
past 15 years. He has coined the phrase ``the great doubling.'' 
If you take the populations of China and India and the former 
Soviet Union and many eastern European countries, that is about 
half of the world's population, and if we go back even just 15 
years, that set of countries economically was effectively sort 
of on the moon. They were very isolated and not part of the 
global economic system.
    So one of the things that is very different today from the 
past when we think about global integration, if we go back, 
say, 10 to 15 years ago in the United States, there was a lot 
of discussion about the implications and ramifications of the 
North American Free Trade Agreement and extending our free 
trade agreement with Canada, to include Mexico. Candidly, 
Mexico is sort of rounding error when you are trying to get a 
hold on the number of people effectively that are now part of 
the population with the great doubling that we have 
experienced.
    So that is something that is qualitatively different, and 
during that period the sense of unease that Robert Samuelson 
has talked about, he is correct. If you look at public opinion 
surveys on people, how they view the nature of their labor 
market attachment, for about 15 years now throughout the United 
States and also in many other countries you see rising self-
reports of worker uncertainty and worker unease. That speaks to 
the fact that the nature of labor market attachment for people, 
it just does not depend on their earnings; it depends on the 
reliability of those earnings. There are many dimensions of 
labor force attachment that people think about.
    In the United States, as I alluded to in my comments, we 
have been enjoying this productivity acceleration that started 
in 1995 and that has continued even further since the year 
2000, which is wonderful from the standpoint of average living 
standards in the United States because productivity growth is 
the only sustainable foundation for rising average living 
standards for America.
    One of the notable features about this productivity 
acceleration, especially since the year 2000, has been the 
critical role played by what economists call ``total factor 
productivity growth,'' not the growth of capital per worker but 
sort of the organization and the innovations that combine 
workers with their capital in terms of what products firms are 
going to make and how they are going to make it. There is now 
substantial evidence from academic research, from the business 
community research, that the force of competition, especially 
international competition, is an important spur to productivity 
growth for firms and, therefore, for countries as a whole, and 
that is just based on a lot of empirical studies of lots of 
industries around the world. One example that I will give is 
retail trade.
    So one of the important industries that has contributed to 
the productivity growth in the United States in the past 
several years has been the retail trade sector. The United 
States has had a very different experience from many 
continental European countries like you cite. We have had a lot 
of innovations in retail trade that have been implemented 
thanks to competition and flexible capital and labor markets in 
the United States.
    So Wal-Mart, Costco, Target, those types of firms, have 
been able to establish and expand new types of retailing 
services in the United States, very different from in Europe 
where they have made a different set of choices, where there 
are much more qualitative and quantitative restrictions on land 
use, labor market use, and capital market turnover that have 
inhibited the ability of retailers to replicate the kind of 
performance we have seen in the United States.
    So I broadly agree with what Robert Samuelson is talking 
about, that the forces of competition are very important for 
contributing to rising living standards in the United States, 
but that competition has certain dimensions to it, and, again, 
one of them is thinking about what is the distribution of the 
overall productivity gains and the sense of certainty or 
uncertainty that that imparts to different segments of the 
workforce.
    Dr. Baicker. To build on what Dr. Slaughter discussed about 
the uncertainties that workers face in the modern economy, 
technology is evolving much more quickly, and the labor market 
is changing much more quickly than it had in the past, as you 
said, so it is especially important that we provide the support 
that workers need to move from shrinking sectors of the economy 
to growing sectors of the economy, whether those changes are 
generated by trade or internal development of new technologies, 
or by changing tastes in the marketplace.
    Any source of displacement for workers necessitates that 
they get additional training and that they have the support 
that they need to get that training and income support during 
the time when they are transitioning between jobs. That is an 
important component to ensure that everyone in the economy can 
benefit from overall economic growth.
    To build on that as well, you mentioned retirement security 
of workers who expect a lifetime pension, and one of the 
important supports for retirement security is that pension 
promises are kept. Through the defined-benefit pension system, 
workers were promised a stream of income in their retirement. 
It is important that we make sure the incentives are in place 
and the regulatory oversight is in place that those promises to 
those workers are kept to them so they can feel more secure 
about their retirement security as they move from job to job.
    Vice Chairman Bennett. Thank you. I will not monopolize. I 
have got a lot of reactions to what you have had to say, but 
just one quick one. As we go into this new world, I think we 
need to get the mentality that pensions and health care are no 
longer tied to the employer but to the employee so that the 
employee who accrues pension benefits working for his first job 
takes those with him to his second job and this third and his 
fourth and his fifth and so on.
    It is now very clear that people will normally and 
routinely in their lifetimes have 10 jobs at 10 different 
places and sometimes change fields entirely. A veterinarian may 
end up as a stockbroker or vice versa. If you can accumulate 
and bring with you your pension benefits, which is what the 
401(K) program is supposed to do, and do the same thing with 
health care, you own your health care benefit rather than your 
employer so there is no concern about a preexisting condition 
because it is your plan, and you take it with you and 
ultimately control it.
    We are not used to thinking like that. We are so tied to 
the old paradigm--we keep trying to keep the old paradigm alive 
because it worked for so many years--that we are actually 
putting ourselves ultimately in the position of jeopardizing 
what has to be done for our children and our grandchildren. 
Mrs. Maloney?
    Representative Maloney. Thank you so much for your 
statement, all of you. It gives all of us a great deal to think 
about.
    I would like to go back to one of the areas that I 
mentioned in my opening statement, and that is the growing 
divide between the haves and the have-nots in this country. 
Last fall, we had a Democratic forum on the economy where one 
economist, Alan Blinder, gave some very interesting testimony 
on this topic, and he argued that there had been a long-term 
trend toward greater inequality interrupted for a short while 
in the late 1990s. He did not use this particular chart, but I 
think it illustrates how we are all on the wrong track on this 
particular issue.
    The blue bars show the usual weekly earnings of full-time 
wage and salary workers at different points in the earnings 
distribution between 1995 and 2000, a time of great economic 
growth, and the red bars show the same thing between 2000 and 
2005. You see that during the Clinton years, the divide between 
the poorest people and the richest people was just a little 
over one percentage point, where now the divide between the 
poorest and the richest is now a clear six points. That is a 
growing inequality that I find disturbing.
    [The bar chart entitled, ``The Bush Economy: The 
Distribution of Earnings Has Become More Unequal,'' appears in 
the Submissions for the Record on page 28.]
    Professor Blinder went on to argue that it was market 
forces, rather than Government policy, that is the major source 
of earnings inequality. That is what he argued. I just want to 
understand what is different about these market forces in the 
1990s compared with now.
    Do you agree with him that it is market forces, not 
