[Economic Report of the President (2000)]
[Administration of William J. Clinton]
[Online through the Government Printing Office, www.gpo.gov]

[[Page 21]]
Sustaining a Record-Breaking Expansion

We had the largest industrial economy, the largest agricultural
economy, the  highest per capita income, the highest level of education.
Must have been a wonderful time to be alive for most Americans, not for
everybody, but for  most Americans....I don't think we can understand
what it was like in 1900  unless you think of optimism, of hope, of
buoyancy, for the United States everything seemed to be going right.

_John Milton Cooper, Jr., in an interview for America 1900,
a documentary in The American Experience series on PBS

The policy strategy of maintaining fiscal discipline, investing in people
and technologies, and opening international markets has borne rich fruit,
allowing the Nation to exploit new opportunities and reap the benefits of
major scientific and technical advances. The results have been a
20-million-job increase in payroll employment since January 1993, the lowest
unemployment rate since 1969, the lowest core inflation rate since 1965, the
lowest poverty rate since 1979, rising productivity, significant gains all
across the income distribution, and a Federal budget in surplus for 2 years
in a row after nearly three decades of deficits. The current economic
expansion, already the longest peacetime expansion on record, is on the
threshold of becoming the longest ever. The mood of optimism that prevailed
at the dawn of the 20th century prevails today as well.

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These successes notwithstanding, the challenges we face on the threshold of
the 21st century leave no room for complacency. Change is a constant in the
American economy and an essential part of its success, but that success must
be earned. America's workers and businesses need to prepare for the arrival
of ever-newer technologies and new ways of doing business. Economic policy
must adapt as well. And even beneficial change, unfortunately, can leave some
people and localities behind. Today amid the general prosperity, some groups
and communities remain in poverty and lack adequate health care coverage.
Some workers may be displaced and see their standards of living suffer. And
many families, well off and not so well off, are facing a time crunch as the
demands of work compete with the needs of their children.

Lengthening life spans reflect the improved health of Americans in general,
but together with changing demographics they present a major challenge for
Medicare and Social Security in the new century. Engagement in the world
economy has been vital to our economic success, but we have important work
ahead in opening up markets and spreading the benefits of trade and
investment more widely in the world. We also face the challenge of keeping
the economy growing while preserving our natural environment.

In this first Economic Report of the President of the 21st century,* each
chapter starts with a look back at the economic history of the century just
ended and contrasts where Americans stood economically at the beginning of
the century with where we stand now. The report reviews those key
developments that offer enlightening perspectives on the century's
achievements and that will help us concentrate our energies on the challenges
to come. We will celebrate the successes, try to understand their causes, and
draw from them lessons for facing future challenges.

This chapter starts with a look at U.S. economic performance over the past
century. That performance has been, in a word, astounding. But it has also
been uneven: in the first half of the century the economy endured a series of
recessions, which culminated in the Great Depression. Although less severe,
the variations in the second half of the century have also been significant.
In particular, the economy's momentum seemed to be lost during the 20 years
after 1973. That momentum has been recovered in the 1990s. This chapter
therefore also examines some of the distinctive features of the 1990s
expansion and the policies that have put it on track to be the longest
expansion in the Nation's history and will, we expect, sustain it well into
the future.
*This report follows popluar convention in regarding the new century as having
begun on January 1, 2000.

[[Page 23]]

Growth and Inequality:
A Century-Long Perspective

Over the past century the U.S. economy has recorded spectacular performance.
It has found the 2 percent answer to the American dream: if living standards
rise at 2 percent annually, they double every 35 years. This means that by
the time they reach their mid-30s, parents can provide their children with a
standard of living that is twice the level that they themselves enjoyed as
children. By maintaining an annual average increase in gross national product
(GNP) per capita of about 2.1 percent over the whole century, the U.S.
economy exceeded this target (Chart 1-1). When incomes grow at this pace,
each generation experiences a far more affluent lifestyle than the previous
one, and over the course of a lifetime, Americans can expect, on average, a
fourfold increase in living standards.

How much richer are Americans today than at the turn of the century? Despite
the uncertainties in the data, it is clear that total growth of the economy
has been remarkable. In 1999 the economy produced almost 30 times the volume
of goods and services that it did in 1899, and it employed about 5 times as
many workers in doing so. (That it took 5 rather than 30 times as many workers
is tribute to another great accomplishment, namely, enormous increases in
productivity.) Measured in 1999 dollars, average income per capita in 1899
was a little less than $4,200. With an average 1999 income of

[[Page 24]]

$33,740, Americans today can acquire (and businesses can produce) more than
eight times as many goods and services as could Americans living in 1899. But
this simple comparison grossly understates the true improvement in living
standards for three important reasons. First, it fails to fully account for
the vast array of goods and services that were simply unavailable in the
past: aircraft, antibiotics, air conditioners, radio and television, and
computers, to name only a few. Second, it fails to account for a substantial
increase in leisure, as the typical workweek has fallen to 35 hours. Third,
it fails to account for the impact of the improved health of the population
in raising life expectancy from 47.3 years in 1900 to about 77 years today,a
while also improving the quality of those added years. (However, the
improvement in living standards may be overstated to the extent that workers,
particularly women, have shifted from nonmarket work at home, which is not
captured in the GNP measure, to market activity, which is.)

