Could We Have Done Better? A Retrospective on the 1990s Peace Dividend in the United States

America’s Peace Dividend, by Ann Markusen (ed.)

Could We Have Done Better? A Retrospective on the 1990s Peace
Dividend in the United States

David Gold

The 1990s began with military budgets falling, the United States economy teetering towards recession while struggling with inflation, persisting "twin deficits" in international trade and the federal government budget and U. S. technology shortfalls the subject of much hand wringing in academic, policy and journalistic circles. The decade ended with military budgets starting to rise, the economy seemingly "locked-in" to a high employment, low inflation, technology driven expansion, and the trade deficit persisting while the budget deficit has been transformed into a surplus visible as far as the eye of forecasters can see. The issue to be explored in this paper is what role in these outcomes can reasonably be assigned to the post-Cold War decline in military spending, and could the record have been improved upon. The focus will be on three sets of outcomes, the overall macroeconomic situation, the federal government budget and the pace of technological change.

The Post-Cold War Peace Dividend

The potential peace dividend is the sum of resources no longer claimed by the military and available for non-military purposes. The conversion of a potential dividend into an actual peace dividend can be analyzed in terms of two processes. The first, similar to the traditional guns-butter trade-off, sees a peace dividend in terms of the increase in non-military expenditures that is brought about by the decline in military expenditures. This is a useful way of looking at the initial aspects of the utilization of a peace dividend, but it is incomplete. The ultimate peace dividend is the improvement in both quantifiable and non-quantifiable living standards that result from the alternative utilization of military resources. The first way of looking at a peace dividend is similar to seeing it as a source of consumption, while the second is as a source of investment. When viewed as an investment, the short-term costs of realizing a peace dividend are necessary in order to achieve the long-term benefits.

The post–Cold War peace dividend occurred in a specific context for budget and macroeconomic policy. This context can be identified through the "twin deficits hypothesis", which dominated macroeconomic and budget policy debates in the 1980s and which remained the dominant view of U. S. macroeconomics well into the 1990s. The argument is that large budget deficits translate into increased demand for credit by the government. To the extent the Federal Reserve eases monetary policy and helps finance (or "monetize") the debt, this adds to inflationary pressures. If, instead, the Federal Reserve preserves monetary tightness, the budget deficit will place upward pressure on interest rates and crowd out private sector borrowers, primarily those borrowing for business investment and housing. Thus, the initial impact of the deficit is to promote greater inflation and/or less investment, neither of which are desirable outcomes. If interest rates do rise, this will attract foreign capital and help mitigate the crowding out of investment. However, the inflow of foreign capital will increase the demand for dollars and raise the international value of the dollar. In turn, a higher dollar will promote U. S. imports and discourage U. S. exports, worsening the trade deficit – the second "twin" – which undermines U. S. employment, purchasing power and economic growth

Not all participants in the policy debates of the late 1980s placed primary blame for this state of affairs on the military buildup, but it was certainly the intent of the Reagan Administration to push the buildup despite its impacts on the budget deficit. By the time the Berlin Wall fell, the buildup had ended and military spending was declining. The end of the Cold War allowed people to see this decline as long-term in nature. For the 1990s, a story parallel to that of the twin deficits can be constructed. In this story, the end of the Cold War led to a decline in military spending which had two effects. It reduced the distortionary effect of military spending, and it moderated the upward pressure on the federal budget deficit which allowed the Federal Reserve to adopt an easier monetary policy stance. Over the first half of the 1990s, a series of budget packages combining tighter spending constraints and tax increases were negotiated, albeit not without the expenditure of substantial political capital. Declining interest rates stimulated investment in plant and equipment and in housing, which touched off a boom that was going strong as the decade ended and which was producing substantial surpluses in the federal budget. Easier credit also provided a push to consumer demand. The trade deficit remains high, leading to possible questions about the missing twin in the recovery. But the boom in information technology and, most recently, in productivity growth has swamped concerns about the macroeconomic impacts of foreign trade. Thus, the role of the peace dividend was to provide, in Lawrence Klein’s phrase, "the initiating spark" that allowed the elements of the recovery to fall into place. ₁

Given the long, high employment, inflation free expansion of the 1990s, it may be reasonable to accept that result as the fruit of the peace dividend, the benefit from reducing the military budget. However, at the risk of playing the Grinch who stole Christmas, it is still important to ask whether an alternative scenario might have been possible. Could we have done better? Could the potential peace dividend have been employed in a manner that could have led to improved macroeconomic and budgetary performance?