Government policies, that lead to this inequality? If so, what 
is different now than before? Some people argue that inequality 
is present because we have cut some spending on domestic 
programs. He argued that that was not the point. He said it was 
market forces causing this. Could you elaborate and further 
explain your take on this to me and to others?
    Dr. Slaughter. Sure. I will offer some initial comments on 
that and turn it over to Dr. Baicker.
    I broadly agree with Dr. Blinder's assessment of rising 
income inequality in the United States.
    Representative Maloney. Do you agree that it is market 
forces, not Government policy?
    Dr. Slaughter. Yes.
    Representative Maloney. I am sorry. I have to hand it back 
to him and read your statements in the published record. I am 
sorry. I have to go vote, first responsibility. We have got to 
vote. Okay.
    Vice Chairman Bennett. We are going to have a lot of fun 
without anybody from the House to monitor us.
    Representative Maloney. I do not think you need to be 
monitored. I wish I was here to hear what you have to say, 
quite frankly.
    Vice Chairman Bennett. Thank you.
    Representative Maloney. I want to add to what you have to 
say, and this is just an observation. I am going to miss a vote 
on this. I am amazed at New York's economy after 9/11. I just 
thought we would never recover because of the devastation. We 
blew out so many jobs and I have to tell you that practically 
everyone I meet tells me they lost their job. Yet our economy 
has rebounded, so it must have rebounded with new jobs, which 
illustrates what you are saying--this tremendous, dynamic 
change. It is really amazing, practically everyone I talk to 
tells me they lost their job. How can unemployment be worse 
than the rest of the country? But it is still not that bad in 
New York even when everybody I talk to says they lost their 
job. It is amazing. I would like to hear your comments on that, 
too.
    Vice Chairman Bennett. Okay. Go back to the chart and 
comment on it.
    Dr. Slaughter. Sure.
    Vice Chairman Bennett. I think that is a legitimate issue 
she has raised.
    Dr. Slaughter. Absolutely. They definitely are. So there 
are two features of that chart that I will highlight and expand 
on. One is that on most measures income equality in the United 
States across skills has been rising since the late 1970s, so 
the red bars there are more reflective of what the U.S. economy 
has been experiencing since, as I said, the late 1970s.
    So one of the features of the U.S. economy that has been 
quite different in the past generation from previous 
generations is the distribution of gains. It has not been the 
rising tide lifting all boats. There has been something going 
on, and this, again, is in pretax earnings. There are some 
changes in the nature of supply and demand in the U.S. labor 
market that have been raising the returns to skills, in 
particular. There are other dimensions of income inequality 
that have been rising as well. What economists call ``within-
group inequality'' has been increasing as well.
    But if you focus on the returns to skills and different 
parts of the income distribution that are shown in that figure, 
the late 1990s that are shown there are actually the exception 
rather than the rule for how the U.S. labor market has been 
performing for quite some time. That is one fact I will 
highlight.
    The other is that one of the striking features is that this 
is not a uniquely U.S. phenomenon. Most other countries around 
the world over the same time period of the past generation have 
also been experiencing rising income inequality. So the U.K. 
and many continental European countries; there sometimes the 
inequality has been manifested more in rising unemployment for 
less-skilled workers, even countries where you might think 
opposite trends would be expected, so middle-income countries 
like Mexico. Even today we see in China and India substantial 
evidence of rising income inequality as well.
    A substantial amount of academic research has looked at 
this question, and the preponderance of evidence and 
conclusions from researchers has been that the main force 
driving up the returns to skills and contributing to the rising 
inequality has, again, been technology innovations that tend to 
favor the demand for skills.
    So it sort of comes back to some of the issues we were 
talking about before, which is that we have got these 
technology innovations that firms are implementing that raise 
the need for more-skilled workers and, as the figure shows, 
raise the returns to more-skilled workers, and that speaks to 
the broad policy challenge of how do we try to ensure that as 
many Americans as possible have the kinds of skills that firms 
are increasingly demanding in the workplace.
    Dr. Baicker. To elaborate on those points, the returns to 
education have been going up over time, and it is especially 
important, then, to ensure that all children have access to 
high-quality education through primary and secondary school and 
that people have the financial resources to continue their 
education beyond secondary school, such as through the 
expansion of grants to community colleges that 
disproportionately train people in growth industries. So 
ensuring access to those educational institutions is 
particularly important in the modern economy.
    One other point I would like to make is that those bars 
would look a little bit different if you took out the full 
income of those different groups. So the earned income tax 
credit has been an important component of increasing the 
resources available to people at the low end of the income 
distribution. It has been a very successful program in both 
giving people income stability and the resources that they need 
and also in promoting participation in the labor force.
    So while the point that income inequality has been rising 
is well taken and true, it is important to also consider the 
total bundle of resources available to people across the income 
distribution.
    Vice Chairman Bennett. Thank you. Is there any parallel 
with the fact that from 1995 to 2000--the recession started in 
2000, or the downturn started in 2000, the last quarter--those 
were five years of expansion and growth. The recession hit in 
2001. How can 2000 be 11.1 and minus 2.1? You have got 2000 up 
there twice. Oh, this is fourth quarter to fourth quarter. 
Okay. Well, then that shows that the recession started in the 
fourth quarter of 2000 with the minus 2.1.
    Does that impact the visual message coming off the chart, 
the fact that you have got five years of expansion and three 
years of the recession and the slow recovery? The recovery 
really did not begin to take hold until 2003, so is that a 
factor here, or is that just coincidence?
    Dr. Baicker. That is a very important point, and I thank 
you for making it. It highlights the fact that a growing 
economy is a prerequisite for everyone in the economy to do 
better, and so policies that encourage economic growth will 
help people at all points in the income distribution.
    Dr. Slaughter. That is right. I believe, if I remember the 
statistics correctly, by the peak that is in around 2000, the 
aggregate unemployment rate in the United States briefly dipped 
below 4 percent to about 3.9 percent. So the strength in the 
labor market overall is a force that does tend to help pull up 
the incomes of everyone, including those at the lower end.
    Vice Chairman Bennett. Yes. Okay. But your overall 
conversation says that the real source of the income gap is a 
skill gap. Is that an acceptable statement, or is that too 
simplistic?
    Dr. Baicker. It is an important component.
    Vice Chairman Bennett. Okay. It is an important component. 
That is an economist's way of saying, you are not quite right, 
Senator. How big a component is it? You are an economist; put a 
number on it. Is the skill gap 50 percent of the problem, 70 
percent of the problem?
    Dr. Slaughter. Again, there has been this ongoing secular 
increase in demand for more-skilled workers relative to less-
skilled workers. I think if you took a look at the body of 
research evidence here, the majority of that shift in demand 
for skills gets attributed to the technology innovations that 
favor skilled workers.
    Other forces that have been looked at that seem to have 
played some role but a much smaller role include freer 
international trade and immigration inflows also. So some 
dimensions of greater international commerce and global 
engagement have played a role, it appears, in shifting demand 
in the United States towards more-skilled workers, but it 
played a relatively small role compared to these technology 
innovations.
