The New Domestic Order?

Two years ago, the sun began to shine on the Western democracies. The collapse of the communist system, first in Eastern Europe, then in the Soviet Union, brought about a general euphoria that reached deceptive proportions. Now the situation has become dark and chaotic. In the Persian Gulf, Iraq’s invasion of Kuwait led to a confrontation which resulted in a crushing military defeat for Saddam Hussein without, however, removing his regime from power. Although the risks of military confrontation have been sharply reduced, the volatility of the region still presents major risks. Until a regional settlement is reached that is both political and economic, the potential for an explosion remains very real.

The breakup of the Soviet Union is a spectacular victory for the ideals of Western freedom and democracy, and, in particular, a victory for the US as the standard bearer of these ideals. It also may have unpredictable and dangerous consequences. The bold nuclear arms initiative announced by President Bush should make the world a safer place. However, it is impossible to predict the social, economic, and security impact of the breakup of the Soviet empire and the collapse of the Soviet economy. Every day, another plan is brought forward to “stabilize” the Soviet economy, each one a fantasy. No Western plan will be worth the paper it is written on until the various Soviet republics have decided on their political relationships, until they have sorted out their individual currencies, their banking systems, their internal and external security arrangements. This could take years: one cannot create a currency stabilization fund without a currency.

Nor can one speak of economic assistance to the Soviet Union without recognizing that the amount of capital which may be required is entirely beyond the capacity of the West to provide. West Germany may well have invested between $500 billion and $1 trillion in East Germany by the end of the decade. If this is required to bring a relatively advanced country of 17 million people up to Western standards over a decade, what will it take to bring fifteen republics of over 200 million people into some form of relative competitiveness when they are now fifty years behind the East Germans? For political as well as humanitarian reasons, the West must provide as much food, medicine, clothing, and other basic necessities as possible this winter. The original request for food amounted to $1 billion. It then grew to $7 billion and now stands at $14 billion. This is only the beginning. Another immediate concern will be to help the Soviets in the servicing of their external debt of over $60 billion. A default on this debt is imminent and would create serious new economic problems.

Over the longer term, a practical measure to assist the Soviet economy might be to increase the price of gold by international agreement gradually to, say, $500 per ounce; this could enable Russia, as the world’s largest gold producer, eventually to provide a gold-backed currency that would be accepted internally and externally. It would also have the advantage of revaluing significantly our own domestic gold reserves. Ultimately, the transformation of the Soviet empire into a group of free republics could result in a huge new market for the West which could be a boon for the world’s economy. However, over the next few years, it may not be possible to avoid social and economic chaos in the former Soviet Union, no matter what we do, with potentially dangerous consequences to the West, starting with Western Europe.

The political reactions to the breakup of the Soviet Union are already apparent in Western Europe. The prospects for European political union are fading, notwithstanding the economic integration that will take place in 1992. No European currency or central bank is likely until the end of the decade, if then. It is impossible to predict whether Europe will conform to the nationalistic visions of Charles de Gaulle and Margaret Thatcher or to the federal visions of the European Community in Brussels and of Jacques Delors. Greater economic stability would come about with a united European economy and currency to counterbalance the yen and the dollar in a free-trading world system; a setback to the political and economic union of Europe will be a setback for all of us.

We have stumbled into a world situation almost as unpredictable and dangerous as any we faced during the cold war. The dangers now, however, are of a different nature. We have derived great and justified comfort from our new cooperative relationship with the Soviet Union. Now there is no Soviet Union and only uncertainty has taken its place. Who will help us to maintain peace in other, more unstable regions around the globe, and who will also encourage a free and fair trading and investment system around the world? Maybe a new Europe ten years from now, but certainly not today. Not if one looks at the performance of the EC during the Gulf crisis, or in the Yugoslav crisis, and at its failure to provide for Eastern Europe. Neither does Japan seem prepared to assume these kinds of responsibilities.

For the foreseeable future, although the Atlantic Alliance will continue to be the cornerstone of our foreign policy, the US will have to become more self-reliant. Seen from this perspective what has happened to America for the last decade is particularly worrying. The United States is still the world’s preeminent superpower. For it to remain so will require military and financial strength, industrial competitiveness, and the highest level of intellectual capacity. Other than military strength, none of these requirements is in evidence today. In order to achieve them, we must be able to put energetic domestic policies into effect; we are not able to do so now, either at the national or at the state and local level.

