Competitiveness: The Challenge of the Deficit

Published by the Government Accountability Office on 1990-04-01.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

         11111  144362

, ‘I
    the Challenge of the Deficit

                   For the past 40 years, if anyone asked
                   what was the primary issue facing the
                   United States, the answer usually
                   involved the cold war threat of the
                   Soviet Union. Throughout the postwar
                   period, both U.S. foreign and domestic
                   policy revolved largely around the ups
                   and downs of our relations with the
                   Russian bear.

                   How quickly times change!

                   Events in Eastern Europe and in the
                   Soviet Union have, with astonishing
                   speed, altered our view of the world.
                   What had been a basic organizing
                   principle of American policy-the
                   Soviet threat-is suddenly gone.

                   Where does that leave us in agreeing
                   upon a new agenda of issues to focus

                   Many thoughtful people cite U.S. com-
                   petitiveness-or a lack thereof-as
                   the predominant issue facing America
                   in the 1990s and beyond. Others
                   would add such contentious problems
                   as the war on drugs, the quality of
                   U.S. education, the viability and
                   soundness of our banking system, the
                   high and rising cost of our health care
                   system, the environment, or a crum-
                   bling transportation infrastructure.

                   Personally, I believe our ability to
                   compete with other nations is the pri-
                   mary issue facing the United States.
                   But I would add one other problem:
                   the deficit crisis and our growing

                   Page 1
the Deficit

national debt. Indeed, the issue of
competitiveness is inseparable from
our ability to deal with the deficit cri-
sis and our growing national debt. Fur-
thermore, our deficit and debt
problems are an integral part of our
ability to deal with the list of problems
that others have mentioned and to
which I just referred.

To understand the challenges that will
confront us in the future, it is impor-
tant to understand where we have
come from, and that means we need to
consider-at least briefly-how      big a
role our confrontation with the Soviet
Union has played in setting the stage
for where we find ourselves today.

Three times during the 20th century,
the United States and the Soviet Union
have faced great challenges.

The first of these occurred at the time
of World War I. Russia, an exhausted
and politically bankrupt state of the
old order, experienced a revolution.
The United States, a young country
with considerably more promise than
experience, played its first pivotal role
in European politics that then doml-
nated our world. The Soviets emerged
after the 1917 Revolution as a country
isolated and shunned by most of the
rest of the world, its economy in tat-
ters. The United States emerged from
World War I with its economy intact
and still growing. But we elected to
pull back, to retreat to our distant
shores, and to largely isolate ourselves

the Challenge of
the Deficit

from the tangled politics of Europe.
Our rejection of membership in the
League of Nations was symbolic of our
distrust of foreign entanglements.

The second event that shaped both
Americans and the Soviets was World
War II. With very different political
and economic systems, both nations
emerged from the war as great mili-
tary powers capable of dominating
Europe from the Ural Mountains to
the Atlantic. It was this rise of two
superpowers that set the stage for the
expensive and protracted conflict of
the cold war of that past 45 years.

Since 1950, the United States has
spent a cumulative total of more than
$4 trillion on national defense. Mea-
sured in 1989 dollars, this comes to
nearly $10 trillion. We have averaged
7.8 percent of the U.S. gross national
product (GNP) for this purpose. The
North Atlantic Treaty Organization
allies have paid substantial, if smaller,
costs. Japan paid very little, enjoying
the luxury of the American nuclear
shield as a greater share of its
resources went into economic growth.

Determining whether the Soviets have
spent more or less than we have on the
arms race would involve such difficult
conceptual and technical problems
that they are probably not worth solv-
ing, if ever they could be. But we need
no fancy analysis to tell us that the
people of the Soviet Union and the

Page 3
the Challenge of
the Deficit

other Warsaw Pact nations paid a tre-
mendous price in terms of foregone
economic growth and their own stan-
dards of living.

What is important to recognize, how-
ever, is that the race for military supe-
riority in the postwar era between the
Soviet Union and the United States-
and the price we each paid-is in large
part responsible for the position in
which each nation now finds itself.