Through sustained economic growth, the United States has been able to
accomplish much both at home and abroad. Although poverty rates still remain
too high, growth has been the driving force lifting many of the poorest
members of society out of poverty. Growth has created more opportunities and
made it much easier to tackle the challenges of supporting a growing number
of retirees. By maintaining solid growth, the United States moved to a
position of global economic leadership sometime near the start of the century
and remains in that position today. Recent World Bank data show that U.S.
income per capita is 27 percent greater than income per capita in Japan, and
47 percent greater than that in Germany (based on purchasing power parities).

As Chapter 2 documents, progress over the century has not always been
smooth. In the century's first half, growth was punctuated by several deep
recessions and by the disaster of the Great Depression. Fewer workers were
employed in 1939 than in 1929. Nonetheless, despite economic instability and
two world wars, in the first 50 years of the century income per capita more
than doubled, and income inequality declined.

The Golden Years of Equitable Growth

The quarter century after World War II was a period of rapid increase in
productivity growth, and the resulting rise in living standards was
remarkable. From the cyclical peak of 1948 to that of 1973, business sector
output per hour rose by more than 3 percent per year, as innovative
technologies, strong capital investment, and a more skilled and educated work
force proved mutually reinforcing (Chart 1-1). Recessions interrupted this
growth, but median family income rose by 3.0 percent per year on average, and
the gains were widely shared. The average income of the poorest fifth of
families rose 3.4 percent annually, whereas that of the top quintile grew at
a 2.8

[[Page 25]]

percent annual rate. On average, living standards in 1973 were 82 percent
higher than in 1948. These were years when the American dream seemed
achievable for all.

Growth Undermined: Stagflation, Rising Inequality, and Deficits

The two decades after 1973 were a rude awakening. It appeared as if the
early postwar vision of continuously rising incomes for all had indeed been
just a dream. The economy's performance deteriorated noticeably in several
dimensions. First, there was much greater economic instability than in the
early postwar period. Spurred by rising oil prices, inflation jumped to 11
percent in 1974, and a deep recession followed. After a few years of
recovery, inflation then soared to new heights, hitting 13.5 percent in 1980.
When, in response, monetary policy made a dedicated effort to bring inflation
under control, the economy entered the deepest recession of the postwar
period: unemployment rose to 10.8 percent in November 1982. Between 1973 and
1983 the U.S. economy recorded average yearly inflation and unemployment
rates of 8.4 and 7.2 percent, respectively_this was the period of the
infamous stagflation. The economy did grow strongly in the mid-1980s, but
exploding Federal deficits, caused by a lack of fiscal discipline, together
with the  crisis in the savings and loan industry, undermined that success.
Inflation again started to rise, and the economy was already teetering on the
edge of recession in 1990 when declining consumer confidence following the
Iraqi invasion of Kuwait pushed it over the edge.

Second, growth in productivity lost its momentum. Between 1973 and 1990,
growth in business sector output per hour rose at 1\1/2\ percent per
year_about half its rate from 1948 to 1973. Slower productivity growth in
turn affected wages. Between 1973 and 1993, annual growth in real
compensation per hour averaged 0.8 percent. Real earnings declined at the end
of the 1980s expansion and continued to decline in the 1990-91 recession. The
economy did sustain a 1.9 percent annual increase in income per capita over
the 1973-90 period, but this was due primarily to rapid labor force growth as
more women and baby-boomers went to work.

Third, the years between 1973 and 1993 also saw a marked increase in
inequality: not only were real income gains meager, but they were also
unevenly shared. Those at the top did far better than those at the bottom.
After adjusting for consumer price inflation, income for the top quintile of
families increased at a 1.3 percent annual pace, but growth was minimal for
the middle class and markedly negative for the less well off. These income
data were partly driven by developments in earnings: between 1979 and 1993,
real earnings in the lowest decile declined by 0.6 percent, whereas

[[Page 26]]

those in the highest decile rose 0.3 percent. The premium earned by college
graduates over high school graduates increased from about 40 percent to 70
percent. Moreover, the dispersion of earnings increased even for workers with
similar education and demographic characteristics. Finally, the poverty rate
of 13.5 percent at the cyclical peak in 1990 was considerably higher than at
the peak in 1973.

The Return to Broad-Based Growth in a
Record-Breaking Expansion

The expansion that began hesitantly in 1991 found its stride and has been
sustained. It will in all likelihood have become the longest expansion in
U.S. history_107 months free of recession_in February 2000. Since the
beginning of 1993, payroll employment has increased by more than 20 million
jobs. Boosted by higher employment and faster productivity growth, output
growth has been strong, with GNP per capita rising at an average rate of 2.7
percent per year between the first quarter of 1993 and the third quarter of
1999. Participation in the labor force has increased to a record 67 percent
of the working-age population, yet the annual unemployment rate has declined
to 4.2 percent_a level not seen in 30 years. After remaining sluggish in the
early years of the expansion, output per hour has accelerated, to an average
annual growth rate of 2.8 percent between the fourth quarter of 1995 and the
third quarter of 1999. In response, solid real compensation gains have been
recorded (Chart 1-2).

[[Page 27]]

The benefits of this growth have been widely shared as well. Some observers
focus on changes over a decade or two and conclude that inequality is still
rising, but they ignore the recent trends. Between 1993 and 1998, real
average household incomes have grown by between 9.9 and 11.7 percent for
every quintile of the income distribution, and the median African American
household has seen a 15 percent increase in real income. Between 1993 and
1998, family incomes in the lowest quintile rose at a 2.7 percent annual
rate, slightly faster than the 2.4 percent rate recorded by the top quintile
(Chart 1-3). This recent experience contrasts sharply with the performance
from 1973 to 1993. Similar breadth is evident in the growth of earnings.
Although wage inequality continued to widen through 1994, for the past 5
years weekly earnings growth has been broad-based.