Last year’s budget agreement in Washington was a reflection of the power of every possible special interest to prevent a real change in our country’s addiction to borrowing for consumption instead of investment. Amid all the fuss about a $500 billion five-year reduction in the budget deficit, very little notice was paid to the fact that, even after this supposed reduction, the national debt will still increase by 50 percent from its 1990 level of $3 trillion to more than $4.5 trillion in 1995. In 1980, the debt stood at $1 trillion; it tripled in the next decade, and will have quadrupled in fifteen years. So a little more than two hundred years after we achieved political independence, our financial independence has come to an end.

It is also worth noting that, throughout the debate over the budget, which was full of the rhetoric of “soaking the rich” and “protecting the middle class,” there was no attempt to deal with underlying problems: our loss of industrial competitiveness; the inadequacy of our public investments; the failure of our public schools; the inadequacy of the capital available to our financial institutions; the losing fight against drugs and crime. The budget agreement locked the administration and the Congress into a fiscal straitjacket until 1993, which makes it practically impossible to put into effect the basic policy changes that are both necessary and appropriate in the new international situation.

It is easy to understand why neither the administration nor the Congress was eager to refer to these issues. For the last decade, they have combined to sponsor the most gigantic spending and speculative binge in the country’s history. By cutting taxes and increasing defense spending while simultaneously failing to slow down the growth of entitlements, they have nearly bankrupted the richest country in the world. They have, simultaneously, devastated state and local governments and the basic needs these local governments are supposed to provide. This is the real price we are paying for the 1980s. In New York City alone, if the federal government had maintained its aid at 1981 levels, the city’s 1991 budget receipts would have increased by $2.4 billion. This would have been enough to close most of the looming city deficit and eliminate the need for some of the thousands of layoffs, service and construction cutbacks, and tax increases which will do enormous damage to the city. What is true of New York is true of every other major city and state in this country.

What is urgently needed now is a national administration that would be elected on the platform of a specific recovery program, and would be able to put that program into effect. The current paralysis in government cannot be allowed to continue. Although I am a Democrat, and I believe that the Democratic Party, if it adapts itself to the realities of the 1990s, is more likely to come up with a program to my liking, I would cheerfully support President Bush and the Republican Party if they were to propose one. Whatever the case, next year’s presidential election must be concerned with the role of government in an advanced industrial democracy such as ours.

The US today is the only superpower with the military and economic strength, together with the political stability, to enable it to exercise influence anywhere on the globe; and of all the major powers today, it has the most benign tradition so far as its geopolitical history is concerned. The war in the Persian Gulf and the instability in the Soviet Union make it clear that we have to maintain an unquestioned military capacity to deter aggression and react to it, if need be.

However, if we do not deal with urgent domestic problems which have long been neglected, we will not be able to exercise our influence as effectively as we have to. We cannot indefinitely maintain military forces with other people’s money. We cannot argue that we have sound foreign policies but that we are somehow deficient in dealing with our domestic problems. There is no dividing line between domestic and foreign policy today. The US has to maintain a global position in which our national security strength is directly related to our economic power and to our social cohesion at home. The success of tomorrow’s leading industries will depend on our investing not just in plant and equipment, but in knowledge and technology. This will require national commitments to improving education as well as to research and development; and unless Japan and some European countries change their way of doing business, some variant of a national industrial policy may well be needed to maintain a strong American position in key industries.

On the financial side, it is likely that there will be a worldwide shortage of capital. The commitments required for the development of Eastern Europe and for the stabilization of the new Soviet Union, of China, and of other parts of the Third World will require much more capital than the developed world is capable of generating. German and Japanese surplus capital will no longer be as readily and as cheaply available to finance American deficits as before. We will have to create capital through higher savings and rates of productivity; the capital will have to be cheap in order to provide a competitive advantage; and it will have to be available to export to other countries. We need a strong dollar with low inflation and low interest rates to achieve our objectives; not a weak one.