I am convinced that today, both coun-
tries are facing their third-and
last-great challenge of this century:
Both superpowers must now compete
on the economic front with the rest of
the world, rather than on the military
front with each other. Whether that is
because the arms race has become
pointless or because it has become too
expensive is almost beside the point.
The fact is that there are other players
on the scene-an economically inte-
grated Europe; Japan, with an econ-
omy dominating the Pacific basin; and
the growing number of fast-developing
nations in Asia. With these other influ-
ential players at the table, the new
competition is far more complex than
the old.

The problems faced by the Soviet
Union are much greater than our own.
The Soviet economy, which has never
been able to satisfy consumer
demands for food and manufactured
goods, is stagnating. The Soviet empire

Page 4
                   the Chdlenge of
                   the Deficit

                   is in danger of collapse as the non-
                   Russian republics assert newfound
                   voices of autonomy, and even outright
                   independence, from Moscow. The sat-
                   ellite nations of Eastern Europe have,
                   one after another, rejected the Soviet
                   model and have begun the exhilarat-
                   ing, if painful, transition to democra-
                   cies driven by market forces.

                   Massive as are the problems facing the
                   Soviets, however, we would be wise to
                   remember that they possess enormous
                   potential and a rich treasury of natu-
                   ral resources. There was a time in our
                   recent history when the United States
                   tended to overstate Soviet advances in
                   science and in military proficiency. It
                   would be equally unwise, now, to
                   understate Soviet capabilities. Freed
                   of the smothering inefficiency and cor-
                   ruption of central planning and a sti-
                   fling Marxist ideology, the Soviets
                   could well surprise the world at some
                   point in the future, especially if West-
                   ern technology becomes readily availa-
                   ble, if they are able to adapt to a
                   market-driven economy, and if their
                   leaders are flexible enough politically
                   to adapt their system to democratic

Competitiveness:   If the Soviet Union, in dealing with its
The American       political crisis, is being forced to turn
                   inward and scale back its international
Challenge          commitments, at least temporarily, the
                   United States ls being forced to con-
                   front challenges on both the foreign

                   Page 6
    the Challenge of
    the Deficit

    and domestic fronts. They are not

    Abroad, we face no letup in the
    increasingly stiff competition we’ve
    encountered in recent years:

9 In Europe we will face, by 1992, a uni-
  fied market, a productive system, and
  a set of financial institutions larger
  than our own-and this does not
  include the long-term potential of
  Eastern Europe. It should come as no
  surprise to us that what Western
  Europe has been able to accomplish in
  the past 45 years is more than com-
  parable to the economic growth of the
  United States in the first 45 years of
  this century.
l In Asia in general, and particularly in
  the Pacific rim countries of Japan, Tai-
  wan, Singapore, Hong Kong, and
  Korea, economic growth has been
  astonishing. Inflation-adjusted rates of
  7 to 12 percent are typical. This
  growth has been baaed upon superbly
  competitive export strategies, which
  in turn have relied upon long-term
  domestic policies emphasizing savings,
  investment, and education. Korea-to
  take one example-has an industrial
  base that produced one-third of the
  world’s shipping in 1988 and a domes-
  tic economy that has improved nutri-
  tion by 50 percent in 25 years and
  provides virtually all families with TV
  sets. Taiwan, to take another example,
  now equals Canada and Holland in
  exports of manufactured goods.

    Page 6
the Challenge of
the Deficit

For the United States, the massive
trade deficit that we have accumu-
lated over the past decade offers
explicit evidence of how complacent
we have become in the face of compet-
itive forces building during the post-
war era and how ill-prepared we were
to deal with them.

Yet even if we’ve come to recognize
the seriousness of the challenge we
face-and I believe we now have-we
will still fiid it difficult to rebuild our
competitive position in the world and
to meet the additional challenges
posed by such events as the integra-
tion of European economies if we are
unprepared to deal with our budget
deficit and our growing level of debt.