    Vice Chairman Bennett. So we have got a skill gap, we have 
got the impact of international trade, we have got the impact 
of technology, and we have got the question of whether we are 
in a growth period or a recessionary period, and all of those 
play into it. Okay.
    Dr. Slaughter. Correct.
    Vice Chairman Bennett. Okay. Mrs. Maloney raised another 
issue that I would like to explore with you. She talked about 
the savings rate. We now have a negative savings rate. As I 
have looked at that, we had a savings rate in the United States 
that was fairly stable and then started to tip downward in the 
1980s and has continued downward on a very even trajectory 
since the 1980s to the point that it finally turned negative. 
It did not turn down and flatten out; it just started down in 
the 1980s and has kept going down in the 1980s.
    So this is not a phenomenon of the last five years or the 
last 10 years; it is the last quarter century that we have been 
dealing with a falling savings rate. Talk about that. Tell me 
why that is the case.
    Dr. Slaughter. So the decline in personal household savings 
rates that you mention has been another long-term feature of 
the U.S. economy. The report discusses that trend and looks at 
some of the possible reasons behind it.
    One of the reasons that has been contributing to it, 
especially in recent years, that the report talks about is it 
kind of looks at the overall financial picture of households 
and points out that one of the positive features of 
productivity growth and the aggregate income gains over time 
has been rising household wealth. So net worth of households in 
terms of the assets they own minus the liabilities such as home 
mortgages; that has been rising, especially in recent years, 
with increases in equity prices and, more recently, home 
prices.
    Vice Chairman Bennett. Have the two gone in lockstep, the 
savings down and the housing, over 25 years?
    Dr. Slaughter. Not as much over 25 years, in part, I think, 
because the increases in household net worth have been more 
noticeable in recent years. A lot of research has shown that 
when households have increases in their wealth, they tend to 
take some of that wealth in terms of higher consumption, and so 
the report looks at some analysis that says, given what we know 
about the propensity of households to increase their 
consumption when they have more wealth, especially in recent 
years as household net worth has increased quite well, that 
explains some of the decline of the overall national personal 
savings rate.
    The other broad feature of savings I would mention is, as 
Mrs. Maloney had correctly pointed out, when we think about 
savings for the United States in a global context, an important 
source of savings for the U.S. economy overall to finance 
investment of firms in recent years has been foreign savings. 
So we have domestic savings, which consists of savings by 
households, there is savings by the Government, there is 
savings by companies, and then to the extent that we have open 
borders, we also can use some of the savings of the rest of the 
world.
    So the economic report talks in detail about how our 
current account deficit reflects the fact that on net, in 
recent years, the United States has been using some foreign 
savings to finance the investment by our companies.
    Vice Chairman Bennett. That brings up the other subject 
that she mentioned in her opening statement about foreign 
investors buying paper from the GSEs. Do you want to comment on 
the comment that she made in that regard?
    Dr. Slaughter. Sure. The data are correct. I do not know 
the exact details offhand, but GSEs are one of the assets that 
foreign private investors and public investors have been 
purchasing, but it speaks to the point that when we look at the 
range of assets that the rest of the world is purchasing from 
the United States in recent years, it is a pretty broad 
portfolio, actually. So the range of assets that are tracked in 
our statistics that we have in the United States include 
Treasury securities, and they include the GSE bonds. They also 
include corporate bonds, corporate equities, bank loans, and 
another major component of that investment is foreign direct 
investment, so companies with an ownership statement.
    When we look at the data that are collected by the Treasury 
Department and also by the Bureau of Economic Analysis, the 
distribution of all of the assets on net that are owned by the 
rest of the world is pretty evenly distributed actually across 
those different classes of assets.
    So foreign investors, both public and private, are thinking 
about what is the right mix of assets to own, and over time I 
think it is reasonable to expect there to be some evolution in 
the composition of the net foreign debt position of the United 
States.
    Vice Chairman Bennett. So they are not necessarily 
targeting GSEs as a preferred investment; they are simply 
diversifying their investments and say we can do a little of 
this and a little of that.
    Dr. Slaughter. I think that is right. On net, when you look 
at, again, the total stock of U.S. assets that are owned by the 
rest of the world, again, I do not have the exact statistics in 
front of me, but it is distributed pretty smoothly across those 
different asset classes. There is no one class, for example, 
that I listed that constitutes over 50 percent of the total 
assets that are owned.
    Vice Chairman Bennett. There is not a disparate preference 
for GSE over Treasury?
    Dr. Slaughter. I would have to look at the changes over 
time in recent years. Offhand, sir, I do not know the exact 
changes in the distribution of Treasury securities versus GSEs. 
I would need to look at those data in particular. I just do not 
have them handy.
    Vice Chairman Bennett. It is my impression that there is 
not, that the appetite for Treasuries remains as strong as it 
has ever been.
    Dr. Slaughter. That very well may be.
    Vice Chairman Bennett. But I cannot prove it, so I will not 
claim it.
    Dr. Slaughter. We need the statistics.
    Vice Chairman Bennett. Okay. I am sure someone would raise 
the issue of the trade deficit. Every time we had Chairman 
Greenspan before us, he would say that the trade deficit in the 
short-term is not a problem and in the long-term is 
unsustainable, so you got a headline either way, depending on 
how you felt about it. Talk to us about the trade deficit, 
short-term and long-term----
    Dr. Slaughter. Absolutely.
    Chairman Bennett [continuing]. And what we can do about it.
    Dr. Slaughter. Sure. The report has substantial discussion 
on the trade deficit. The facts as we know is that the trade 
deficit has been rising, so the recent data for 2005, the trade 
deficit for the United States with the rest of the world in 
goods and services came in at about $726 billion. A better 
metric is the share of GDP. It is a share of 5.8 percent of 
GDP.
    Vice Chairman Bennett. What is the breakdown between goods 
and services?
    Dr. Slaughter. We actually run a surplus with the rest of 
the world in services.
    Vice Chairman Bennett. That was my sense because many times 
the newspapers focus on the goods trade deficit and say the sky 
is falling, and they do not understand that we are recovering 
some of that with services.
    Dr. Slaughter. That is correct, sir. So for 2005, our trade 
surplus in services with the rest of the world was a little 
over $56 billion. That increased from the previous year, and it 
comes back to some of the issues you raised earlier. There is 
more change in the global economy, and part of that means a lot 
more activities that used to not be tradable now can be traded 
across borders, like business-processing services that we hear 
a lot of anecdotes about recently. That increases the 
possibility for U.S. companies, which tend to be quite good at 
a lot of service activities, which reflects the fact that over 
80 percent of jobs in the U.S. economy are in the service 
sector. That raises the potential for more export opportunities 
for U.S.-based companies. So we run a bigger trade deficit in 
goods, then, that leads to the total trade deficit.
    So the rise in the trade deficit that has been ongoing is 
definitely a source of concern, and thinking about the 
underlying causes and possible transitions going forward is 
very important, I think. We know that some of the features of 
the strength of the U.S. economy in recent years account for 
the rising trade deficit. One, in particular, is the fact that 
we have had much faster economic growth that we have been 
discussing than have most of our major trading partners.
    So about two-thirds of our trade is still with other high-