One way to look at this question is to break the standard story into its component parts. The starting point is the military budget and its impact on the federal government budget. Military spending jumped over the course of the Carter-Reagan buildup, from 4.7 per cent of GDP in FY1979 to 6.2 per cent in FY1986. This was largely offset by a decline in nondefense discretionary spending of 1.2 percentage points over the same period, reflecting the Reagan Administration’s attempt to pay for more guns by buying less butter. ₂

At the same time, entitlements spending rose as a share of GDP, as did net interest outlays, the latter reflecting both the rise in the deficit and the rise in nominal interest rates that accompanied the inflation and tight monetary policy of the period. Tax revenues fell by one per cent of GDP. However, revenues had risen through FY1981 and the large decline in revenues after the 1981 tax cut largely coincided with the jump in the deficit. The federal government deficit rose from 1.6 per cent of GDP in FY1979 to 5.0 per cent of GDP in FY1986, or 4.8 per cent on a cyclically adjusted basis.

The new decade began two months after the fall of the Berlin Wall. The Cold War, which had been the single most important determinant of United States foreign policy, military strategy and military spending for 45 years, was coming to an end. Budgetary allocations for the defense function had peaked in FY1986 at 6.2 per cent of GDP and had fallen to 5.6 per cent of GDP by FY1989. Real military purchases peaked in FY1987, while the military function’s share of the budget began declining after FY1985. The fact that defense spending was already turning down when the Berlin Wall fell suggests that the end of the Cold War was not the only element behind this particular swing in the military budget. ₃

Defense spending declined more rapidly after 1989, with the exception of an upward blip in 1991 for the Gulf War. Defense outlays were 3 per cent of GDP in FY1999, and the Office of Management and Budget has projected defense outlays to fall to 2.7 per cent of GDP by FY2005. However, the absolute level of defense outlays is beginning to increase and projections of a continuing decline in the share is based upon the continuation of recent high rates of growth of GDP. Moreover, it is widely agreed that present military acquisition and force structure plans cannot fit within projected budgetary caps. One possible outcome is a larger than projected growth in real military outlays.

The post-Cold War drawdown was accompanied by slightly different spending patterns than the buildup. Military spending declined substantially, by 3.2 percentage points of GDP through FY99, but nonmilitary discretionary spending did not rise, falling very slightly as a share of GDP. Within discretionary spending, outlays for science and space, transportation, education and training, and health rose over this period. Entitlements spending rose slightly, while net interest outlays fell from 3.1 to 2.5 percent of GDP, reflecting the reversal of the high deficits and high interest rates of the 1980s. The other big change is on the revenue side, where tax revenues rose by 2.5 per cent of GDP. The deficit was turned into a surplus, reaching 1.4 per cent of GDP in FY1999, while the cyclically adjusted deficit was zero.

The differing patterns in the changes that accompanied the 1980s buildup and the 1990s drawdown illustrate the difficulties in assigning causation. Since the defense buildup was largely offset by the decline in nondefense discretionary spending, the deficit can be seen as the result of tax cuts, an increase in entitlements and the jump in interest expenditure, itself a result of the deficit. It would be just as reasonable to see the decline in nondefense spending as a means of paying for tax cuts, with the buildup being financed by the deficit. Budgets are examples of simultaneous determination, the result of a political iteration where give and take operates over the course of a budgetary cycle. The Carter Administration began the Cold War buildup but it was given a major boost under Reagan, and given equal priority with tax cuts. It seems reasonable, therefore, to treat the 1980s deficits as a joint product of the Cold War military buildup and the policy of cutting taxes, with the effects offset to some extent by cuts in non-military outlays.