The economy is increasingly providing workers with good employment
opportunities. A recent analysis by the Council of Economic Advisers and the
Department of Labor found that 81 percent of new jobs created from 1993 to
1999 are located in industry and occupation categories that pay wages above
the median. These good jobs have not gone only to the professional elite:
even when professional occupations were excluded from the sample, the study
found that 71 percent of new jobs were in categories paying above the median
wage. Nor are workers with college degrees the only ones gaining ground. Among
workers with only a high school education, an overwhelming proportion of
job growth was found to occur in those industry and occupation categories in
which these workers earn the highest wages.

[[Page 28]]

Data on poverty also show progress. The proportion of Americans living in
poverty fell from 15.1 percent in 1993 to 12.7 percent in 1998. The poverty
rate for African Americans in 1998, although still high at 26.1 percent, was
the lowest ever recorded, and that for Hispanics is the lowest it has been
since 1979. Since 1993, African American unemployment has declined from 13.0
percent to 8.0 percent, and Hispanic unemployment has fallen from 10.7
percent to 6.4 percent. For both groups these represent the lowest rates on
record. Meanwhile the unemployment rate for females aged 16 and over has
dropped to 4.3 percent, the lowest in 46 years.

Data on the probability of job displacement, which showed a rise in the late
1980s and early 1990s, show a drop since then. The share of all workers with
3 or more years of job tenure who became displaced from their jobs was 3.9
percent in the 1991-92 period but declined to 2.9 percent in the 1995-96
period. And because the labor market has been so robust in the 1990s, the
rate of reemployment following displacement has been higher in this decade,
as have earnings after displacement, than at comparable levels of
unemployment during the 1980s. Workers' fears of job loss have also eased in
recent years: the share of workers who believe they are likely to lose their
jobs declined from 12 percent in 1993 to 8 percent in 1998.

The Engines of the 1990s Expansion

The performance of the economy over this expansion has surprised most
observers. Two decades of slow growth and rising inequality have ended. In
their place is a record-breaking expansion that has brought strong and
equitable growth. The gloomy view of long-term U.S. prospects so popular in
the 1970s and 1980s has proved decidedly misguided. The record of the past 7
years suggests that it may be time to reappraise what one popular book at the
turn of the last decade called the Nation's ``diminished expectations.''
Before undertaking such a reappraisal, however, it is useful to identify the
principal engines of this expansion, and to see how these have resulted in an
expansion that is unusual in important respects from previous long
expansions. In this section we look at the policy and private sector drivers
of growth under four headings: technology; trade and competition; education
and skills; and pro-investment policies.

Information and Other Technology

The economy is clearly in the ferment of rapid technological change (a story
documented in Chapter 3). One powerful contributor to the strength of this
expansion has been investment in plant and equipment, particularly

[[Page 29]]

computers and information technology. Prices of computers and semiconductors,
adjusted for quality improvements, have been falling particularly rapidly.
Investment in information processing equipment and software took off in the
1990s, growing at a rate of 19 percent per year from 1993 to 1999
(Chart 1-4). More broadly, the share of real investment in GDP has risen
dramatically, as has the share of high-technology investment in total
investment. Real spending on research and development (R&D) increased at an
estimated annual rate of 5 percent between 1993 and 1999.

For many years it seemed that the information technology revolution was not
paying off in higher productivity, but that now seems to be changing.
Companies have learned to use the new technology to operate more efficiently.
New ways of producing and delivering goods and services have been developed.
Venture capitalists provide both funds and expertise to new companies with
bold ideas. And of course, the improvements in communications technologies
have been as dramatic as those in computers. The diffusion and development of
the Internet promise continued productivity payoffs still to come.

The revolution in information technology is the most visible and probably
the most important technological trend, but it is far from the only one.
Materials science, biotechnology, and medical technology have all advanced
rapidly and are generating their own economic benefits. America hosts many of
the preeminent scientific research institutions in the world, which have
pioneered numerous advances and trained the people who are now leading these
technological revolutions.

[[Page 30]]

Over the years, government support of scientific research and education has
been a vital element in the success of U.S. technology. Going forward, the
increased funding proposed in the President's science and technology
initiative is important to sustaining growth in the years to come.

Competition and Trade

Industries in which companies compete vigorously tend to be more productive.
Conventional economic logic argues that companies operate efficiently and
innovate whenever there is the chance of a profit payoff. In practice,
however, companies can become complacent and keep doing things the old way
even when new, more profitable methods are available. The pressures of
competition encourage change and force companies to adopt the more productive
methods. And even as it keeps the pressure on businesses to improve and
innovate, competition exposes them to best-practice technologies that will
help them to do so.

Competition in the global economy adds benefits beyond those from domestic
competition. The economy benefits from trade as firms face new incentives,
and resources shift to the most productive industries. In addition, companies
that face global competition are exposed to best practices worldwide,
challenging them to reach for the highest possible performance themselves.
The U.S. economy has become increasingly open to overseas trade in the course
of this expansion. Indeed, its importance in GDP has grown even more than in
previous long expansions. Between 1991 and 1999, trade (measured as the sum
of exports and imports) in goods and services as a share of GDP rose by 4.8
percentage points, compared with increases of 1.5 and 3.5 percentage points
during the expansions of the 1960s and the 1980s, respectively (Chart 1-5).

