Testimony presented by Robert Genetski

before the United States Joint Economic Committee

Monday, June 12, 1995

The Third Wave:

A Perspective on the Economy of the 21st Century

Broad economic movements occur in waves. For fifty years these waves focused on shifting responsibility away from individuals and toward government. At the beginning of the 1980s, the waves began to shift in the opposite direction. The Contract With America represents the second wave of a major transfer in power from government back to individuals.

The Contract is not an end in itself. It is an interim move that will be followed by a more significant and powerful third wave. It is this wave that will form the basis for the economy in the 21st century. The third wave will produce a major boost to productivity and living standards. In the process, it will place the US economy in a position of unsurpassed prosperity.

Shifting Power to Government

Classical economic principles extol the importance of the individual in creating prosperity. Throughout most of its history, US economic policies placed maximum power and responsibility in the hands of individuals. Policies began to shift away from these pro- growth, classical principles in three waves. The first wave came in response to the Great Depression. A frightened public began to rely more on government and less on individual initiative in an attempt to restore prosperity and economic security. Government programs, such as Social Security, began on a fairly modest scale. As they grew, these programs produced a major shift in power from individuals to government.

In the aftermath of World War II there was a major retrenchment in the power of government. Still, the seeds of government control over the lives of individuals were taking root. The Social Security system grew relentlessly, shifting power from individuals to government. Also, the experience from the Depression years left many with a view that if serious problems arose, government could solve them.

By the late 1960s, policies allowing for government control over the lives of individuals entered as second wave. Government control over retirement income was extended to include control over the funding of health care for retirees. Government also assumed responsibility for health care for the poor as well as countless other responsibilities that were previously left to individuals.

The final wave of government control occurred during President Carter's Administration. Government responsibility extended to the creation of jobs, incomes, safety, energy and the environment. The more government tried to accomplish, the more living standards deteriorated. Instead of living standards doubling every thirty years, by the late 1970s, living standards were rapidly declining.

The experiment with higher tax rates and a greater reliance on government was a costly failure. Instead of productivity growing at 2%-2.5% a year as it had historically, growth slowed to virtually nothing by the end of the 1970s. Each year of poor productivity meant less income for US workers.

Productivity is the key to living standards. When productivity falters, living standards suffer. Although real worker compensation may increase faster or slower than productivity for a limited time, eventually the two must move together. With productivity increasing at 2.25% a year, the real value of a worker's salary would double every thirty years. With the shift in power and responsibility to government, by the late 1970s, productivity stopped growing.

Had greater and greater responsibilities not been taken from individuals, the inefficiencies associated with government would not have occurred. US productivity in 1981 would have been roughly 13% higher than it actually was. This means that total compensation per full time worker would have been roughly $37,000 in 1981 instead of $32,700. Since there were 88 million full-time equivalent workers in 1981, the experiment with big government cost the economy almost $400 billion in lost output in 1981 alone. (All figures are in 1993 dollars.)

Restoring Power to Individuals

The deterioration in living standards in the late 1970s led to backlash against government. What followed was the first wave of a broad historical movement back toward pro-growth classical principles. In 1981, President Reagan began to reverse almost fifty years of government intrusion. Critics of the first wave complained about many of the changes. They argued that the tax cuts benefited the rich, that government spending and regulation continued to grow rapidly, and that reforms in the Social Security system placed more power than ever in the hands of government.

While all of these criticisms were valid, they missed a sense of what was happening. For the first time in half a century, the American people were beginning to question whether a more powerful government was an asset or a liability. In 1989 the first wave came to an end. During the years 1981-89 living standards for the typical worker had increased by anywhere from 7%-12% depending upon the measures used. This was the first significant increase in living standards in twenty years and provided the first hint of the direction future policies would take.

Few leader in either party realized the significance of the first wave. Some complained that whatever improvement occurred was the result of increased government debt. Oddly enough, they chose to associate the improvement in productivity with an increase in government debt. Actually, the productivity improvement in the 80s came in spite of more government debt. The increase in government debt resulted primarily from a failure to control the growth in government spending.

Many observers failed to recognize the role of lower tax and regulatory burdens in improving productivity and living standards in the 1980s. As a result, the first wave was followed by a move backward. From 1989 to 1994, major new tax and regulatory burdens were placed on the economy. Productivity faltered and living standards quickly reversed their upward trend.

The second wave emerged from the setback of the past five years. The Contract With America is the main symbol of this wave. As with the first wave, this one has its shortcomings. The focus on the goal of a balanced budget threatens to do more harm than good.

If the arguments about the negative effects of the deficit on future generations are correct, then cutting taxes makes no sense at all. Fortunately for the sake of overburdened taxpayers,the arguments about the damage from government debt are not valid. My research indicates that tax cuts are not valid. My research indicates that tax cuts may well lead to lower government revenues within the first five years. However, tax cuts also lead to higher private incomes. In the wake of the tax cuts in the early 80s, private incomes rose by $3.50 for every dollar of lost revenue to the government.

