A Call for Austerity Is Misdirected When There’s So Little Fat to Spare

Talk of austerity is in the air. We’ve been living high on the hog, one hears, and it’s time to tighten our belts.

Former Commerce Secretary Peter G. Petersen writes in the Atlantic Monthly that “the day of reckoning is at hand.” A phalanx of corporate executives runs a two-page ad in major newspapers that insists we must “discourage consumption.” A New York Times report on a recent international conference of business executives and government ministers concludes that “its unofficial theme seemed to be: ‘It’s the Morning After in America and Time for the U.S. to Stop Living Beyond Its Means.’ ”

These warnings are almost always translated into a sweeping policy imperative: Everyone in the United States must substantially cut consumption in order to foster savings and investment. Without such reductions of consumption, we will never be able, as one Swiss banker put it, “to set things right.”

These arguments are misplaced and misdirected. They are misplaced because they identify the wrong problems with the U.S. economy. And they are misdirected because they focus on the wrong targets for correction.

It is definitionally true, in a purely formal sense, that something has to give: We cannot keep running such large trade deficits and government deficits forever.

But it does not follow that these deficits have resulted from the country’s “living beyond its means” in a universal, orgiastic binge of shortsighted self-indulgence.

Forced to Save Less

Two of the first indicators to which the “beyond-our-means” critics point are the personal savings rate and the rate of personal borrowing. It is true that the personal savings rate declined to less than 4% in 1987, setting a new post-World War II record low--smashing the previous nadir set in 1986. It is also true that the ratio of consumer loans outstanding to personal income reached nearly 16% in 1987--setting a new postwar high.

But these records have not been set as a result of new levels of self-indulgence or of new and insidious changes in attitudes. They have occurred because most Americans have been on a belt-tightening diet for years.

To view these trends most clearly, it makes sense to look at the incomes of the vast majority of Americans who depend on wage and salary income and who are employed as production, non-supervisory or government workers--somewhat more than five-sixths of all non-farm employees.

The total wage and salary earnings paid to these workers stagnated between 1979 and 1986, rising in real terms at a rate of less than 1% a year. (Real hourly wages actually declined; employees protected their earnings by working longer hours.)

It is small wonder, as a result, that many of those households were forced to save less and borrow more to try to maintain their living standards. Tightening their belts even further is likely to simply force even greater borrowing and less savings.

So where’s the fat?

There have been three important changes in the U.S. economy since the late 1970s that have, indeed, involved significantly greater corpulence, permitting belt-loosening for at least a lucky few.

- As real interest rates have soared, real interest payments have increased at a rate of roughly 4% a year since 1979--dramatically increasing the incomes of those very wealthy households that control most of the interest-bearing personal assets in the United States.

- Financial speculation has diverted more and more income into paper investment, draining away funds that might otherwise go for investment in productive plant and equipment, and enriching the lawyers, bankers and speculative arbitragers who eat junk bonds for breakfast.

- Compensation going to managerial, administrative and professional personnel--the one-sixth of all non-farm employees working in supervisory and non-production jobs--has also soared as U.S. corporations have grown more and more top-heavy.

Total real compensation going to this small group of affluent employees increased at a rate of nearly 4% a year from 1979 to 1986, while the ratio of their average hourly wages to those of production/non-supervisory employees increased by roughly one-seventh. (It’s worth noting that many management-consultant studies have found roughly one-third of all managerial employees in U.S. corporations to be completely superfluous.)

Identifying these particular trends helps us compare the possible fruitfulness of alternative belt-tightening exercises.

Suppose, on the one hand, that we took steps to cut back in these three areas of recent enrichment. Suppose, more specifically, that we:

- Reduced real interest rates by half, resulting in reduced nominal interest rate burdens;

- Cut back paper investments to their relative levels of the 1950s and 1960s (when productive investment was booming);

- Reduced bureaucratic waste and redundancy by shifting one-third of all private supervisory/non-production personnel into productive employment at average non-supervisory/production workers’ wages.

These three moves toward reallocation and retrenchment would have freed up in 1986 roughly $260 billion, allowing us to increase net fixed non-residential investment by more than 200%.

How does this compare to the potential returns to belt-tightening through reduction of consumption?

A 1% reduction in total personal consumption would have released only $28 billion in 1986. To free up as many resources for investment in 1986 as through our previous fat-reducing exercise, it would have been necessary to reduce total personal consumption expenditures by nearly 10%.

No Fat to Spare

Most American households are already living close to the margin, earning barely enough to stay afloat. Another 10% reduction in consumption would not come easily.

These are only hypothetical comparisons. But their implications should be poignantly clear: We should stop all this loose talk about general austerity and universal belt-tightening.

Most people in the United States have been on that diet for more than a decade and have no more fat to spare.

We should concentrate instead on controlling the most egregious examples of opulence and inefficiency in our economy. We should start focusing, specifically, on usurious real interest rates, profligate paper investment and top-heavy corporate bureaucracies.

Let’s impose some austerity where it can be afforded--and where it might actually do some good.