WHY IS everyone worrying about what Wall Street is worrying about? Oh sure, it's important, in the larger scheme of things, to keep the financial markets reasonably happy in their work of supplying liquidity to the U.S. economy. But right now, in the wake of the Great Crash of 1987, why should Congress and the news media be falling all over themselves to consult Wall Street's view of why it happened and what needs to be done to remedy the situation?
Wall Street wants to blame it all on Washington: on the budget deficit, on protectionist legislation pending before Congress, and on a House Ways and Means Committee proposal to remove tax advan-tages for takeovers. Wall Street lobbyists are now swarming over the Hill and through the halls of the White House, demanding an end to these pernicious policies. Investment bankers are filling the airwaves and op-ed pages with their prescriptions for what Washington must do. Financiers are taking out full-page advertisements in newspapers. Wall Street is mobilized as never before.
Washington, in its own plodding way, is trying to oblige. The president and congressional leaders have agreed to budget deficit reductions totaling $30 billion this year and $45 billion the next. Democrats are having second thoughts about their trade bill. Ways and Means Chairman Dan Rostenkowski has promised to reconsider the tax provision. The press reports daily about whether Washington is doing enough to restore Wall Street's confidence.
But why, at this time, should restoring Wall Street's confidence be high on the list of public policy concerns? After all, the Street's mindless confidence over the past several years has been a contributing cause of our present predicament. Now that Wall Street is finally concerned about the future of the American economy the rest of us should feel reassured rather than alarmed. We should be relieved that the Street is now back in touch with reality, a fevered child awaking from its hallucinations.
The economic "crisis" that Wall Street tells us we have just experienced is, in fact, no different from the slowly-gathering crisis that existed before Oct. 19. Some Americans may now feel poorer than before, but their apparent prosperity in the halcyon days of the bull market was largely illusory -- a paper prosperity. The real economy had been unraveling for years while America busily consumed more than it produced. In 1986, for example, the nation generated some $800 billion more in goods and services than it had in the recession year of 1982, but it spent about $900 billion more -- Mr. Micawber's recipe for eventual misery.
We were able to ignore our profligacy only because foreigners kept lending us money, buying our corporations and purchasing our real estate. By the time of the crash, we were $350 billion in the hole, one-third of downtown Los Angeles (among other U. S. cities) was in foreign hands and our foreign creditors were growing distinctly nervous about our ability to repay our debts.
Anation living beyond its means faces precisely the same choices as a family living in the same manner. It may either grow poorer, or it may improve its means by becoming more productive. Before Oct. 19, we were already exercising the first option: The declining dollar was rendering imports more expensive; in many families, two wage-earners were needed to make ends meet; young people found it hard to afford houses nearly as nice as the homes they grew up in.
The second option -- becoming more productive -- was being pursued less vigorously. Our indebtedness to the rest of the world would have been no cause for alarm had we invested our borrowings in our future productivity. But net investment in plant and equipment, as a percentage of gross national product, was no higher than in the perilous 1970s, supply-side predictions to the contrary notwithstanding. Meanwhile, the government had cut back on public investment in education, training, commercial research and development, and in the roads, bridges, ports and tunnels that comprise the nation's "infrastructure."
Spending to upgrade and expand the nation's infrastructure dropped from 2.3 percent of GNP two decades ago to .4 percent by the early 1980s. Total public and private-sector spending on commercial research and development dwindled to below 2 percent of GNP, far lower than in previous decades, and significantly lower than that of our major trading partners. While manufacturing productivity rose healthily, overall productivity gains -- weighted down by slow or negative gains in the increasingly important service sector -- dropped to only one percent a year, from over 3 percent a decade before. In the last two years, even a declining dollar has yet to help American producers regain market share from foreigners who continue to supply world markets with relatively cheap, high-quality goods.
The anomaly through it all was the Wall Street bull market, which surged upward in seeming disregard of the underlying decline. One big reason: Stock prices were responding in large measure not to the real economy but to takeovers, or threats of takeovers, which prompted corporations to do whatever was necessary to raise their share prices in the short term. Often this meant purchasing their own shares and thus going deeply into debt and jettisoning long-term projects. The new debt ballooned by over $700 billion between 1982 and 1987, about the same amount by which share prices tumbled last month. This new debt made corporate America much more vulnerable to economic downturns. Interest payments soaked up an ever-larger proportion of corporate earnings -- last year, over half.
Wall Street's reverie could not go on forever, and it did not. The balloon was sure to burst eventually. It did.
In light of this recent history, there is something vaguely unseemly about Wall Street's new demands. Of course, the budget deficit needs to be tamed. But the deeper problem is not the budget deficit per se; it is the nation's chronic unwillingness to reduce its total consumption and increase its total investment -- both public and private. Moreover, to suddenly and significantly reduce government spending and increase taxes now -- at a time when consumers and companies are likely to scale back their purchasing plans in light of economic uncertainty, and when there is as yet no firm guarantee that our trading partners will expand their economics to fill the gap -- threatens a deep and prolonged recession.
