Knowledge that Transforms

The performance of the economy has been characterized as unacceptable by President George Bush, and that opinion is widely held. However, the nature of the problem is a matter of controversy. Some observers believe that the tax system is to blame. In my opinion, we do not have a tax problem; we have a much broader economic problem. One reason for a tax bill now would be the recession that began in the middle of 1990 and may not yet have ended. Countercyclical stimulus is a classic purpose of tax policy. However, it is possible to make the classic error of countercyclical fiscal policy and hit the accelerator only after recovery has begun. We might also add to the deficit and the national debt in the long run, raise long-term interest rates, and thereby reduce investment. Concern about the long run is well taken. Growth was extremely slow for a full year before the recession officially began. In fact, there have been 11 consecutive quarters of annualized real growth less than 2.5 percent, and that string is about to be rounded to three full years. Many forecasters, extrapolating from the expansion of the 1980's, believe that long-term potential real growth is less than 2.5 percent per year-well below the actual growth enjoyed in the 1950's and the 1960's. Some economists allege that slow recent growth and the recession were caused by failures of tax policy, specifically the Tax Reform Act of 1986 and the reconciliation bill of 1990. However, the following sectoral analysis suggests that these indictments are incorrect. A decline in real consumption in mid-1990 was probably the major single contributor to the recession. Few would allege that structural flaws in tax policy have decreased consumption; indeed, the mantra of a vocal group of policy pundits has been that the tax code has encouraged consumption. Some analysts have tried to blame the recession on either the revenue increases included in the 1990 reconciliation bill or the luxury tax included in that bill. Such claims are absurd. The deficit-reduction agreement was not even legislated until October 1990 (two months after the recession began) and its near-term fiscal impact was small. The notion that recession was brought on by declines in demand for expensive boats (whose sales peaked in 1987) and expensive automobiles (most of which are imported) makes even less sense. In the aggregate, investment has been one of the bright spots of the economy, and has held up in this recession better than in others. In the long term, the picture is even brighter. Equipment investment is stronger than total investment, with gross real investment in equipment matching its historical peak. The weak segment is investment in commercial structures which many economists would agree should not be taxfavored in pursuit of long-term economic growth and which were drastically overbuilt in the 1980's. Government budgets are restrictive, partly because of federal restraint, but even more because states and localities are cutting * Budget Committee, U.S. House of Representatives, 220 O'Neill House Office Building, Washington, DC 20515-6065. Albert J. Davis, Joseph E. Stiglitz, and Emil M. Sunley provided helpful comments but should not be implicated in any errors or omissions.

In their paper in this Review, Jeffrey A. Frankel and Katherine E. Rockett (1988) show that when international macroeconomic policymakers do not agree on the correct macroeconomic model, they will still be able to agree on a cooperative policy package that each believes will improve his welfare. Yet the package may turn out to move target variables in the wrong direction. From extensive simulation experiments with ten empirical models, Frankel and Rockett conclude: ...the bargaining solution is as likely to reduce welfare as to improve it. But more definitions of cooperation should be investigated... (p. 338). In this paper we propose an alternative definition of a policy bargain to that investigated by Frankel and Rockett and show that results in a higher success rate and higher expected utility in cooperation exper-iments. It follows from our finding that, given uncertainty or ignorance about the true model, a measure of disagreement is beneficial because facilitates a simple robustness check for proposed policy bargains. As Frankel and Rockett (1988 p. 328) acknowledge: it is the countries' failure to perceive the true model, not their failure to agree with each other per se, that alters the standard conclusion regarding coordination (i.e., is uncertainty, not disagreement, that leads to failure). We go further: given the inevitable failure to perceive the true model, some disagreement is better than unanimity in error. Extreme disagreement about the nature of reality, however, makes robust bargains impossible.

Is a comprehensive income tax like the one envisioned by the Shoup Commission still the goal of the Japanese tax system? Or, have economic conditions changed so much that a different goal should be adopted? The gravest problem of the tax reforms of the 1980's was the absence of a judgment on this point. In fact, there was a contradiction with respect to choice of tax base. On the one hand, reform aimed at the comprehensive income tax goal by including in the tax base interest income and capital gains from sales of securities. On the other hand, there was a deviation from the principle in attempts to introduce a broadly based consumption tax. This is justified only if one admits the expenditure tax principle.

The Federal Trade Commission's action to eliminate basing-point pricing in the soft plywood industry during the mid 1970s created a natural experiment: the author finds that the FTC's action had no effect on the delivered price of the base-site product (Douglas fir plywood) but decreased the delivered price of the non-base-site product (pine plywood) for many consumers. The evidence suggests that the detrimental effects of basing-point pricing for economic welfare were reflected entirely in the behavior of non-base-site firms. Copyright 1992 by American Economic Association.

The 1992 program for completing the European single market, represents a massive experiment in economic liberalization. To the extent that the 1992 objectives are attained, the European market of over 350 million consumers will constitute the world's largest, with a per capita GNP comparable to that of the United States. Associated effects include larger potential sales for winning firms, as well as much more rigorous import and foreign subsidiary competition within the markets of the member states of the European Community (EC). Such developments could generate substantial distributive effects. In this laissez-faire perspective, and in view of significant industrial restructuring involving firms from both inside and outside the EC, the question can be raised whether there is a role for an industrial policy to promote European high-tech firms, or should we simply accept the general conclusion of Damien Neven and John Vickers (1990 p. 33), who found little to disturb the tentative conclusion, that in the area of industrial adjustment, competitive market forces do an imperfect job, but one that the instruments of industrial policy are unlikely to improve upon. This paper focuses on, the crucial link between the relative technological competitiveness of European industries and the consequences of post-1992 industrial restructuring. More precisely, we will contend that: 1) firms of European origin are handicapped by their present competitive position, which is inherited from an era of highly segmented markets and national champions; 2) this disadvantage may have farreaching consequences for the economic welfare of the EC; 3) a technology policy at the EC level could potentially alleviate this handicap; 4) the European Commission's existing RD and therefore, 5) the role of the Commission in promoting an optimal European technological policy should not be limited by the subsidiarity principle, which suggests that responsibility for decision-making should be delegated to lower government levels whenever feasible.