income advanced countries, such as Japan, Germany, and France, 
and they have been growing at much slower rates than has the 
United States, which means our faster growth rates and faster 
income growth tend to mean we are importing a rising amount of 
their goods and services compared to how much of our exports 
they are taking in with their income growth. That said, some of 
the forces that account for the increases in the trade deficit 
are more worrisome, and you correctly point out that the 
ongoing decline in personal household savings is one of those.
    Going forward, then, we can think about different market-
based and policy-based adjustments in the rest of the world and 
in the United States that would contribute to a moderation in 
the global imbalances that we see in the world today. In the 
United States, raising national savings relative to investment 
would be changes that would contribute to an amelioration of 
the trade deficit, so that would be savings by households 
perhaps. Again, that is a difficult issue, given that we have 
seen household savings falling for some time. One of the broad 
motivations for the tax reform panel was to think about putting 
in place a different set of incentives that might stimulate 
savings.
    For the rest of the world, I think policy challenges 
include things like trying to undertake policy reforms that 
would stimulate faster economic growth that would contribute to 
more exports from the United States going to those countries if 
they were enjoying faster growth.
    Vice Chairman Bennett. Well, let us look into our crystal 
ball and say Europe is not going to grow. Japan, aging economy, 
shrinking population. They do not encourage immigration. India 
and China, yes, they are growing at dramatic rates, but they 
are still not major sources for American exports.
    Dr. Slaughter. Right.
    Vice Chairman Bennett. How do you turn this around?
    Dr. Slaughter. That is an excellent question to which I do 
not have the perfect crystal ball.
    Vice Chairman Bennett. All right. What happens if we do 
not?
    Dr. Slaughter. I would say two things. One is you are 
correct to point out that both China and India have been 
growing quite quickly. Of our major trading partners, our 
exports to China have been growing faster than any other 
country, over 20 percent per year in the past five years.
    So one of the broad forces that we can hope for is faster 
economic growth and productivity growth, in particular, in 
China and India that will raise average incomes there and allow 
them to have the earning power to purchase more goods and 
services from the United States.
    For Europe and Japan, you are absolutely correct, sir, that 
the growth challenges there are, at some level, daunting, given 
the underlying demographics that are going to limit the 
population and labor force growth and given that, again, in 
recent years, at least, they have not enjoyed the kind of 
productivity performance that the United States' economy has. 
In the near term, at least, there are signs of strengthening 
both business and consumer sentiment in Japan and in Germany, 
in particular. So for those two countries, which are two of our 
largest trading partners, if capital investment and 
productivity growth could strengthen, those would be forces 
that would lead to greater trade between the United States and 
those countries.
    Going out, then, it will remain to be seen what other 
sources of growth there might be abroad and then what sorts of 
adjustments, again, both from a policy standpoint and from a 
market-based standpoint, of what firms and households choose to 
do around the world to see the distribution of U.S. trade and 
the total amount of U.S. trade with the rest of the world.
    Vice Chairman Bennett. You have not answered my question 
about looking out. Say that things do not change dramatically. 
Okay. Europe gets a little stronger here and there, but over 
the next 30 years, things do not change, and the trade deficit 
just continues to grow every year, not every year, but the 
trend line continues to go up every year for the next 30 years. 
What does that mean to us at that point? Is there a day of 
reckoning out there, or can we go on like this indefinitely?
    Dr. Slaughter. Again, that is an excellent question. As the 
report talks about, the companion of the trade deficit in goods 
and services that we run is this surplus in trade in assets. So 
another way to think about the question going forward is to 
what extent will the rest of the world continue to be willing 
to purchase more and more U.S. assets. To the extent that there 
is a shift in demand away from U.S. assets towards other 
countries' assets, either from private actors or public actors, 
that will be a force that will slow the rate of growth, if not 
start to bring down the global imbalances that we see today. 
What we would see in the marketplace, in part, might be a 
change in the market prices of currencies and also of interest 
rates as well.
    But, again, one of the broad puzzles, I think, that we are 
not quite sure about how it will play out, is that the 
imbalances that we have seen arise in recent years are 
qualitatively different from the ones we have seen in previous 
decades and generations in part because many countries around 
the world have relaxed policy restrictions on the flows of 
capital across borders, and so we are now in an environment 
with a much greater degree of capital mobility across borders 
than we had in earlier times, and the underlying economics.
    We know, kind of like trade in goods and services, that 
when we liberalize, there should be imbalances across borders, 
and so one of the challenges for policymakers, for researchers, 
for the business community going forward is trying to ascertain 
to what extent now this sort of new environment with greater 
capital mobility, what degree of imbalances might be 
sustainable.
    Vice Chairman Bennett. You are not drawing a doomsday 
scenario. You are basically describing a readjustment and a 
soft landing. As long as the U.S. economy remains strong, we do 
not worry about the trade deficit?
    Dr. Slaughter. No. We continue to worry about the trade 
deficit, absolutely.
    Vice Chairman Bennett. But you have not given me, and I do 
not think there is, any prescription of what to do about it. As 
long as we remain stronger than other people, and our economy 
is growing faster, we are going to run a trade deficit. We do 
not want to slow us down just for the sake of statistically 
getting rid of the trade deficit.
    Dr. Slaughter. Correct.
    Vice Chairman Bennett. But what is the problem? What will 
be the consequence, long-term, as these adjustments occur? Will 
the U.S. economy slow down? Will there be greater income 
imbalance? What will be the consequences?
    Dr. Slaughter. That is the excellent and correct question 
to ask. Again, it is going to be a mix of changes in the United 
States and changes in the rest of the world in terms of the 
balance of the United States on net having much higher 
investment than the pool of national savings, and the converse 
holds in many of our many trading partners like Japan and 
Germany. So those countries, for example, have seen sharp 
declines in their investment rates in recent years relative to 
their savings.
    So, again, I could foresee a number of different scenarios 
in which there is greater capital investment in countries like 
Japan and Germany, as I talked about, related to their savings, 
which would mean that they would run smaller trade surpluses. 
In the United States, then, some mix of greater national 
savings related to our investment would be the offsetting 
change. Again, how quickly that happens and the kind and extent 
of adjustment of prices of currencies and interest rates 
depends; there is just a number of different scenarios that one 
could envision there.
    It is hoped for that the adjustment would not be sudden and 
dramatic, the kind of hard landing that you are referring to. 
Instead, it is hoped for that, given market flexibility that we 
have been discussing, that the adjustment would be more gradual 
over a longer period of time.
    Vice Chairman Bennett. Well, we have been here an hour, and 
I have taken up almost all of it with my questions and your 
answers, which, for me, is just great, but it looks as if our 
House colleagues will not be returning, and I have run out of 
things to ask in their behalf. So thank you very much for being 
here, and the Committee is adjourned.
    Dr. Slaughter. Thank you.
    Dr. Baicker. Thank you.
    [Whereupon, at 11:37 a.m., the Committee was adjourned.]
                       Submissions for the Record