The Administration's antitrust and regulatory policies have fostered
competition at home. At the same time, its trade policies have worked to
expand trade and open markets through major regional and multilateral

Education, Skills, and Work Incentives

Dazzling new technologies, redesigned business systems, new services_the
promise of these sources of economic growth can be realized only if people
have the skills and the knowledge to use them. To take advantage of the
benefits of trade in expanding those industries where the United States has
comparative advantage, workers must acquire the necessary skills. Workers who
lose their jobs when industries contract, whether because of foreign
competition or because of technological advance, must often be retrained in
order to reenter the productive economy at a comparable living standard.

[[Page 31]]

Strong job growth and low unemployment have been possible in this expansion
only because people have found that work has paid off. Providing work
incentives is an essential element in strong economic growth. With one of the
most highly educated, skilled, and motivated work forces in the world, the
United States has also been able to take advantage of growth opportunities

Policies to increase access to education and training and make work pay have
been a central theme of economic policy in this expansion.

Pro-Investment Policies

Output growth in this expansion has gone predominantly to households and
businesses rather than for government purchases. One can measure how the
growth of GDP over time has been allocated among the components of GDP:
consumption, investment, government purchases (Federal, State, and local),
and net exports (Chart 1-6). When this is done, the current expansion stands
out for the strong contribution of private investment spending. The
contribution of government purchases of goods and services to growth has been
only 7 percent, about a third of what it was in the two previous long

Government purchases of goods and services reflect the direct use of
economic resources. But Federal spending also includes Social Security
payments and other transfers to households and businesses. On this broader

[[Page 32]]

basis, the current expansion also shows evidence of fiscal restraint. Federal
outlays in 1991 were 22.3 percent of GDP. By fiscal 1999 this ratio had
fallen to 18.7 percent, as efforts to restrain spending combined with strong
economic growth. This decline in spending of 3.6 percentage points of GDP is
much greater than the 1.3-percentage-point decline during the 1982-90
expansion. Since this measure typically declines as the economy moves out of
recession_and the deeper the recession, the greater the decline_the
comparison between the two expansions is striking given that the current
expansion was launched from a much shallower recession. Moreover, this
decline in spending occurred even as revenues were rising (Chart 1-7).

According to the Administration forecast, assuming implementation of policy
as proposed by the President, Federal outlays are forecast to fall to 16.7
percent of GDP by 2010. This reduction results in part from a decline in
interest costs as debt is paid off.

But perhaps the most dramatic illustration of how unusual budget policy has
been in this expansion comes from estimates of the structural budget deficit
by the Congressional Budget Office (CBO). The structural budget deficit
adjusts the actual deficit to take out the effect of fluctuations in the
business cycle. It estimates what the budget deficit would have been if GDP
had been at its potential. According to the CBO's estimates, structural
deficits were pervasive during the long expansion of the 1960s, except at the
very beginning (Chart 1-8). And those deficits increased sharply until the
tax increase of 1968. Throughout its duration, the expansion of the 1980s was

[[Page 33]]

also associated with large structural deficits_and large actual deficits as
well. This expansionary fiscal policy was accompanied by a tight monetary
policy, and this combination of policies contributed to relatively high real
interest rates and declining net national saving and domestic investment.

[[Page 34]]

The current expansion, by contrast, started with a large structural deficit
and turned it around, to the point that there is now a structural surplus, as
Federal spending has been kept in check while revenues have risen. Monetary
policy, meanwhile, has been given the freedom to encourage real growth while
keeping inflation low. Interest rates, as a result, have been lower than they
would have been. Indeed, real interest rates in this expansion have been
considerably lower than in the 1980s expansion. Using survey data to measure
inflation expectations suggests that real short-term interest rates have been
about half what they were in the 1980s expansion, and real long-term rates
are about a third lower. Lower interest rates have stimulated investment
spending, and this investment has, in turn, boosted capacity growth and
raised productivity_two key factors that have helped keep inflation in check.

Although the current account (the balance of trade in goods and services
plus net factor income and net transfers) moved into deficit in both the
1980s and the 1990s, the forces behind these shifts were different. In the
1980s both net national saving and net domestic investment declined as a
percentage of GDP, so that foreign borrowing was used, directly or
indirectly, to finance consumption and Federal budget deficits rather than
investment. In the 1990s, by contrast, net national saving increased, and the
capital inflow has helped finance an investment boom.

Key Features of the Expansion

Driven by technological advance, more open markets, and investment in
physical capital and human skills_all with the ongoing support of Federal
policy_this expansion is on track to become the longest ever. In 1999, the
ninth year of the expansion, GDP grew by 4.0 percent, and 2.7 million payroll
jobs were created. The expansion remained youthful-looking and vigorous
despite its chronological age. How did the engines of this expansion, just
described, translate their energy into such a sustained performance?

Productivity Growth

The start of an expansion is usually a period of rapid productivity growth.
Companies set up factories and offices that are designed to produce a certain
target level of output. In a recession, output falls below this target,
plants operate less efficiently, and productivity falls. Companies may also
retain valued workers that are not needed today but will be needed when the
upturn comes, and this, too, lowers average productivity. The surge of
productivity growth at the start of an expansion occurs as businesses are
again able to make better use of their workers and their physical capital.