With the drawdown, however, the perspectives have altered. The size of the expenditure drawdown has tended to mirror the size of the reduction in the deficit, and it has become common to attribute the potential peace dividend to the cause of deficit reduction. Such a view tends to ignore the substantial rise in tax revenue, partly the result of deficit-reduction packages that included revisions in tax rates. In addition, the growth in tax collections has outstripped forecasts, as the widening income distribution placed a large share of income growth in the hands of those who pay higher marginal tax rates, and as the boom in asset prices has increased realized capital gains. Looking at the size of the drawdown and the growth in tax revenue tends to over determine the change in the deficit. It is not unreasonable to conclude that the size of the drawdown provided some protection to nondefense spending categories in the context of annual fights over the budget. This protection was the result of the budget determination process and not a targeted use of the peace dividend

In an earlier paper, I presented a rough estimate of the distribution of the potential U. S. peace dividend. ₄

Under the assumption that the increase in tax revenue cited above was applied to deficit reduction, I calculated that, as of FY1997, up to 60% of the decline in defense spending was shifted to deficit reduction, about 10% was utilized to meet adjustment costs associated with the defense draw down, and some 30%, and perhaps more, was allocated to civilian government programs. In FY1997, the defense budget was approximately $100 billion lower, in real terms, than at its Cold War peak in FY1986. Thus, approximately $30 billion can be seen as having protected civilian programs from further cuts. Of course, to the extent defense’s contribution to deficit reduction provided an extra stimulus to growth and therefore to tax revenue, the amount potentially spent on civilian programs as a result of the draw down would be even higher.

The Macroeconomics of Twin Deficits

The twin deficits hypothesis begins with the effect of higher deficits on interest rates. An increased supply of government bonds can be sold if prices are lowered and yields raised, which would draw funds from other uses, the most important of which from a long–term perspective is the funding of business fixed investment. The Federal Reserve can prevent this outcome by buying the extra government debt, but this increases banking system reserves, which translates into an increase in the money supply and heightened inflationary pressure. Thus, the central bank is caught between a rock and a hard place and whichever alternative, or combination of the two, it chooses, leads to an unpleasant outcome.

The empirical evidence linking deficits with interest rates and crowding out has been mixed, at best, in part because deficits usually accompany a relatively weak economy. A number of sophisticated empirical studies – including many that were widely available at the time the twin deficits hypothesis was most prominent — found essentially no link between the two. The absence of a relationship was due to the factors mentioned above, the importance of the state of the economy and the role of monetary policy. But the notion that budget deficits automatically crowd out investment has essentially no basis in the research literature. ₅

Behind the twin deficits scenario, therefore, is a set of assumptions about the linkages. First, in order for either the crowding out or the inflation scenario to hold, the economy must be operating at a high level of resource utilization, what used to be called, in simpler times, the full employment level of output. In the 1980s, the unemployment rate was well over six per cent, and in the second half of the decade, during the expansion phase of the business cycle, unemployment averaged 6.1 per cent. The consensus view was that shifts in the composition of the labor force and inefficiencies in labor market institutions had raised the rate of unemployment consistent with stable inflation, the non-accelerating inflation rate of unemployment, or NAIRU, to approximately six per cent. In addition, the experience of the 1970s and early 1980s had undermined confidence in the ability of the government to prevent inflation and reinforced inflationary expectations. Thus, it was argued that full employment had been reached and rising budget deficits would lead to crowding out and/or inflation. ₆

The consensus view lasted well into the 1990s and has been altered only as the economy has expanded without inflationary pressure, even with unemployment falling to, and at times below, four per cent. One explanation is that markets for labor, intermediate goods and final products have become substantially more flexible with a reduction in cost pressures emanating from high employment. Robert Gordon, for example, has identified a dozen changes that, in his view, have lowered the NAIRU in the 1990s. These include the expansion of temporary-help agencies that allow people greater flexibility in their labor force participation, the rise in incarceration rates that tend to remove a high unemployment segment from the labor force, and the rising dollar that introduces a downward pressure on prices. ₇