=======================================================================

[GRAPHIC] [TIFF OMITTED] T0343.004

     Prepared Statement of Senator Robert F. Bennett, Vice Chairman

    Today, the Committee will hear testimony from two members of the 
President's Council of Economic Advisors relative to the recently 
released Economic Report of the President. As members of the Committee 
are aware, the President has nominated Dr. Edward P. Lazear of Stanford 
University to serve as Chairman of the Council of Economic Advisors. 
When confirmed by the Senate, Dr. Lazear will replace Dr. Ben Bernanke 
who was recently confirmed as the new Chairman of the Board of 
Governors of the Federal Reserve. We are pleased, however, to welcome 
the Council's two other members, Dr. Katherine Baicker and Dr. Matthew 
J. Slaughter to the Committee.
    As we examine the Economic Report of the President, we do so 
against the backdrop of a strong and growing economy. The economy has 
created two million new jobs over the past twelve months and more than 
4.7 million new jobs since August 2003. Core inflation remains 
relatively contained. Interest rates remain historically low despite 
recent increases by the Federal Reserve.
    This does not mean that our economy does not face significant 
challenges in the future. We are faced with high energy prices and ever 
increasing competition in an increasingly global economy. Additionally, 
we face serious long term fiscal challenges as a result of promises 
made in entitlement programs and the demographic reality of an aging 
population.
    It is imperative that Congress and the Administration work together 
to meet these and other challenges head on. We must work to reign in 
entitlement spending. We must work together to improve our educational 
system. We must improve our competitiveness in the global economy. And 
we must reform a tax system that is overly complex and highly 
inefficient if we hope to compete effectively in the future.
    I believe this is of particular importance and I look forward to 
hearing our witnesses describe how that system can best be replaced--
yes replaced--not simply altered. The time has come to start with a 
clean sheet of paper and the novel concept that the purpose of the tax 
system is to raise money to run the government and not to engineer 
society. We need a system built on three straightforward principles--it 
must be simple, it must be efficient, and it must be competitive.
    Again, welcome to the Committee. We look forward to your testimony.
                                 ______
                                 

               [From the Washington Post, June 15, 2005]

                           The End of Europe

                        (By Robert J. Samuelson)