[[Page 35]]

The magnitude of this surge varies from expansion to expansion and tends to
be greater, the deeper the recession that preceded it. After a deep
recession, there is more ground that can be made up before the economy
returns to its long-term potential. After a while, however, this productivity
surge ends, and the economy moves closer to its normal or trend rate of
productivity growth, which is determined by the rates of capital
accumulation, technological change, and enhancement of skills. Finally, in
the last year or so of an expansion, productivity growth often slows again in
what has been called an end-of-expansion effect. This likely results from
diminishing returns, as capacity becomes strained and a shortage of
experienced and skilled workers develops.

Chart 1-9 shows that the expansions of the 1960s and the 1980s very much
followed this pattern. Productivity growth was rapid in the first 2-year
period of the expansion but then started to fall off. It had dropped off
sharply by the seventh year of expansion in both cases. But the pattern for
the current expansion looks very different. After the initial productivity
surge, growth fell for a couple of years, but since then it has actually been
accelerating. Instead of looking like an old expansion suffering from
diminishing returns, this one has been getting stronger. This pattern of
strong productivity growth at a mature stage of the cycle is a key reason why
this expansion is set to become the longest on record. And that is exactly
the result one would expect from policies that have stimulated investment,
technology development, and skill enhancement.

[[Page 36]]


Accelerating inflation poses a threat to expansions and, unless kept under
control, eventually brings them to a halt. Chart 1-10 shows the pattern of
core inflation, as measured by the consumer price index excluding food and
energy, in the three long expansions since 1960. The 1960s expansion was
marked by 5 years of strong economic growth with low inflation.
Administration policies in those years restored prosperity and full
employment after bouts with recession between 1957 and 1961. But during the
mid-1960s, the pressures of expenditure at the time of the Vietnam War
stretched industrial capacity too much, causing inflation to accelerate
rapidly, until rising interest rates and monetary restraint brought the
expansion to an end.

The 1980s expansion started with very high unemployment and slack resources,
which helped restrain inflation in the early years of the expansion, as did
the collapse of oil prices and a strong dollar. But eventually the inflation
path flattened out and started to turn up as the economy reached lower levels
of unemployment.

The pattern of inflation over the current expansion is surprising: core
inflation has been low and stable, when not actually declining, even as
unemployment has approached 4 percent. Chapter 2 describes several factors
that have contributed to this combination of low inflation and low
unemployment. Certainly the pattern of productivity described earlier and the
rapid expansion of capacity have been important. The importance of investment
for productivity growth was noted above, but rapid investment growth

[[Page 37]]

has also been the driver of capacity expansion. Chart 1-11 shows that capacity
utilization has remained at a moderate level and has grown more slowly than
in previous long expansions.

Questioning the Causes of Inequality

Three of the major driving forces behind the economy's recent success_rapid
technological change, increased trade, and tight fiscal policy_have all in
the past been viewed by some as sources of greater inequality of income. It
is remarkable, therefore, that even though these forces have been
particularly powerful in the current expansion, the trend toward greater
inequality that began in the 1970s has been arrested, and income gains are
now being shared equally across income groups.

Economists are sometimes said to agree on very little, but there is a broad
consensus among them that the most important cause of rising earnings
inequality in the 1970s and 1980s was technological change. It was simply a
matter of supply and demand. The supply of highly skilled and well-educated
workers was growing relatively rapidly during these years. Between 1973 and
1992, for example, the share of the civilian labor force with some college
education increased from 29.4 percent to 51.6 percent_or 3 percent a year on
average. But the relative earnings of these workers were rising even as their
supply was expanding, because demand was growing even faster. Something,

[[Page 38]]

it was argued, must be shifting the relative demand for skilled and unskilled
workers, raising demand for the former and lowering it for the latter. Some
attributed this skill bias to the impact of new capital investment in general
and computers in particular; others saw changes in management approaches and
the adoption of new, more flexible production methods as the cause. In either
case, technological change was seen as at the root of the wage disparity.

A second cause of inequality has been said to be international trade,
although most economists believed its contribution was far smaller than that
of technological change. Expanded trade benefits all countries that take
part, but within each country some people and industries may be hurt. Those
who maintain that trade had increased inequality made the following argument.
As developing countries with many low-skilled workers increasingly
participate in trade, they put downward pressure on world prices of products
intensive in low-skilled labor. If the United States then opens up to trade
with these countries, low-skilled workers here become less scarce in the
world market, and their relative wages fall. Some claimed that globalization
imposes painful consequences on relatively underskilled workers: accept lower
wages, as in the United States, or suffer higher unemployment, as in many
European countries. In addition, the threat of foreign outsourcing by firms
and of increased international competition was said to have reduced labor's
bargaining power_a factor also sometimes held responsible for the slow rise
in real wages.

Still other institutional and structural changes in the economy have been
implicated in increasing inequality. The decline in union membership, for
example, is seen as a factor reducing the bargaining power of U.S. workers. A
second source has been changes in the mix of industries, in particular the
relative decline in manufacturing employment for reasons other than
international trade. A third element was the decline in the real minimum

To be sure, some of these proposed explanations are not mutually exclusive.
Indeed, they may be interrelated. International competition may have
stimulated technological change. It has also been invoked to help explain the
declining share of manufacturing employment. Some also blame technology and
trade for higher structural unemployment: both may bring about structural
change in the economy, as employment rises in some industries but falls in
others. Workers who have developed skills in one field are forced to make a
difficult transition into another.