On the military side, the US will still need the nuclear deterrent and the ability to project conventional power to defuse regional conflicts or to deal with terrorist states. The dramatic reduction in nuclear weapons proposed by President Bush is an excellent initiative by an American leader toward a safer world. The level and the types of forces needed should continuously be reviewed and adjusted downward if possible, as Senator Nunn has suggested. Greater reductions in military spending should still be possible, although this may not happen as quickly as some suggest. The European Community and Japan will have to carry a much larger share of responsibility for regional stability, along with the financial burdens that go with this responsibility.

By the year 2000, Germany and Japan will certainly qualify as superpowers so far as both industrial and financial strength are concerned. The United States, if we continue on our present path, may qualify only as a military superpower. That is not good enough. In order to deal with this situation, the administration and the Congress must come up with new policies to correct our continued failure to invest, our overdependence on foreign capital and on foreign energy, and our relatively weak economy. Notwithstanding optimistic statements by some academics and economists, we are now facing a recession, both in the United States and in Western Europe, as well as a slowdown in Japan. We have to change the direction in which our economy is now heading. Last year’s budget accord should be scrapped in the light of the new domestic and foreign situation, and new policies should be put in place in the light of these other realities.

In order to determine what we might do, it is well, in a global economy, to look at what other advanced industrial democracies are doing. France is investing $100 billion in a national high-speed rail system and is exporting electrical energy from its successful nuclear generating program to other Western European countries. France and England are investing billions in the Channel tunnel, which will improve tourism, communications, trade, and transportation throughout Europe. A Western European industrial consortium, with government support, is in a race with Japanese technology to dominate the high definition television market of the twenty-first century. France and England are developing, jointly, the successor to the supersonic Concorde. Japanese banks are replenishing their capital and shifting their lending to domestic needs in support of the Japanese government’s policy of increased public investment. Backing up these national industrial and investment policies are public education systems whose primary and secondary schools are far ahead of ours. Any American reconstruction program will have to recognize this competition and deal with it, both in the public and private sectors.

Financing such a program, with the reduced availability of foreign capital, will require organizing and reallocating domestic resources, and this will require a determination and a willingness to experiment that have not been much in evidence since the post-World War II period. A vast national public investment program should be started promptly, both to meet the needs of the country and to provide a long-term countercyclical effect to the weak economy. It is worth nothing that the most competitive economies in the world today are backed by the highest levels of investment in infrastructure. Schools and airports, roads and bridges, and many other types of public facilities must be built.

To support such a program, state and local governments could be supplied with additional resources from public and private pension funds. The assets of these pension funds currently amount to almost $2 trillion and will double to $4 trillion over the next ten years. During that period, an additional $500 billion of pension fund money could be invested in the public sector. This would have a significant impact on our social needs and our economic health. The program could be carried out by the purchase of special state bonds by the pension funds, and possibly other financial institutions, which would be serviced through a portion of a national gasoline tax. These bonds would carry high investment grade ratings and fully meet the fiduciary requirements of pension fund trustees. The funds could be channeled through a system of state or regional development banks which would be responsible for the actual construction of the projects.

Our banking system urgently needs new capital. The greatest danger to our economy today is the inability of our financial institutions to provide the credit needed for growth. The S&L industry is moribund; insurance companies are under strong pressures; the banking system is woefully under-capitalized and is compounding our economic downturn by drastically shrinking the availability of credit. The trend toward big bank mergers will not soon relieve this situation. On the contrary, these banks will continue the drive to increase capital by shrinking their assets and restructuring their new lending. Urging the bank examiners to be more lenient will not solve the problem.

In the next year or so, legislation will be taken up in the Congress to rationalize our banking system. The further revision of the Glass-Steagall act, which separates commercial from investment banking, and the creation of banks that operate nationally, among other issues, will be considered in order to provide the country with a banking system that can better respond to our needs. As part of that effort, the Federal Reserve Bank should encourage the formation of institutions of sufficient size and efficiency to enable the US economy to grow and to compete worldwide. The Federal Reserve should be authorized to inject new capital where it is needed through the purchase of new, nonvoting bank securities to provide a broader capital base to our banking system, as was done by the RFC in the 1930s.¹