The General Accounting Office has
long taken the position that the deficit
is a major impediment to our own com-
petitive position in the world. In the
first of our 26 transition reports sent
to President Bush and to the Congress
in November 1988, for example, we
identified the deficit as the primary
problem facing the new

But we have hardly been alone in this
assessment. Other organizations reach-
ing the same conclusion have included
the Council for Competitiveness,
chaired by Jack Young, the Chief
Executive Officer of Hewlett-Packard;
the Committee for Economic Develop-
ment, whose 250 trustees are mostly
presidents or board chairpersons of

Page 7
                     the Challenge of
                     the Deficit

                     corporations or presidents of universi-
                     ties; and the American Agenda,
                     chaired by former Presidents Ford and

The Worsening        Conventional wisdom held, at least
                     until recently, that the deficit crisis
Deficit Crisis       was easing, thanks to the Gramm-
                     Rudman-Hollings law that is supposed
                     to force yearly reductions in the

                     In fact, the deficit is a worsening cri-
                     sis. There are a number of reasons
                     why this is so:

                 l   First, the operating part of the govern-
                     ment is underfunded, and this problem
                     is growing worse. The unified budget
                     deficit, which includes the surpluses
                     of the social security and other trust
                     funds and is used to calculate the
                     Gramm-Rudman-Hollings deficit lim-
                     its, has declined from its high of $221
                     billion in 1986 but seems to be stuck at
                     about $150 billion. However, if you
                     take out social security and the other
                     trust fund surpluses that mask the
                     true operating deficit, there is no
                     improvement; things are only getting
                     worse. Last year the operating deficit
                     was $275 billion, and the Congres-
                     sional Budget Office (CBO) projects it
                     may approach $300 billion by 1995 if
                     current policies are not changed.
                 l   Second, the cost of solving problems
                     the federal government must pay for,
                     but has not, is becoming larger. That
                     means even CBO projections-usually

                     Page 8
    the Challenge of
    the Deficit

    considered realistic-are too low. In
     1988, for example, GAO estimated the
    huge costs of cleaning up the nuclear
    weapons complex would reach
    between $100 and $150 billion. Now
    the administration acknowledges the
    problem but has requested an increase
    of only $800 million in its 1991 budget
    request. Meanwhile, to take another
    example, the costs of resolving the
     savings and loan (S&L) crisis continue
    to escalate by billions of dollars.
l   Third, the Gramm-Rudman-Hollings
    process is missing its targets by ever-
    larger amounts. We now know that
    formula budgeting is a very poor sub-
    stitute for political responsibility. As I
    just mentioned, the targets include the
     social security and other trust fund
     surpluses that mask the true deficit.
     Even so the record is dismal. The origi-
     nal deficit target for 1989 (later
    revised) was $72 billion. The actual
    deficit was $152 billion, $16 billion
    over the revised target. For the cur-
     rent fiscal year, 1990, the deficit tar-
    get is $100 billion. CBO projects the
     actual deficit will reach $159 billion
     and even the Office of Management
     and Budget (OMB) admits to $124 bll-
    lion-and the OMB estimate was made
    only a few weeks after completing leg-
     islative action on the budget that was
     supposed to ensure that we would
    meet the target. If you add off-budget
    borrowing for the S&L bailout and
    trust fund surpluses, you get $310 bil-
    lion. David Stockman’s statement
     about $200 billion deficits as far as the

    Page 9
                            the Chdlenge of
                            the Deficit

Masking the Federal Deficits With Trust Funds
                               FY 1985 FY 1986 FY 1989
Revenues                                       $734    $769     $991
Outlays                                         946     990     1,143
  Total deficit                           $-212       $-221    $-152
Federal funds deflclt                          -266    -283     -276

Trust fund surtAuses:
  Social Secunty                                  9       17       52
  Other trust funds                              45       45       71
Subtotal, trust fund
  surpluses                                      54       62      123
  Total deficit                           $-212       $-221    $-152