Finally, there is a view that the rise in inequality could be attributed to
cuts in government social expenditure. The reductions in poverty in the
1960s, in this view, were not simply the result of faster economic growth.
The expansion of social programs, particularly Social Security for the
elderly, played an important role. By contrast, cutbacks in social spending
were seen as hurting the poor in the 1980s.

[[Page 39]]

In light of these explanations, the recent direction of trends in inequality
is surprising. As reflected in the data on investment and productivity
growth, technological change appears to have accelerated over the past 5
years. Trade and international investment have expanded at rapid rates, the
price pressures from this increased trade have been considerable, and the
trade deficit has grown. Yet over this same period, real average hourly
earnings have increased, and income gains have been widely shared, in
contrast to the 1980s. Moreover, research shows that the hourly wages of
lower wage groups have increased about as much as or more than the wages of
upper wage groups.

This remarkable turnaround shows that rapid growth in an open economy can
occur without worsening inequality. There always was a nagging doubt
associated with blaming technological change for rising inequality. Why,
during the 1980s, was technological change apparently contributing little or
nothing to productivity growth, yet at the same time causing major shifts in
relative wages? Likewise, the explanation that ascribes a role to trade was
always controversial, because the evidence in support of these claims either
was weak or suggested that any impacts were small. This is not surprising,
because most U.S. workers are in domestic industries where there is little or
no international trade. Moreover, a large proportion of U.S. trade is with
countries such as Canada, Germany, and Japan, where wages are not very
different from those in the United States. Only a small fraction of U.S.
workers compete directly against very low wage workers overseas. To be sure,
in some economic models, international competition in even a few industries
is the sole determinant of relative wages across the economy, but the
evidence is that many domestic factors have an important influence on
relative wages.

Whatever the explanation for the growth in inequality during the 1980s, the
recent experience suggests that it is time to reappraise the inevitability of
the allegedly adverse impacts of technology and trade. It is time to look at
the ways in which they may actually help foster growth with equity, and to
recognize that a flexible economy can adjust to these changes.

Rapid productivity growth and openness to trade_and the policies that have
supported them_have allowed the U.S. economy to operate and sustain a
high-employment economy. And in this high-employment economy, employers have
been recruiting workers at all skill levels and training many who lack the
necessary skills. Moreover, faster productivity growth may allow firms to pay
higher wages without raising prices, thus dampening the inflationary impact
of higher levels of employment. Similarly, falling import prices will
increase purchasing power, enabling real wages to rise without accelerating
inflation; surplus global capacity can also help reduce inflationary

It is also quite possible that the shocks due to technology and trade have
been dissipated over time by responses in the economy itself. One possibility

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is that the direction of technological change responds to economic
incentives. As the relative cost of workers who are less well educated falls,
firms have an increased incentive to employ them. Similarly, as international
competitive pressures increase, firms either figure out new strategies
(improved technology, new products, or higher quality of existing products)
that allow them to compete, or they exit. Those firms that survive can
compete successfully with low-wage countries and thus are less affected by
pressures to reduce wages. The result is a far more resilient economy.

Finally, the connection between aggregate government spending and poverty
reduction is too simplistic. Determined deficit reduction in the 1990s has
not hurt efforts to reduce poverty, because spending has been more carefully
targeted. Increased funding for the Earned Income Tax Credit and for
education and training programs has played an important role. Also important
have been increases in the minimum wage. Certainly a higher minimum wage has
raised wages at the bottom of the income distribution, and it has not had a
noticeably negative impact on employment of the lowest paid workers.

Taken as a whole, the evidence on inequality suggests that policy has been
doing the right things. In addition, it provides an optimistic message. We
remain masters of our fate. We are not, as some suggest, condemned to be
buffeted by hostile global or technological forces, in the face of which we
are helpless. To be sure, two qualifications to this proposition are in order.
First, the final verdict on the impact of these forces is not yet in. The
strongest test will be whether these more recent trends are sustained if
there is slower growth at home and a global economic environment with less
excess capacity. And second, we must not become complacent. Although the
trend of rising inequality has been stopped, it has not been reversed.
Similarly, although progress has been made in reducing poverty, poverty rates
remain far too high. There remains much for policy to do, but the turnaround
so far is heartening.

Is the Dream Restored?

Chapter 2 discusses reasons to believe that the level of unemployment at
which the economy will experience strong inflationary pressures has declined.
But far more important over the long run is the question of whether
productivity growth has increased. Certainly a great deal of anecdotal
evidence suggests that technological change has been particularly rapid and
widespread, but until recently the official data offered scant proof that
these changes had boosted productivity. Over the past few years, as this
chapter has noted, productivity growth has clearly increased, but the full

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implications of the economy's recent performance remain difficult to interpret
because we have not seen the end of the current expansion.

One favorable interpretation of the unusual behavior of productivity growth
in this cycle is that is not part of a typical cycle at all, but rather
reflects a shift to a new wave of innovation. Typically, when a technology is
first introduced, inexperience prevents users from extracting its full
potential. Over time, however, users learn by doing and productivity
accelerates. Similarly, it is possible that the innovations in the current
technological wave are interrelated, so that breakthroughs in some areas
yield benefits in many others. But we cannot be certain how long the current
growth spurt can be sustained.