    Europe as we know it is slowly going out of business. Since French 
and Dutch voters rejected the proposed constitution of the European 
Union, we've heard countless theories as to why: the unreality of 
trying to forge 25 E.U. countries into a United States of Europe; fear 
of ceding excessive power to Brussels, the E.U. capital; and an 
irrational backlash against globalization. Whatever their truth, these 
theories miss a larger reality: Unless Europe reverses two trends--low 
birthrates and meager economic growth--it faces a bleak future of 
rising domestic discontent and falling global power. Actually, 
thatfuture has already arrived.
    Ever since 1498, after Vasco da Gama rounded the Cape of Good Hope 
and opened trade to the Far East, Europe has shaped global history, for 
good and ill. It settled North and South America, invented modern 
science, led the Industrial Revolution, oversaw the slave trade, 
created huge colonial empires, and unleashed the world's two most 
destructive wars. This pivotal Europe is now vanishing--and not merely 
because it's overshadowed by Asia and the United States.
    It's hard to be a great power if your population is shriveling. 
Europe's birthrates have dropped well below the replacement rate of 2.1 
children for each woman of childbearing age. For Western Europe as a 
whole, the rate is 1.5. It's 1.4 in Germany and 1.3 in Italy. In a 
century--if these rates continue--there won't be many Germans in 
Germany or Italians in Italy. Even assuming some increase in birthrates 
and continued immigration, Western Europe's population grows 
dramatically grayer, projects the U.S. CensusBureau. Now about one-
sixth of the population is 65 and older. By 2030 that would be one-
fourth, and by 2050 almost one-third.
    No one knows how well modern economies will perform with so many 
elderly people, heavily dependent on government benefits (read: higher 
taxes). But Europe's economy is already faltering. In the 1970s annual 
growth for the 12 countries now using the euro averaged almost 3 
percent; from 2001 to 2004 the annual average was 1.2 percent. In 1974 
those countries had unemployment of 2.4 percent; in 2004 the rate was 
8.9 percent. Wherever they look, Western Europeans feel their way of 
life threatened. One solution to low birthrates is higher immigration. 
But many Europeans don't like the immigrants they have--often Muslim 
from North Africa--and don't want more. One way to revive economic 
growth would be to reduce social benefits, taxes and regulations. But 
that would imperil Europe's ``social model,'' which supposedly blends 
capitalism's efficiency and socialism's compassion.
    Consider some contrasts with the United States, as reported by the 
Organization for Economic Cooperation and Development. With high 
unemployment benefits, almost half of Western Europe's jobless have 
been out of work a year or more; the U.S. figure is about 12 percent. 
Or take early retirement. In 2003 about 60 percent of Americans ages 55 
to 64 had jobs. The comparable figures for France, Italy and Germany 
were 37 percent, 30 percent and 39 percent. The truth is that Europeans 
like early retirement, high jobless benefits and long vacations.
    The trouble is that so much benevolence requires a strong economy, 
while the sources of all this benevolence--high taxes, stiff 
regulations--weaken the economy. With aging populations, the 
contradictions will only thicken. Indeed, some scholarly research 
suggests that high old-age benefits partly explain low birthrates. With 
the state paying for old age, who needs children as caregivers? High 
taxes may also deter young couples from assuming the added costs of 
children.
    You can raise two objections to this sort of analysis. First, other 
countries are also aging and face problems similar to Europe's. True. 
But the aging is more pronounced in Europe and a few other nations 
(Japan, for instance), precisely because birthrates are so low. The 
U.S. birthrate, for example, is 2.1; even removing births to Hispanic 
Americans, it's about 1.9, reports Nicholas Eberstadt of the American 
Enterprise Institute. Second, Europeans could do something about their 
predicament. Also, true--they could, but they're not. A few countries 
(Britain, Ireland, the Netherlands) have acted, and there are 
differences between Eastern and Western Europe. But in general Europe 
is immobilized by its problems. This is the classic dilemma of 
democracy: Too many people benefit from the status quo to change it; 
but the status quo isn't sustainable. Even modest efforts in France and 
Germany to curb social benefits have triggered backlashes. Many 
Europeans----maybe most--live in a state of delusion. Believing things 
should continue as before, they see almost any change as menacing. In 
reality, the new E.U. constitution wasn't radical; neither adoption nor 
rejection would much alter everyday life. But it symbolized change and 
thereby became a lightning rod for many sources of discontent (over 
immigration in Holland, poor economic growth in France).
    All this is bad for Europe--and the United States. A weak European 
economy is one reason that the world economy is shaky and so dependent 
on American growth. Preoccupied with divisions at home, Europe is 
history's has-been. It isn't a strong American ally, not simply because 
it disagrees with some U.S. policies but also because it doesn't want 
to make the commitments required of a strong ally. Unwilling to address 
their genuine problems, Europeans become more reflexively critical of 
America. This gives the impression that they're active on the world 
stage, even as they're quietly acquiescing in their own decline.
                                 ______
                                 

               [From the Washington Post, Feb. 16, 2006]

                     The Fears Under Our Prosperity

                        (By Robert J. Samuelson)

    A puzzle of our time is why the economy has become increasingly 
stable while individual industries have become increasingly unstable. 
The continuing turmoil at General Motors and Ford simply reflects this 
more pervasive industrial instability--also in airlines, 
telecommunications, pharmaceuticals and the mass media, among others. 
Hardly a week passes without layoffs from some major company, which is 
``downsizing,'' ``restructuring'' or ``outsourcing.'' And yet, the 
broader economy has undeniably become more stable. Since the early 
1980s, we've had only two recessions, lasting a combined year and four 
months and involving peak unemployment of 7.8 percent. By contrast, 
from 1969 to 1982, we had four recessions lasting altogether about four 
years and having unemployment as high as 10.8 percent.
    A cottage industry of economists is cranking out studies on these 
questions. One intriguing theory--completely counterintuitive--is that 
the greater overall stability stems in part from the increased 
instability of individual industries. You would, of course, expect the 
opposite: As individual industries became less stable, so would the 
larger economy.
    But the reality may be more complex. Different industries may go 
through cycles that are disconnected from each other, argue economists 
Diego Comin and Thomas Philippon of New York University. All don't rise 
and fall simultaneously. To simplify slightly: Housing, autos and 
farming might strengthen, while computers, airlines and chemicals 
weaken.
    Assuming there's something to this theory--which seems a good bet--
it helps explain the riddle of why there's so much anxiety amid so much 
prosperity. As Americans stock up on BlackBerrys and flat-panel TVs, 
it's hard to deny the affluence. But people also look to their 
employers for a sense of confidence about the future--and here doubts 
have multiplied, because more companies and industries seem assailed by 
menacing forces. We can all identify the usual suspects. Globalization. 
Deregulation. Greater domestic competition. In a series of papers, 
Comin, Philippon and various colleagues have shown that, for most 
businesses, sales, profits and employment have all become more volatile 
in recent decades. They bounce around more from year to year, 
suggesting greater industry instability. Competitive pressures have 
dramatically intensified. One telling statistic: In 1980 a firm in the 
top fifth of its industry had about a 1-in-10 chance of losing that 
position within a five-year period; by 1998 the odds had increased to 1 
in 4. Feeling threatened, corporate managers have altered pay and 
employment practices. In 1994, economists Peter Gottschalk of Boston 
College and Robert Moffitt of Johns Hopkins University showed that 
annual wage gains also had begun to bounce around more in the 1980s (in 
technical lingo, there was more variation around the average). Now, 
Comin and Erica Groshen of the Federal Reserve Bank of New York and 
Bess Rabin of Watson Wyatt Worldwide have connected these erratic wage 
increases to firms' fluctuating fortunes. In good years, companies 
enlarge the pot for wage and salaries, says Groshen; in bad years, the 
pot grows less or shrinks. About four-fifths of big U.S. firms also 
resort more to bonuses, personal incentives and stock options, Hewitt 
Associatesreports.
    The same sort of cost-conscious behavior also leads to more 
layoffs, even among career workers. In 1983, 58 percent of men ages 45 
to 49 had been with their current employer 10 years or more, reports 
the Bureau of Labor Statistics. By 2004, the comparable figure was 48 
percent. Little wonder that we have rising job insecurity, despite 
lower average unemployment.
    Not by accident do many of these trends begin, or strengthen, in 
the 1980s. From 1980 to 1983, the Federal Reserve crushed inflation, 
which fell from 12.5 percent to 3.8 percent. Inflation dulls 
competition. Sloppy managers can simply raise prices. Because most 
companies are rapidly increasing prices, customers have a harder time 
discriminating. Inflation also comes to dominate the business cycle. It 
overwhelms other influences. Once inflation declined, competition--
based on prices, new products and technologies--intensified. 
Differences among sectors became more pronounced. So we return to the 
original puzzle: Why does an economy of greater stability have 
industries of lesser stability? The answer is competition. An intensely 
competitive economy enhances overall stability by holding down 
inflation (which is itself destabilizing) and spreading economic 
disruptions throughout the business cycle (rather than letting them 
accumulate for periodic, massive downturns). But the solution to one 
problem creates other, though smaller, problems. Except during 
unsustainable booms, say, the late 1990s, even good times are 
punctuated with insecurities, disappointments, job losses, broken 
promises and shattered expectations. What may be good for us as a 
society may hurt many of us as individuals. The unending challenge is 
to find the necessary social protections that help the most vulnerable 
without frustrating desirable, if sometimes painful, change.