What we need to do now is what we should have been doing all along: Gradually scale back aggregate consumption by, for example, spurring the growth of personal savings through expanded IRAs and Keoghs, hobbling hostile takeovers and leveraged buyouts, taxing more of Social Security benefits, reducing farm supports, getting our allies to foot a larger portion of the defense bill, and cutting back on weapons systems that are of low priority or fail to perform as planned.
But this is only half the agenda. We should simultaneously attend to the investment side of the ledger by, for example, inducing more private-sector spending on plant and equipment (restoring the investment tax credit), and increasing government spending for education, retraining, child nutrition, research and development, and infrastructure. These investment strategies may make it more difficult to reduce the current federal budget deficit, but they are more important to our long-term economic health than any short-term budget fix. To focus singularly on reducing the federal budget deficit distracts us from these more fundamental agenda, which long predate Oct. 19.
Wall Street's other immediate demands merit similar skepticism. America's drift toward protectionism is dangerous, but no more dangerous today than it was last month or last year. Regardless of what happens to the Democrats' trade bill, the political reality is as yet unaltered: Without new jobs for our industrial workers whose present jobs are threatened by cheaper foreign goods, and without opportunities for them to train for such jobs or get help in finding them, demands for protection will continue to mount. To make matters worse, there are no longer clear international ground rules for what constitutes fair trade.
Technological changes and ballooning service sectors in all advanced economies have rendered irrelevant much of the General Agreement on Tariffs and Trade. Every government, including our own, is subsidizing and protecting its major industries. The very absence of global agreement about what sorts of government interventions are now permissible further invites distressed workers and communities to claim unfair injury at the hands of foreigners. Here again, the longer-term agenda -- in this case, to ease workers out of older industries, and to reach a new understanding with our trading partners about fair trade -- is no more or less urgent than it was before Oct. 19.
Wall Street's third demand is the most dubious of all. In the weeks preceding the crash, the House Ways and Means Committee had introduced legislation to cap interest deductions on debt incurred for the purpose of acquiring another company. Financiers now claim that this proposal triggered Wall Street's free fall, since, if enacted, the provision would render hostile takeovers unprofitable. Says Donald Drapkin, vice chairman of Revlon Inc., and a key figure in his company's effort to take over Gillette, "If you couldn't deduct interest incurred in an acquisition, it would be a disaster for the stock market and for American companies."
Takeovers and takeover threats certainly did help to prop up share prices during the great bull market. But there is little evidence that corporations became very much more efficient or productive as a result. If, as is argued by raiders and their apologists, such ploys rid corporations of inept managers, there would be no particular reason to subsidize them through the tax system. Takeovers would occur anyway, prompted by the bonus available to the clever raider who replaces inept managers with those who can generate bigger profits.
If Revlon could make Gillette into a more profitable company, it would be in Revlon's interest to take it over, regardless of any tax advantages for doing so. Thus Wall Street's current assertion that the tax break is needed in order to spur takeovers -- and that the threat of its withdrawal had a disastrous effect on the market -- only serves as further evidence that the takeover activity of the last few years did little to improve underlying corporate performance. Takeovers merely filled Wall Street's balloon.
The economy (although perhaps not Wall Street) would be served by enacting the Ways and Means Committee's proposal. The removal of the interest deduction would screen out takeovers that added nothing to the American economy -- in fact, which were likely to undermine long-term productivity gains -- while still allowing takeovers that arguably promoted efficiency.
The point is that Wall Street's goals and America's goals are not quite the same thing. Wall Street wants to restore stock prices to their levels before the crash, and to the upward trajectory they were on before last August. But our more basic goal should be to rebuild our economy, and restore productivity gains to the levels they were at more than a decade ago. If America were to accept Wall Street's perceptions of the current economic crisis, and the Street's preferred remedies, stock prices might well rise once again to record heights. But the underlying economy would continue to deteriorate, thus inviting another pop of Wall Street's balloon.
It is perhaps understandable that Republicans would fail to differentiate between Wall Street and the rest of us; Republicans have traditionally had difficulty with the distinction. But there is no excuse for the Democrats. The Great Crash provides Democrats with a signal opportunity to show how Ronald Reagan's policies during the last seven years have hastened our economic decline, and to reveal how our tax dollars have been used by the wealthy to make themselves even richer by gambling on Wall Street.
The Crash also allows Democrats to make a strong case for new public agenda directed at rebuilding our economy. Democrats should be talking about the importance of reducing overall consumption while increasing both public and private investment; easing the transition of our work force out of older industries; reaching new multilateral understandings about what sorts of government interventions promote productivity and thus do not impede trade, and which should be prohibited because they advance one nation at the expense of another; and removing tax benefits for speculative activities like takeovers.
It is, in short, the Democrats' hour. They should not be wasting precious minutes looking over their shoulders to see if Wall Street is soothed by their efforts.
Robert B. Reich teaches political economy at Harvard's John F. Kennedy School of Government and is the author of "Tales of a New America."