A conservative approach is to measure the change in productivity not from
1995  but from the previous cyclical peak in 1990, so that the last
recession, the initial sluggish recovery, and the subsequent acceleration are
all included. On that basis, it is striking that growth in GNP per capita at
2.1 percent per year, and that of GNP per worker at 1.8 percent per year,
have matched the pace recorded for the century as a whole (Table 1-1). One
cannot say for certain, therefore, that the past decade has witnessed the
emergence of a new economy that will generate historically unprecedented
growth. But we can be more confident that we have at least returned to the
pace of growth sustained over most of the 20th century, which gave us the 2
percent answer to the American dream and the more than eightfold increase in
output per worker over the 20th century. This, moreover, is a conservative
view. There is certainly support, if not  yet overwhelming evidence, for the
view that the future could be even more prosperous.

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Challenges for the Future

This chapter concludes with a brief summary of each of the remaining
chapters and the principal challenges that they identify for policy.
Sustaining the outstanding performance of the past several years means
meeting the challenges that still confront us as well as the new ones that
lie ahead.

Stabilizing the Macroeconomy

Chapter 2 recounts in greater depth the story summarized in this chapter of
a strong expansion that shows no signs of losing its vitality. Following a
long tradition of the Economic Report of the President, the chapter focuses
on the performance of the past year. For stabilization policy the key future
challenge is to sustain this performance: to maintain high levels of
employment while keeping inflation low and stable_a goal the Administration
shares with the independent Federal Reserve.

Given the current strength of the economy, prudence indicates that fiscal
policy should be directed at paying down the Nation's debt and preparing for
predictable needs such as those of Social Security and Medicare as well as
unexpected ones. Fiscal discipline also frees capital for productive
investments in education, businesses, and technology. Tax cuts should be
modest and targeted. Discipline over spending should continue. Policies
should stay directed toward such critical areas as saving, work incentives,
education and training, families and children, the environment, health care,
and research and development.

The chapter also examines the recent acceleration of labor productivity and
the role that computers have played in it. We find that from 1990 to 1999 the
acceleration in productivity is associated strongly with the production and
use of computers. But over the shorter period from 1995 to 1999, there was a
substantial increase in total factor productivity growth outside the
computer-producing industry.

Enhancing Productivity

Chapter 3 looks at the microeconomic, or industry-level, side of the
technological change that has driven growth in this expansion and in this
century. Technological change has created new industries and altered the
competitive landscape of the American economy. The chapter describes the
dynamic process by which innovative products and services allow competitors
to enter and compete with established firms, lowering prices and improving
service for consumers. Two examples of these trends are evident in the
telecommunications and information technology industries; here many firms are

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the economic opportunities made possible by innovations in computers,
communications technology, and the Internet and e-commerce.

In telecommunications, technological and regulatory changes have led to a
surge in demand for communications equipment and services. Many of these new
products, in turn, are critical inputs into the information technology
industry. Firms are adopting information technology to lower costs, create
new products, and improve their productivity. By improving information flows
within the firm and between the firm and its customers, information
technology has the potential to revolutionize how businesses conduct business
in this century. E-commerce could fundamentally reshape the nature of
relationships between businesses and their customers, and between businesses
and businesses.

The Administration has acted as a catalyst for this growth by supporting the
basic and applied research necessary for creating new technologies. It has
also supported regulatory reforms, like the 1996 Telecommunications Act, that
encourage competition and entry from new providers and new technologies. The
future challenge is to sustain and increase this stimulus by increasing
investment in R&D and encouraging competition and innovation.

Promoting Skills, Education, and Development

Chapter 4 examines the implications for the labor market of an increasingly
technology-driven economy. The chapter focuses on two key transformations of
the labor market: the increasing value of education and the improved
opportunities for women, minorities, and persons with disabilities. The last
several decades have seen a substantial gap emerge between the earnings of
those with a college education and of those with less education, even though
the average level of educational attainment has risen over the century. The
economy has clearly put a high premium on a new set of skills, and despite
the progress that has been made, there remains for some workers a mismatch
between the skills they possess and the skills that firms demand.

Chapter 4 also examines the role of government and the policies put forth by
this Administration to help workers adjust to the rapidly changing economy.
The chapter includes a discussion of education policies from preschool to
postsecondary, and of private and government training programs. The chapter
presents evidence on the effectiveness of these training programs in
improving the achievement levels of students as well as the labor market
outcomes of various groups of workers. The evidence suggests which types of
programs might be most successful and cost-effective at improving the skills
of workers in the future.

The challenge in this area is to develop a comprehensive set of education
and training policies that create a framework of lifetime learning within
which workers can acquire and maintain the skills they need to be successful

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in the new labor market. The chapter discusses a number of recent initiatives.
These include efforts to reduce class size and improve teacher quality,
policies that have been shown to be effective at the elementary and the
secondary level; initiatives, such as the Technology Literacy Challenge and
the E-rate, that are attempting to provide students access to the
technologies they will need to master in order to succeed in today's labor
market; the HOPE Scholarship program, a tax credit that will ideally make the
first 2 years of college as universal as high school; and the Workforce
Investment Act, a new training initiative being phased in during 2000, which
will help workers acquire the skills they need in the 21st-century economy.

Supporting the Diverse American Family

The importance of skills and the shift from backwork to brainwork have
changed the employment prospects for women and, together with other changes,
have altered the character of the American family. Chapter 5 discusses how
the decline in the importance of the traditional one-breadwinner,
one-homemaker family and the increase in the prevalence of two-earner and
single-parent families have changed the opportunities and challenges that
American families face at the beginning of the new century. In particular,
the chapter looks at the balance between the rewards of work and the needs
and rewards of family time. It notes three key trends that have shaped the
American family. One is the rise in female labor force participation over the
century, as more opportunities have opened up for women to work and more
women have taken advantage of those opportunities. Another is the changing
patterns of family formation and dissolution, which have contributed to the
growing prevalence of single-parent families. A third is the improvements in
health and life expectancy that have added new responsibilities to those that
most families can expect to face, namely, care of elderly parents in addition
to preparation for their own retirement.

