Managing Macroeconomic Imbalances

The United States is enjoying one of its longest economic expansions of the postWorld War II period. Inflation, unemployment, and interest rates are all dramatically lower than at the beginning of the decade. Yet, the reviews of economic policy by many economists have been highly negative, with frequent predictions that recession lies around the corner. Most voters who have enjoyed substantial gains in their standards of living, at least as measured by their consumption, may conclude that the concerns expressed by economists are simply the rantings of negativists who have been wrong in the past and are probably wrong about the future. Most of the pessimistic economic assessments of the U.S. economy can be reduced to a single issue: the current expansion is based on an unprecedented consumption binge that cannot be supported in the future without a substantial increase in debt burdens. The consumption orientation of the current expansion is highlighted by an examination of the trends in the saving-investment balance, as shown in table 1. The most dramatic aspect is the collapse of the net national saving rate from an average of 7.7% of net national product in the 1970s to 2% in 1986-87. This is even more remarkable in light of the emphasis that was placed on increasing national saving at the beginning of the decade. The decline is evident in both the private and the public sector. The private saving rate, household plus business saving, has fallen from 9.7% to 6.6% national net product (NNP) despite the introduction of several new tax incentives in the early 1980s to promote private saving. Essentially, with the creation of Individual Savings Accounts (IRAs) and other measures, most taxpayers faced a zero tax rate on new saving. We also know that many Americans took advantage of the new saving instruments: tax returns indicate that the inflow of new funds into IRAs approached 1.5% of national income by 1985. Yet, the overall private saving rate, which had been slowly rising in prior decades, leveled out and declined sharply after 1984. Apparently, as is often the case with tax incentives, Americans took advantage of the opportunity to rearrange their savings in order to reduce their taxes without increasing their overall rate of saving. By far the largest blame for the decline in national saving, however, must lie with the federal government. The combination of expenditure increases and tax reductions has resulted in a budget deficit that peaked at 5.4% of NNP in 1986 and remains near 4% in 1988. The goverment budget deficit continues to absorb over half of all private saving. Deficits of this magnitude far exceed the historical experience. The problem for international economic relations is evident in comparing a 1987 national saving rate of 2% of NNP with a rate of domestic investment of 6%. To fill the gap, the United States borrowed 4% of its income annually overseas-foreign investors are financing more than half of U.S. investment. The 4% can be taken as a rough measure of the extent to which the United States is living beyond its means-borrowing abroad to support a level of domestic spending in excess of the nation's productive capacity. The result has been to shift the United States from a net creditor to the world's largest debtor nation. Contrary to the usual arguments about unfair foreign competition, the United States has a trade deficit because its saving is inadequate to finance investment. In addition, the low level of domest c investment, 5.8% of NNP in 1987, refutes the argument that the foreign financing is being used to finance a surge of investment in a revitalized America-clearly the borrowing is to finance a surge of domestic consumption. The extent to which the budget deficit translated into a trade deficit did surprise most American economists. It was not difficult to anticipate that the 1981 combination of a defense buildup and a large tax cut would result Barry P. Bosworth and Robert Z. Lawrence are senior fellows in economics at the Brookings Institution, Washington, D.C.