An alternative, however, is that the NAIRU approach is itself flawed, and that the economy of the 1980s was never close to full employment. James Galbraith has pointed out that two major tenets of the NAIRU have not been empirically validated. One is that if actual unemployment is pushed below the NAIRU inflation will accelerate, and the other is that low unemployment will force up real wages and lead to excess demand and inflation. Instead, low unemployment has not been accompanied by accelerating inflation, while high unemployment has been associated with decelerating inflation. And real wages have tended to lag behind both price level changes and real GDP growth since the early 1970s, the period when the NAIRU was supposedly reaching six per cent. ₈

Inflationary episodes have been heavily influenced by wars (e.g., Korea and Vietnam), oil price shocks (e.g., the 1970s and early 1980s), and falling exchange rates (e.g., the late 1980s).

An alternate version of the crowding out scenario was derived from a supposed shortage of savings, so that budget deficits would serve to transfer resources from productive to unproductive uses. The unproductive nature of government spending can, of course, be questioned, especially when used as a blanket indictment. Government spending on physical and human capital (e.g., roads, airports, education, health), on the maintenance of legal and regulatory systems (e.g., prudential regulation of financial institutions), and in the provision of certain public goods (e.g., basic R&D) can be growth-enhancing. The issue is whether the social rate of return to deficit-financed government outlays is greater than the social rate of return to the private sector activities that are presumably crowded out. This is an empirical, and of course political, consideration and should shift the terms of debate from the size of the deficit (or surplus) to what the deficit supports.

Second, the crowding out scenario assumes that investment will be constrained by higher costs of borrowing, and stimulated when interest rates fall. While this is certainly true in many instances, the size of the interest-elasticity of investment demand is by no means a settled question in economic research. Some analysts believe it to be very low and focus instead on expected future demand for final output as the primary driver of investment spending. Others point to the large role played by internal finance, including retained profits and cash flow resulting from depreciation allowances, and the small role played by debt and equity in the financing of corporate investment. Still others claim that the cost of capital, of which borrowing costs represent one important component along with tax rates, the price of capital goods and depreciation schedules, is a major determinant of investment spending. The differing views on the relative importance of interest rates are one of the elements that have distinguished Keynesian from neo-classical models of the economy. ₉

However, the strong performance of investment in the 1990s may have less to do with interest rates and more to do with the type of investment being undertaken. Business fixed investment has grown rapidly since 1993, and has clearly been a leading element in the expansion. And the leading element in investment spending has been investment in computing equipment and software. Investment in computers has been stimulated by high rates of depreciation and substantial declines in real prices, both a reflection of rapid technological change. The apparent sensitivity of investment to interest costs may instead be masking the sensitivity of computer investment to large changes in real prices, the effects of rapid, and presumably long-term, technological change. ₁₀

Moreover, although interest rates are commonly thought of as being lower in the 1990s than they were in the 1980s, reinforcing the supposed link from deficit reduction to investment stimulation, in fact real interest rates in the 1990s are considered to be high, by historical standards. Nominal interest rates are the sum of real interest rates and expected rates of inflation and a major reason for swings in market rates is shifts in expectations about the price level. Since the latter are not directly observable, they are frequently inferred. With actual inflation remaining at or below three per cent since 1992, and assuming price level expectations adjust to the relatively constant actual rate of inflation, a pattern that has been found in the forecasts of professional forecasters, real interest rates have been higher in the 1990s than in the 1960s, the last period of relatively stable inflation and rapid economic growth. And real interest rates have risen since the end of the recession in the early 1990s. Yet investment keeps booming.