The chapter then considers differences among family types with respect to
income and time available outside of work. It looks at Administration
policies that address the ``money crunch'' faced by families who feel their
resources are stretched to the limit. These policies include expansion of the
Earned Income Tax Credit, increases in the minimum wage, welfare reform, the
$500-per-child tax credit, and policies to help families invest in skills,
such as the HOPE Scholarship program, already mentioned. The Administration
has also pursued policies like those embodied in the Family and Medical Leave
Act to help families deal with the ``time crunch'' they face while trying to
balance work and family time.

Policies like the child tax credit and the Family and Medical Leave Act have
addressed important challenges facing the American family. But the
Administration recognizes that it will be a continuing challenge to ensure

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that the economy provides workers both the opportunity to work and the ability
to spend quality time with their families.

Exploiting the Potential of Globalization

Chapter 6 analyzes the effects of globalization on the U.S. economy. Trade
and, to a much lesser extent, investment links were well established a
century ago, but both deteriorated during the interwar period. Over the past
50 years, however, international trade and investment have risen sharply.
Today, global ties_through goods and services trade, through capital flows,
and through integrated production relationships among firms and their
affiliates_are generally broader and deeper than ever before.

The forces driving globalization include technology and policy.
Technological improvements_in transportation, communications, information
management, and elsewhere_have reduced the costs of doing business
internationally, thus lowering significant barriers to trade and capital
flows. These improvements have also increased the range of possible
commercial transactions, particularly in financial markets, and have created
venues for new kinds of transactions, such as electronic commerce. Policy has
also played an active role in reducing barriers to trade and investment. For
example, in the latter half of the 20th century, policy measures have sought
to reduce tariff and nontariff trade barriers. More recently, and especially
since the 1970s, many countries have decided to remove restrictions on
capital flows.

Our openness to the world makes us more prosperous. The freedom of consumers
and businesses to choose from a wider range of products and services improves
efficiency, promotes innovation, encourages the transfer of technology, and
otherwise enhances productivity growth. Trade allows us to specialize in what
we do best. All these benefits, in turn, lead to higher real incomes and

The United States has long sought to extend the benefits of international
trade and investment as widely as possible, but significant challenges
remain. Although trade liberalization lies at the heart of the World Trade
Organization (WTO) and continues as a central objective of U.S. policy, a
number of institutional issues have come to the fore. The United States is
seeking greater consideration of labor and environmental concerns in the WTO
and more openness in its proceedings. Moreover, despite the substantial
benefits of trade, the transition to more open markets may be difficult for
some U.S. industries and their workers. Those who are dislocated suffer real
costs, and therefore the Administration supports domestic policies that help
ease the transition for those affected. The recent financial crises in Asia
have been particularly disruptive. Such crises in emerging markets draw
attention to yet another challenge: the risk that sudden reversals in capital
flows can be

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disruptive in some cases. Finally, the growing U.S. trade deficit raises the
challenge of ensuring not only that the United States remains an attractive
location for investment, but also that Americans are saving enough for the

Maintaining the Environment Efficiently

Chapter 7 notes that although economic growth and structural and
technological change have altered the U.S. economy substantially for the
better over the past century, they have brought in their wake an array of
environmental problems, including air, water, and soil pollution. However,
economic growth has also provided the innovation and the resources to address
these environmental problems.

The chapter describes how traditional regulatory approaches designed to
address environmental problems have delivered substantial benefits but have
carried significant economic costs. It then discusses how experiences with
market-based approaches to pollution abatement, such as permit trading and
emissions charges, have shown ways to achieve environmental goals at lower
cost while providing the proper incentives for innovation. It suggests that
applying these lessons about the design of environmental markets to future
environmental problems is critical if environmental goals are to be achieved
most efficiently.

The most significant environmental problem of the 21st century is probably
global climate change. Chapter 7 argues that this problem is best addressed
through market-based approaches. The challenge is to design policies
appropriate to the problem. Emissions trading could serve as a powerful tool
to reduce greenhouse gases, because these come from a very large number of
sources with a wide range of abatement costs and have the same environmental
effect regardless of the source location.

In negotiations of the Kyoto Protocol to the Framework Convention on Climate
Change, the Administration has advocated international emissions trading and
project-oriented mechanisms that effectively allow for flexibility across
sources and countries in meeting climate goals. A broad international trading
system can significantly lower the costs of achieving emissions targets set
in the Kyoto Protocol while also delivering substantial revenue to
low-cost-abating countries, which would be sellers in an international
emissions market. Future international climate negotiations can resolve many
of the implementation issues regarding these market-based approaches.
Appropriate design of these approaches can ensure that the first steps taken
to address climate change will deliver environmental benefits at the lowest
possible cost.

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As we enter the 21st century, the principal challenges we face are to
sustain the extraordinary progress that America has made in this
record-breaking expansion, and to make sure that all Americans share in the
strong economy. The goal should be to make the accomplishments of this new
century even better than those of the last. New policy issues will surely
emerge, but the policy framework that has worked so well_maintaining fiscal
discipline, investing in people, and opening international markets_is the
right one to take us forward.