If tax cuts raise private incomes by more than the loss of government revenues, then such a policy is clearly beneficial. It must be political myopia that leads some policy makers to limit their analysis of tax changes to their impact on the government revenues alone. There should be no doubt that cutting taxes in an overtaxed economy makes a great deal of sense regardless of the impact on the federal deficit. Hence, balanced budget amendment that would serve to discourage tax cuts would not be in the best interests of the economy.

As with the first wave, focusing on the shortcomings of the present movement misses the significance of what is happening. The second wave is attempting to shift power from government to individuals as quickly as possible. The family tax credit and the focus on cutting government spending are designed to accomplish this objective.

When it is over, the second wave will have accomplished several things. It will mark the end of the tragic experiment of taking power from individuals and giving it to government. Power and responsibility will flow from government to individuals. Productivity and living standards will once again be increasing. As this move advances, the third and final wave will begin.

The Third Wave

The third wave will permanently shift vast amounts of power and responsibility from government to individuals. The broad outlines of the third wave are already emerging in different areas. The move toward term limits is characteristic of the third wave. Term limits provide further incentives for politicians to shift vast amounts of power and influence from government to individuals. In the third wave, politicians will serve brief periods in government and then have to work under the laws they created.

A low, flat tax is another characteristic of the third wave. This simple change would save over $100 billion a year in direct costs and more than another $100 billion in indirect costs. Every bit as important as these savings is the transfer of power that accompanies such a change. Rather than lobbying Congress for tax favors, a simple, flat tax would enable those in the private sector to devote all their time and energy toward producing their output as efficiently as possible.

In the third wave the responsibility for health care will be place primarily with individuals, not with government or insurance companies or HMOs. Instead of serving third parties, doctors and hospitals will be able to serve their new customers--their patients.

Another major policy change in the third wave will be the privatization of Social Security. This move will get its impetus from Chile's experience. Chile privatized its social security system in 1981 and the results have been astonishing. In less than ten years from now the typical Chilean worker (whose annual income is roughly $5,400) will have more assets in a retirement account alone than the total assets of the typical American family. Few policy makers will want to explain to their constituents why they refuse to support a similar plan for US citizens.

One of the most exciting aspects of the third wave is the implication for productivity and living standards. The structural changes in the third wave will not just improve productivity performance to match the 2%-2.5% trends of history. Rather, productivity performance will surpass its historical trends as the new move toward efficiency makes up for the inefficiencies of the past 30 years. Instead of simply doubling in the next 30 years, living standards can be expected to increase by one and a half times their current level.

Can the third wave possibly overcome the entrenched power of the bureaucracy? Will power be shifted so completely away from government and back toward individuals? Absolutely! The reason is that the third wave is being ushered by powerful forces; the computer chip, the telecommunications revolution and the spread of democracy around the world. Each of these forces is interacting in a way that will shift power away from the government and toward individuals.

The computer chip has contributed to an outpouring of research that measures the efficiency and inefficiency of economic processes. What this research is showing is that government is far less efficient than even the most diehard conservative could have imagined. In the areas of regulation, education, health and retirement benefits, studies are finding average waste that approaches 50%.

Although research into the true cost of government inefficiency is still in its infancy, the results across a wide range of studies tend to be conclusive. Just as Fidel Castro has a difficult time conceding that communism has failed, many who spent their lives extolling the virtues of government can not believe its damage can be so great. As further studies confirm the huge cost of government, the last defenses of the bureaucracy will crumble.

The telecommunications revolution will ensure that the results of the latest research are transmitted throughout the world. This is already leading to an acceleration in the move to shift power away from government in one country after another.

Finally, the spread of democracy will ensure that politicians that stand in the way of these changes will be quickly replaced by those who are willing to shift power back toward individuals.

The timing of the changes that usher in the third wave is extremely important. Having slipped well below its historical trend, the US is operating at a level far below peak efficiency. Even with the productivity improvement of the 80s, the economy continues to move further from its most efficient level. In 1993, potential productivity was 30% above the actual. From the standpoint of salaries, it means that compensation per full time worker could have been $48,000 instead of $37,000. For the economy as a whole, this shortfall amounted to $1.2 trillion in 1993 alone.

There is no way to tell how long it will be before the third wave begins. However, delay is costly. Accelerating the move toward the privatization of social security, toward a low, flat tax, and toward the adoption of individual medical savings accounts will lead to an unprecedented boost in productivity and living standards. Politicians who are wise enough to understand the forces at work will help to accelerate the changes and will be tremendously successful. Those who attempt to defend the bureaucracy will soon find themselves involved in other endeavors.

When the final wave has ended, the United States of America will truly fulfill the dreams of the Founding Fathers. More so than at any time in its history, the country will be a land of plenty, a land of unsurpassed opportunity.