Interest rates have assumed greater importance in overall macroeconomic policy. At one time, the real variables in the economy – investment, consumption, savings, government expenditures, imports and exports – were thought to be relatively insensitive to changes in interest rates. Instead, interest rates were thought to effect the economy through influencing asset holdings, that is, choices among equities, bonds with differing risks and yields, cash equivalents, foreign assets, etc. The revived importance of interest policy may be due to several recent developments. First, with the government budget being focused on deficit reduction and the experiment of tightly controlling the money supply having long been abandoned, interest rate policy is the only major instrument left. Second, following on rapid growth in the volume of financial assets relative to real economic activity, there may be more scope for interest rate policy to affect some elements of economic activity. However, it remains unclear how this affects the real economy. And third, we are in a period where a substantial amount of economic stimulation is coming from the private sector, so there is less need for government to provide an economic boost. This situation is not likely to be permanent, however, and there will come a day when the budget will once more be a necessary instrument of macroeconomic policy.

The Second Twin

The second twin is the deficit on current account, or the difference between imports and exports in the national income accounts. The "twinned" relationship is derived from a specific interpretation of an accounting identity, whereby the combined balance of public and private sector domestic savings and investment is filled in by foreign capital flows. If total domestic savings are not sufficient to finance private plus public investment, there will be an inflow of foreign capital. In turn, net foreign capital inflows are equal, by a second accounting identity, to the deficit on current account, which in turn is largely comprised of the balance of imports and exports. Thus, the trade deficit is not a twin to the budget deficit but to the shortfall of national savings in relation to planned investment, both public and private. It is possible for a country to have a government budget surplus and a trade deficit, if private sector savings falls short of investment needs by an amount greater than the budget surplus

Whatever link might have existed between the budget and trade deficits in the United States in the 1980s appears to have been severed in the second half of the 1990s when the disappearance of the budget deficit was accompanied by deterioration, not improvement, in the trade balance. The accounting identity linking the current account balance and the savings-investment balance cannot be interpreted as one always causing the other. Instead, in any specific situation, either could cause the other, or there could be mutual determination. The trade deficit does not simply fall out from domestic decisions regarding savings, investment, taxes and spending but has independent determinants. Determining the direction of causation is an empirical issue. In the 1990s, the U. S. trade deficit has deteriorated because the strong expansion relative to activity in other areas of the world has increased demand for imports, and because the value of the dollar relative to other major currencies has risen, which has the effect of increasing the prices of U. S. exports relative to other internationally traded goods and services. Continual improvements in U. S. productivity, recovery in Asia, better growth prospects in Europe and a slowing of the U. S. expansion will lead to a lower trade deficit. ₁₁

Technology and the Boom

If reducing, and even eliminating, the budget deficit was not required, what explains the boom of the 1990s and its relation to the peace dividend? On the demand side, the boom has been led by private sector consumption and investment, which has more than offset the negative effects on demand from the large swing into surplus of the federal budget, and the deterioration of the trade balance. Both consumption and investment have been stimulated by the availability of a wide variety of new and improved products based upon developments in information technology. On the supply side, the growth of the computer sector has transferred some of it’s rapid productivity gains to the economy as a whole, in part as a composition effect and in part as businesses become more proficient in integrating computer technology. In addition, the explosive growth of the Internet is creating a positive supply shock as its effects are permeating the economy. Finally, the Federal Reserve and the Administration have shown a flexibility in policy formulation that has reinforced the boom. Alan Greenspan in particular has received well-deserved praise for recognizing the important changes that are underway in the economy. However, to paraphrase a comment originally made about Isaac Newton, while Greenspan may be a brilliant central banker, he is also a lucky one, presiding over a monetary policy that benefited first from a peace dividend and then from the maturation of a major-cost reducing technological innovation.