Our banking system today urgently requires a minimum of $25 billion of new capital to function effectively: such an increase could support $250 billion of new lending for economic growth. Lower interest rates are highly desirable but they are not enough to stimulate the economy; only a greater availability of credit, coupled with economic stimulus, will have a real impact. There is renewed talk of cutting capital gains taxes to provide such stimulus; but cutting capital gains taxes will do little but churn securities in existing portfolios. I would support, however, reinstatement of the investment tax credit as a real stimulus to new investment. Coupled with a recapitalized banking system, it could be a powerful engine for new growth. If the recession deepens and more direct stimulus of the economy is required, Senator Moynihan’s proposal to cut Social Security payroll taxes should be considered, although it should be tried only on a modest scale since the costs would be considerable. I am fully aware of the political problems in suggesting Federal Reserve direct investment in the banking system after the fiasco of the S&Ls, and I am opposed to government ownership of banks. However, the Federal Reserve is not a Texas S&L commissioner, and an appropriate regulatory environment can protect the taxpayers against similar risks, for instance, by tightening the standards for issuing loans and the amounts of federal deposit insurance.

Reallocation of resources to assist state and local governments is another necessity. Neither the national economy nor the social system can function unless state and local governments can fulfill their responsibilities. This is no longer possible. Neither New York State nor New York City can face up to its responsibilities to deal with problems such as health care, homelessness, drugs, and declining infrastructure without a change in the federal contribution to state and local governments and a reallocation of national resources. We in New York do not have an adequate local tax base to do so by ourselves, and we are not alone in this. California and twenty-five other states are in a similar situation. Continued federal cutbacks as well as rising demands to finance such services as public safety and public health have forced these governments to raise taxes continuously while cutting back on other services.

The taxes raised by state and local governments, mainly sales and property taxes, are the most regressive ones. Sooner or later, we will have to devise a program of raising federal revenues to allow for a new revenue-sharing program aimed at reducing local taxes. The high level of local taxes is a terrible drag on the national economy. It will get worse unless relief is provided by the federal government. The political difficulties of such a program are immense, but it should, nevertheless, be debated and examined. Combined with a national investment program to improve infrastructure, such new sources of revenue would enable state and local government to meet their responsibilities under our federal system.

Over the longer term, we may also have to consider some version of industrial policy to make sure we can compete with other nations as we enter the twenty-first century. This will require cooperation between business and government in working out new approaches to fundamental problems such as energy and transportation. It may include the development of safe nuclear-generating technology as well as long-term oil supply agreements with Mexico, Venezuela, and Canada in order to minimize our dependence on Middle Eastern energy sources. The potential development of Russian energy resources to supply Europe, along with increased use of North and South American resources to supply the US, would enable us to break, once and for all, Western dependence on Middle Eastern oil. In transportation, we should encourage partnerships between government agencies and private business to link up high-speed rail systems with new airports and improved local mass-transit systems.

There are many other spheres that will affect our position in the twenty-first century, where a certain amount of planning for the future, with the government and business acting in concert, are necessary to keep up with competing nations. Intelligent cooperation between business and government, together with some forms of planning, are practiced with success by every one of our major competitors. We cannot ignore this.

Inevitably questions will arise about how to pay for any of these initiatives, especially since, after our recent budget battles, federal deficits are now projected in excess of $300 billion for 1992 and the real deficit of all levels of government power (including all government agencies) is probably closer to $500 billion.

I have two suggestions. First, in improving public education more money will not be the only answer. Making better use of currently available funds, under a carefully structured system of parental choice, coupled with a systematic shrinkage of the educational bureaucracy, would be a good beginning. The federal government could make two other contributions to education: decent physical facilities and new applications of technology. Insofar as physical facilities are concerned, the ability of pension funds to invest in state and local government bonds for infrastructure projects could be very significant in helping local school construction, which is badly needed.

The public schools may be one of the last places in America where technology has had practically no impact; and the federal government should be devising programs, in partnership with private industry, to bring technology to them. The technology must be aimed at parents as well as children. Beginning in kindergarten, the use of computers, television, and VCRs in the teaching process should be part of any program to improve learning and reverse the high dropout rates of our public school systems. A quick look at some of the minimum educational standards being recommended to the European Community for 1992, and at the uses of technology in other countries, should convince Americans that, unless we change, we will be falling further and further behind.