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[GRAPHIC] [TIFF OMITTED] T0343.001

  Prepared Joint Statement of Dr. Matthew Slaughter and Dr. Katherine 
             Baicker, Members, Council of Economic Advisers

    Chairman Saxton, Vice-Chairman Bennett, Ranking Member Reed, and 
other members of the Joint Economic Committee, we are pleased to 
testify today about the 2006 Economic Report of the President. The 
Report reviews the state of the economy and the economic outlook, and 
discusses a number of economic policy issues of continuing importance. 
Across its 11 chapters, the Report highlights how economics can inform 
the design of better public policy and reviews Administration 
initiatives.
    The performance of the U.S. economy continues to be strong. In 
2005, the Nation's real GDP grew 3.5 percent for the year, above the 
historical average. Key components of demand that accounted for growth 
in 2004--consumer spending, business investment in equipment and 
software, and exports--continued to do so in 2005. Employment increased 
by almost 2 million payroll jobs over the year, and the unemployment 
rate dropped to 4.7 percent last month, well below the averages of 
recent decades. Real disposable personal income increased, and real 
household net worth reached an all-time high. This growth comes on top 
of an already strong expansion, the foundation of which has been 
exceptionally rapid productivity growth. The Administration's forecast, 
consistent with consensus private forecasts, shows the economic 
expansion continuing for the foreseeable future.
    Increases in investment spurred by the dividends and capital gains 
tax relief enacted in 2003 have played an important role in the 
strengthening of our economy. Since the Jobs and Growth bill became 
law, capital investment has increased by 25 percent, contributing to 
sustained job growth and directly benefiting workers. It is essential 
that this tax relief be extended.
    American productivity growth and thus competitiveness in the 21st 
century will rely upon American ingenuity, entrepreneurship, and labor-
force talent. The President's American Competitiveness Initiative aims 
to support these forces. Promoting a flexible and skilled workforce--
through improved access to high-quality primary, secondary, and post-
secondary education, through policies that attract the world's best and 
brightest to our shores, and through investment in R&D and the 
continuing education and re-training of our mobile workforce--will help 
ensure that the United States remains a leader in this rapidly changing 
world economy.
    But maintaining this leadership will also require a continued 
commitment to competition in and flexibility of U.S. product, capital, 
and labor markets that help transform innovations into the new products 
and processes in the marketplace that ultimately support rising incomes 
for workers and their families. Innovation alone is not sufficient to 
guarantee rising prosperity. It also requires the dynamism of the 
marketplace for which America is uniquely positioned.
    This continuing strength and competitiveness of the American 
economy in the global marketplace depends upon policies that open 
international markets to U.S. goods, and that promote growth and 
investment at home. The performance of the U.S. economy depends on an 
effective financial-services sector and on a tax system that promotes 
domestic growth and international competitiveness. Further opening 
foreign markets to U.S. goods would yield great rewards for Americans. 
Over the past 70 years, policymakers across political parties have 
consistently recognized the importance of international commerce, and 
have achieved major trade liberalization both here and abroad. The net 
payoff to America from these achievements has been substantial.
    The Administration's policies will make even greater gains 
possible. Support of the agricultural sector can be provided in ways 
that are less distortionary. We must work to eliminate further barriers 
to trade, especially in services, and to further open markets in 
global, regional, and bilateral negotiations. Americans will reap the 
greatest benefits from this trade when intellectual property rights are 
well-defined and well-enforced. The Administration continues to enforce 
vigorously the laws that protect the rights of American intellectual-
property owners.
    The continued expansion of energy markets and diversification of 
energy sources can further increase our resilience to energy-supply 
disruptions. Hurricanes Katrina and Rita demonstrated that competitive 
markets play a central role in allocating scarce energy resources, 
especially during times of natural disaster or national emergency. 
Policies that build on economic incentives and that spur our 
development of alternate fuel sources can reduce U.S. vulnerability to 
energy disruptions and reliance on foreign oil, encourage energy 
efficiency, and protect the environment.
    Even as living standards rise, Americans are increasingly concerned 
about their retirement security and health care costs. Most working-age 
Americans are in fact on track to have more retirement wealth than most 
current retirees. There are, however, a number of risks to the 
retirement preparations of Americans. People today are living longer 
and could face higher health-care costs in retirement than members of 
previous generations. In addition, both defined benefit pensions and 
Social Security suffer from fundamental financial problems that expose 
not just retirees but all U.S. taxpayers to risk of substantial losses. 
The Administration is focused on addressing these problems and 
protecting the Nation's retirement security.
    Rising health care costs are of concern to all Americans, young and 
old. All Americans deserve access to reliable, affordable, high-
quality, high-value health care. Health care in the United States is 
second to none, but it can be better. Both public and private health 
care spending have grown much more rapidly than general inflation or 
wages, straining consumers, employers, and government budgets. The cost 
of finding new health insurance locks some workers into their current 
jobs if they or someone in their family is chronically ill. Frivolous 
lawsuits raise health care costs for everyone. Perverse tax and 
insurance incentives have led to inefficient use of health care 
resources.
    Promoting a stronger role for consumers can help create a health 
care system that is more affordable, transparent, portable, and 
efficient. Health Savings Accounts should be strengthened by allowing 
people to contribute enough to them to pay for all of their out of 
pocket expenditures tax free. Individual purchasers should have the 
same tax advantages as those who get insurance from their employers. We 
need to ensure that patients and their doctors have the information 
that they need to use this control to get the health care that is best 
for them, and that electronic health records are widely used to reduce 
costs and improve the quality of medical treatment.
    The Report provides an analytical backdrop for the President's 
agenda, which includes restraining government spending; making tax 
relief permanent; making health care more affordable and accessible; 
creating an economic environment that encourages innovation and 
entrepreneurship; continuing to open markets to American goods and 
services; and reducing America's dependence on foreign oil by 
diversifying our energy supply. These policies will help maintain the 
economy's momentum, foster job creation, and ensure that America 
remains a leader of the global economy.
    We will briefly outline for you the highlights of the Report. 