The initiating spark attributed to the defense drawdown was not its only contribution to the character of the post-Cold War boom. The decline in defense purchases added to unemployment and the relatively slow absorption of defense sector labor into civilian activities may have contributed to the slow initial pace of the recovery. During its initial phase, the recovery was often described as a "jobless recovery." The strong performance of the economy over the last few years should not obscure the recovery’s slow start. Indeed, through the end of 1999, the overall performance of the present cyclical expansion is not better by most measures than previous long expansions in the 1960s and the 1980s, largely due to its slow start. The main exception, of course, is inflation where the record is far better at present than in either the 1960s or 1980s. ₁₂

It might be possible to see the defense drawdown as one of the sources of the boom in technology. Military spending on R&D has been thought to crowd out civilian R&D. If this were the case, a decline in military R&D would presumably expand the supply of resources available for civilian technology. However, the decline in military R&D was substantially smaller than the decline in procurement, operations and maintenance and other defense budget categories. Research and development takes a larger share of the defense dollar today than at the height of the buildup. Moreover, the shift of military scientists and engineers to civilian information technology was slow, and appears to have followed, not led, the recovery.

The roots of the technology boom of the 1990s lie in the 1970s and 1980s, prior to the post-Cold War peace dividend. The personal computer was developed and commercialized in the 1970s and its "take-off" can be dated to the introduction of the IBM Personal Computer with its Microsoft operating system and Intel microprocessor in 1981, at exactly the time the Reagan Administration was ramping up the defense buildup. By 1987, the rapid spread of computers had given rise to Robert Solow’s famous paradox, namely that we see computers everywhere except in the productivity statistics. The Silicon Valley-based venture capital industry was founded in the late 1970s, and grew in the 1980s. The early-1980s deregulation of the telecommunications industry provided a stimulus to many of the innovations and entrepreneurial initiatives that have contributed to the 1990s boom. And changes in laws and government regulations in the 1970s and 1980s paved the way for greater commercialization of the fruits of government and university research.

The link between military and civilian R&D is complex. Some trade–off mechanisms clearly are at work but there are also interdependencies, in the form of "dual use" technologies and products and externalities between civilian and military activities. Military R&D and procurement has provided "infant industry" protection to civilian technology with a prominent example being the computer industry in the 1940s and 1950s. The current information technology revolution has some of its origins in military programs including, as is widely known, the internet itself which began as ARPANET, a system designed to link scientists working on defense projects with each other and with the Pentagon. There are also numerous examples of military programs that appear to have retarded civilian initiatives, such as the U. S. Air Force’s subsidization of overly complex machine tools in the 1950s.

What Might Have Been

My conclusions are as follows. First, a portion of the potential peace dividend was utilized to protect some civilian public sector programs from the budget-cutting ax in the context of a bi-partisan attack on the federal budget deficit. These public sector programs are commonly seen as public consumption ("butter"), but many, such as those in education, health, transportation, science, etc, are more properly investment and will yield benefits in the future. However, the protection function was not the result of a thought-out process whereby resources were directed towards the most productive activities, but instead emerged from the budgetary infighting that characterized the period. Second, the remainder of the potential peace dividend contributed to deficit reduction directly, and contributed to an easing of monetary policy indirectly, in part by easing market expectations about inflation, and through these channels presumably fed the recovery, again providing long-tern benefits. My view, however, is that using the peace dividend for deficit reduction may not have been necessary, in part because the supposed link first to interest rates and then to investment was weaker than widely claimed, and in part because the core of the recovery, the boom in investment in information technology, was already underway and would most likely have accelerated in any event.

Could policy-makers have reasonably been expected to adopt this view at the time the peace dividend was becoming an issue? Probably not. Lawrence Klein’s view that the defense drawdown was a necessary spark seems an accurate summary of both the political and intellectual situation at the time. Indeed, President Clinton’s attempt to introduce a mildly stimulative budgetary package early in 1993 was met by extensive criticism and a sharp negative reaction in financial markets. (This episode led to James Carville’s remark that if he were reincarnated he did not want to return as a President or a General, but as the bond market so he could exercise real power!) The lack of acceptance of an alternative view of budget deficits by policy makers and financial market participants is a striking parallel to the phenomena of generals basing current strategy on old wars and old paradigms.