Secondly, the US compared to other developed democracies is not overtaxed. A recent article in these pages by Robert Heilbroner highlighted the difference between the levels of taxation in the US and other Western countries.² German tax revenues, for instance, represent about 38 percent of GDP as opposed to the US level of 30 percent, which is, incidentally, the lowest of all Western democracies. If our taxes matched those of Germany before it took on the additional burdens of subsidizing the East German economy, we would, at current levels of economic activity, raise an additional $400 billion per annum in lieu of borrowing.

Once our economy has stabilized, it would not be difficult to impose a temporary 5 percent surcharge on personal and corporate income to pay off the $150 billion of S&L losses over five years. Such a tax would essentially consist of a transfer from taxpayer to depositors and would be neutral from an economic point of view. However, it would be preferable to borrowing $500 billion over thirty years as is now planned. As gas prices come down now that the Gulf crisis is over, we can surely impose a tax of 50 cents per gallon on gasoline, phased in over five years, or $50 billion a year, to invest in our own country, while making exceptions for people with low incomes. Another $20 to $25 billion a year can be gradually taken out of our defense budget over and above what is at present forecast, and these defense costs could be absorbed by Europe and Japan. Taxing benefits such as Social Security and Medicare for upper-income recipients could raise tens of billions of dollars annually and would meet the test of fairness. The lower interest rates and stronger dollar resulting from such a program could give a powerful boost to our economic recovery.

It is clearly within our means to do what we have to do: increase our savings and investment rates; re-create a banking system which will adequately finance our business as well as our social needs; invest in an adequate public infrastructure to support our private and our public sectors. West Germany is proving, in East Germany, that government financing can succeed when it finances investment rather than consumption. The West German government and German industry are investing tens of billions of D-Marks in new facilities and new infrastructure while maintaining a social safety net to make the transition to a market economy bearable. The result already seems clear. The new Germany will be the dominant economic power in Europe and Eurasia, and the D-Mark will be the European currency.

A more active economic program will not eliminate our deficit in the very near future, but new investment, together with economic growth, will bring it down to tolerable dimensions. John Maynard Keynes was not altogether wrong. Deficits, even large ones, can be tolerated, but they must be dedicated to investments that create wealth and jobs instead of consumption. This should be our objective.

We have just seen the end of the greatest decade of speculation and financial irresponsibility since the 1920s. Financial deregulation, easy credit, and regulatory neglect have combined with a degradation of our value system to create a religion of money and glamour. Wealth and fame became the ultimate standard, to be achieved at any price. The most conservative and traditional professions such as the law and banking became centers of egregious financial behavior that would have made Diamond Jim Brady seem like a puritan. Beginning first in New York, but subsequently spreading to the rest of the country and to the world, our so-called financial wizards turned the country and its values into a vast casino. The result was not merely a matter of careless violations or the introduction of new financial techniques, as some have argued, but crimes that will cost taxpayers tens of billions of dollars and that have undermined standards of conduct that were built up over generations. Permissiveness eroded our system of values; deregulation eroded the integrity of the financial system. Together, they created a disaster.

We are obviously not alone in suffering from this disease. Scandals involving Japanese, French, Italian, German, and British financial institutions have created a series of shocks. The sanctions for financial crimes are obviously insufficient to provide a real deterrent, and the regulatory system has been equally weak. A combination of more effective regulation and tougher enforcement will be needed, on a worldwide basis, to restore the confidence in the financial markets without which our economies cannot function.

The kind of program I have outlined here is obviously controversial. New taxes of any kind are bound to be resisted even if offset by other tax reductions. Any kind of cooperation between business and government that smacks of planning will be heavily criticized. So will the use of pension funds, no matter how secure, to finance infrastructure, of capital from the Federal Reserve to refinance the banks, and federal revenue sharing to reduce local taxes. But I believe that in our current situation we must seek different solutions or face disorder.

The “new world order” is anything but orderly, and looks at times more like the world of 1913 than the world of 1991. But it is a “new domestic order” that we need. The problems of race, of extremes of wealth and poverty, of decaying physical facilities, of drugs and crime, of slow productivity growth and inadequate capital formation are putting enormous strains on our political system and our economy. Abroad, rampant nationalism, ethnic and religious hatreds, and the possibility of economic collapse in Eastern Europe and the Soviet Union are creating new challenges every day. The failure of communism does not guarantee success at home. That success will require the highest level of political leadership that we have had in decades as well as understanding and sacrifice by the American people.