Chapter 1, The Year in Review and the Years Ahead, reviews the economic 
developments of 2005 and discusses the Administration's forecast for 
the years ahead. The expansion of the U.S. economy continued for the 
fourth consecutive year in 2005, with strong growth in real GDP. Most 
components of demand that accounted for growth in 2004--consumer 
spending, business investment in equipment and software, and exports--
continued to do so in 2005. Labor markets continued to strengthen, with 
almost 2 million new jobs created in 2005 and a year-end unemployment 
rate of 4.9 percent. Productivity growth remained well above its 
historical average. Overall inflation rose substantially at mid-year, 
but came down by year-end as it reflected the movement of energy 
prices, while core inflation (which excludes food and energy prices) 
has remained in the moderate 2-percent range. The Administration's 
forecast, consistent with consensus private forecasts, shows the 
economic expansion continuing for the foreseeable future.
    Chapter 2, Skills for the U.S. Workforce, discusses the economics 
of education, immigration, and job training. Promoting a flexible and 
skilled labor force--through improved access to high quality primary, 
secondary, and post-secondary education, through policies that attract 
the world's best and brightest to our shores, and through investment in 
the continuing education and training of our mobile workforce--will 
ensure that the United States remains a competitive leader in this 
rapidly changing world economy.
    Chapter 3, Saving for Retirement, addresses the concern that 
Americans have been preparing inadequately for retirement. Most 
working-age Americans are in fact on track to have more retirement 
wealth than most current retirees. There are, however, a number of 
risks to the retirement preparations of Americans. People today are 
living longer and could face higher health-care costs in retirement 
than members of previous generations. In addition, both defined benefit 
pensions and Social Security suffer from fundamental financial problems 
that expose not just retirees but all U.S. taxpayers to risk of 
substantial losses. The Administration is focused on addressing these 
problems and protecting the Nation's retirement security.
    Chapter 4, Improving Incentives in Health Care Spending, reviews 
the causes and consequences of health care spending growth and 
discusses how the President's consumer-driven proposals can improve the 
health care system. Growth in spending on health care has been much 
more rapid than general inflation, straining consumers, employers, and 
government budgets. Perverse tax and insurance incentives have led to 
inefficient levels and composition of spending on health care. 
Promoting a stronger role for consumers is a promising strategy for 
improving health care value and affordability.
    Chapter 5, The U.S. Tax System in International Perspective, 
examines U.S. tax system choices in the context of other countries. 
These choices matter because they affect living standards and economic 
growth. The United States has a different tax structure from most other 
advanced economies, raising more of our revenue through a tax on 
personal income instead of consumption. While the U.S. system has been 
significantly improved in recent years, it could benefit greatly from 
additional reforms, particularly those focused on the taxation of 
capital income.
    Chapter 6, The U.S. Capital Account Surplus, discusses the enormous 
number of trade and financial transactions the U.S. has with other 
countries. In 2004, the United States ran a current account deficit of 
$668 billion--meaning that the United States imported more goods and 
services than it exported, and that foreign investors purchased more 
U.S. assets than U.S. investors purchased in foreign assets. The size 
and persistence of U.S. net capital inflows reflect a number of U.S. 
economic strengths, as well as some shortcomings. Greater global 
balance of capital flows can be promoted by higher domestic savings, 
better growth and investment opportunities in Europe and Japan, and 
greater exchange rate flexibility and financial sector reforms in Asia.
    Chapter 7, The History and Future of International Trade, notes 
that while economic research and historical evidence show that the 
benefits of trade outweigh the costs, trade liberalization has always 
generated concerns in the United States and throughout the world. Over 
the past 70 years, policymakers across political parties have 
consistently recognized the importance of international commerce, and 
have achieved major trade liberalization both here and abroad. The net 
payoff to America from these achievements has been substantial. The 
Administration is working to eliminate further barriers to trade, 
especially in services, and to further open markets in global, 
regional, and bilateral negotiations.
    Chapter 8, The U.S. Agricultural Sector, examines the effects of 
agricultural support payments and trade policy on domestic prices, the 
wellbeing of the agricultural sector, and of the economy overall. In 
2005, the Federal Government spent approximately $20 billion on 
agricultural support payments, but most farmers do not benefit from 
these subsidies. In addition, the United States maintains barriers to 
the import of some commodities, and these barriers raise the domestic 
prices of these commodities relative to world prices. Support to 
agriculture can be provided in many forms that are potentially less 
market-distorting.
    Chapter 9, The U.S. Financial Services Sector, explores what 
financial services do for an economy, how financial development relates 
to economic performance, and how financial services can be effectively 
regulated. The U.S. financial services sector improves economic 
performance by addressing informational problems and facilitating 
innovation. An effective financial regulatory system appropriately 
balances the costs and benefits of public regulation.
    Chapter 10, The Role of Intellectual Property in the Economy, notes 
that intellectual property rights create incentives for investment in 
research, development, and innovation. Well-defined and enforced 
intellectual property rights are an important element of the American 
economy and can contribute to the economic growth of all countries. The 
Administration continues to enforcevigorously the laws that protect the 
rights of American intellectual property owners.
    Chapter 11, Recent Developments in Energy, discusses crude oil, 
refined petroleum products, natural gas, and electricity markets. 
Increased scarcity and rising prices over time will encourage 
conservation, increase incentives for exploration, and stimulate the 
development of new, energy efficient technologies and alternative 
energy sources. In the near term, unexpected disruptions to energy 
supply and distribution networks may continue to affect consumers and 
businesses. Hurricanes Katrina and Rita demonstrated that competitive 
markets play a central role in allocating scarce energy resources, 
especially during times of natural disaster or national emergency. The 
continued expansion of energy markets through regional and global trade 
can further increase our resilience to energy supply disruptions. 
Policies that build on economic incentives can reduce U.S. 
vulnerability to energy disruptions, encourage energy efficiency, and 
protect the environment.
    Thank you for this opportunity to discuss the 2006 Economic Report 
of the President. We would be happy to answer any questions you might 
have.
  

                                  
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