What alternatives were available? The Clinton Administration, upon taking office in 1993, did have proposals for utilizing some of the potential peace dividend to meet social and technological objectives, but these initiatives tended to lose out in the political battles over the budget and to conflicting priorities among the various interests involved. ₁₃ There are several areas where additional investment would have increased the chance that the peace dividend had a long-lasting impact.

Investment in technology – Knowledge is a classic public good and a strong case can be made for additional government investment in the basic knowledge base. The increased privatization of research and development over the last several decades has beet accompanied by a shift of resources from basic research towards applied research and development, a shift that is consistent with the greater ability of firms to appropriate returns from stages of the R&D process that are closer to commercialization. This suggests a growing shortfall in basic research and education where the public goods properties are greatest. The government engaged in substantial investment in basic knowledge under the stimulus of the cold war and that investment has paid off handsomely. Government investment in bio-medical research is one of the pillars of the pharmaceutical industry, while public research in agriculture has contributed to U. S. economic growth for close to a century and a half. Investment in basic research, knowledge creation and knowledge dissemination would avoid some of the conflicts over specific interests that develop when government investment becomes highly specific.

Investment in physical capital -- The current period is one in which the infrastructure investment for the spread of information technology is being undertaken by the private sector. Investment in information technology infrastructure is similar to earlier communications investment, such as telegraph, telephone, radio and television. Other infrastructure investments, in canals, railroads, highways, airports, hydroelectric power, water supply, urban transport systems, etc., were either undertaken or subsidized by government. These public investments have been shown to be growth enhancing in that the social rate of return to public sector infrastructure investments can be quite high. However, not every example of infrastructure investment has a high prospective return, and substantial care needs to be taken in selecting specific projects.

Investment in human capital – Expenditures on education, health, worker retraining and workplace safety, while popularly considered as social spending, or public consumption, are actually productivity-enhancing investments. Government subsidies to promote the computerization of the primary and secondary school system, and the active promotion of preventive health care, are two specific examples of possible expenditures in this area.

Investment in poverty and inequality reduction -- The triumphalism about the present recovery should not obscure the persistence of high levels of poverty in the United States and the widening of the income and wealth distribution that has occurred over the past quarter-century. ₁₄ There are economic reasons for attacking poverty and inequality, in that higher incomes allow people to expand their demand for goods and services as well as engage in more investment in skill acquisition. There are also political reasons in that rising inequality is one of the sources of frustration with high technology-based economic growth. There is a solid foundation in welfare economics for having the government transfer some of the gains from the relative "winners" of a major economic change to the relative "losers," although redistribution does not have a solid foundation within the political system.

This list could, of course, be extended or modified. And it reflects current issues and not necessarily the ones that existed in 1990. Investments along these lines, however, could have contributed to a long-term peace dividend without harming the recovery.

Endnotes

Note 1: Lawrence Klein, "A New Economy," paper presented at the Spring meeting of Project LINK, United Nations, New York, April 19, 2000. (http://www.chass.utoronto.ca/link/meting/agen0400.html). Back.

Note 2: Although the guns-butter analogy is widely used in the context of budget debates, this episode represents one of the only times in post-war U. S. history that it might be valid. See Bruce Russet, "Defense Expenditures and National Well-Being," American Political Science Review, vol. 76, no. 4 (December 1982). p. 93. Back.

Note 3: The decline in defense spending can be traced to domestic political opposition to the buildup, reduced tensions with the Soviet Union under Gorbachev, the stretching out of procurement and heightened concern over the federal budget deficit. These points are developed in David Gold, "Whatever Happened to the Peace Dividend in the United States?" in Joern Broemmelhoerster, editor, Demystifying the Peace Dividend, Baden-Baden, Nomos Verlagsgesellschaft, 2000, pp. 47-68. Back.

Note 4: See Gold, op. cit., pp. 56 to 59.. Back.

Note 5: See, e.g., Paul Evans, "Do Deficits Produce High Interest Rates?" American Economic Review, vol. 75, no. 1 (March 1985), pp. 68-87. In 1987, the Congressional Budget Office published a review of 22 empirical studies and found no conclusive relationship between budget deficits and interest rates. The Economic and Budget Outlook: Fiscal Years 1988-1992, Part I, Washington, D. C.: U. S. Government Printing Office, January 1987, pp. 97-102. Another issue is that the size of the budget deficits was overstated by failing to adjust for changes in the real value of government debt. See Robert Eisner and Paul Pieper, "A New View of the Federal Debt and Budget Deficits," American Economic Review, vol. 74, no. 1 (March 1984), pp. 11-29. Back.

Note 6: "If the 6.1% unemployment ... maintained on average during 1985-90 ... were known to have been well above the corresponding ‘full employment’ rate, ... many economists who viewed the deficits ... with alarm would have had a more benign prospect." Benjamin M. Friedman, "What Have we Learned from the Reagan Deficits and Their Disappearance?" Challenge, vol. 43, no. 4 (July-August 2000), pp. 7. Back.

Note 7: Robert Gordon, ""Explaining the U. S. Economic Miracle," Paper presented at the OECD jobs conference, Helsinki, January 27, 2000 (http://faculty-web.at.nwu.edu/economics/gordon/researchhome.html). The growth of electronic commerce is another cost-reducing phenomena, e.g., Martin Brookes and Zaki Wahhaj, "The Shocking Economic Effect of B2B," Global Economics Paper No. 37, Goldman Sachs, New York, February 3, 2000.. Back.

Note 8: James K. Galbraith, "Time to Ditch the NAIRU," Journal of Economic Perspectives, vol. 11, no. 1 (Winter 1997), pp. 93-108. Other prominent critics of the NAIRU concept include the late Nobel laureate William Vickery and the late Robert Eisner. Galbraith’s article is part of a symposium on the NAIRU that includes contributions from both critics and proponents. A recent critique of the NAIRU and formulation of an alternative is George A. Akerlof, William Dickens and George Perry, "Near Rational Wage and Price Setting and the Long-Run Phillips Curve," Brookings Papers on Economic Activity, 1: 2000 Back.

Note 9: One example of the importance of this distinction can be found in forecasts of the macroeconomic effects of declining defense spending. The Congressional Budget Office, in 1992, projected economic gains assuming the drawdown would be converted into deficit reduction and lead to a lowering of interest rates. Robert Coen and Bert Hickman, writing in 1995 under a similar scenario whereby the peace dividend would lead to deficit reduction, projected a declining GDP since the lower deficit would withdraw demand from the economy. See CBO, The Economic Effects of Reduced Defense Spending, Washington, U. S. Government Printing Office, February 1992, and Coen and Hickman, "Macroeconomic Impacts of Disarmament and the Peace Dividend in the U. S. Economy," in Nils P. Gleditsch et al, editors, The Peace Dividend, Amsterdam, Elsevier, 1996, pp. 27-61. Back.

Note 10: Stacy Tevlin and Karl Whelan, "Explaining the Investment Boom of the 1990s," Board of Governors of the Federal Reserve System, Finance and Economics Discussion Series 2000-11, March 2000. (http://www.bog.frb.fed.us/pubs/feds/2000/index.html) Back.

Note 11: TShaikh, Anwar. 1999. "Explaining the U. S. Trade Deficit." Testimony before the Trade Deficit Review Commission, December 10. (http://homepage.newschool.edu/~shaikh.papers2.html) Back.

Note 12: FA detailed comparison is presented by Victor Zarnowitz, "The Old and the New in U. S. Economic Expansion of the 1990s," National Bureau of Economic Research Working Paper 7721, May 2000. (http://www.nber.org) Back.

Note 13: One example is the demise of the Technology Reinvestment Program. See Jay Stowsky, "The History and Politics of the Pentagon’s Dual-Use Strategy," in Ann Markusen and Sean Costigan, editors, Arming the Future: A Defense Industry for the 21st Century, New York, Council on Foreign Relations Press, 1999, pp. 106-157 Back.

America’s Peace Dividend