Total federal debt                        $1,817      $2,120   $2,866
Note Totals may not add due to rounding
                            eye can see is now out of date. It’s
                            $300 billion!
                        l   Fourth, our national savings rate con-
                            tinues to be the lowest of the large
                            industrial democracies and is too small
                            to sustain the investment we need for
                            a strong and healthy economy in the
                            next century. This problem is exacer-
                            bated by the fact that federal budget
                            deficits have taken an average of
                            three-quarters of net private savings
                            over the past 8 years. Very recently
                            there have been some hopeful signs
                            that the domestic savings rate may be
                            picking up, but these trends, such as
                            they are, could be dwarfed by the pos-
                             sible shifts in capital from the high
                            savings nations (principally Japan and

                             Page 10
    the Challenge of
    the De&it

             CBO estimate
    FY 1990 FY 1991 FY 1993 FY 1995
     $1,067  $1,137   $1,277 $1,438
       1,226       1,298     1,409     1,548
     $-I59       $-161      $-132    $-110
       -290        -298      -289      -298

          66           74       98       128
          65           64       60        60

        131         136        156       188
     S-159       S-161      S-132    $-I10

     $3,156      $3,454     $4,012   $4,603

    Germany) away from the United
    States into Eastern Europe and other
    parts of the world. It has been this for-
    eign capital that has allowed us to sus-
    tain domestic investment despite our
    low savings rates, but we cannot con-
    tinue to count on the rest of the world
    supplying the capital to support our
    investment needs.
l   Fifth, the peace dividend, while impor-
    tant and reflecting major changes in
    world politics, is not going to ball us
    out of the deficit problem any time in
    the near future. We cannot reverse our
    military commitments overnight, and
    we need to take the time to select pru-
    dently the force structure and weap-
    ons systems that will serve us best

    Page 11
                                      the Challenge of
                                      the Deficit

                                      given new world political relation-
                                      ships. The Pentagon is only beginning
                                      to adjust its planning to the new reali-
                                      ties, and changes in spending patterns
                                      will lag well behind the decision
                                 l    Finally, in addition to the obligations
                                      the federal government must face,
                                      there is a long list of unmet national
                                      needs awaiting action, many of which
                                      are likely to involve calls on the Trea-
                                      sury. These issues include the drug

Figure 1: Budget Outlays for Major Programs, 1970-I 993*
340        Dollars In Bllllons

           -        Defense
           ----     Social Sacurlty
           ------   Medwre
           -..a     Gross Interest

*Figures      br 1970-l 989 are actual    Figures for 1990 and 1993 are CBO estimates.

                                      Page 12
the Deficit

war, education, health care, the envi-
ronment, transportation, and a grow-
ing concern over the U.S. financial
services sector. There are different
views of what is important and what
is not and what is a federal responsi-
bility and what is not. But the notion
that our democratic process will reject
all of them as either not critical or not
a federal responsibility is inconsistent
with history.

Facing up to the facts of these prob-
lems is crucial to any understanding of
the future implications of the deficit,
for this is where foreign and domestic
policy considerations meet. These are
issues that not only have a bearing,
large or small, on our ability to com-
pete effectively in world markets but
that also go to the heart of our ability
to satisfy expectations of the Ameri-
can public.

Alice Rivlin, the former head of CBO
and cochair of the economic panel put
together by former Presidents Ford
and Carter as part of their group, the
American Agenda, put it this way:

“We cannot address the other issues
facing the country effectively
unless and until we get the budget
deficit under control. The budget
deficit has become a defense issue, a
foreign policy issue, a health care
issue, an education issue. We must
put our fiscal house in order so that
we can address the other problems

Page 13
            the Deficit

            which are important to us as a
            nation. Getting the budget deficit
            under control is a test of our ability
            to govern.“’

            Traditionally, in times of need, the
            federal government has been able to
            respond. It found the resources for the
            recovery of Western Europe through
            the Marshall Plan. It financed the
            interstate highway system beginning
            in the 1950s. It has supported the
            National Institutes of Health in a quest
            for the cure of disease. It implemented
            Medicare and Medicaid to meet the
            health care needs of the elderly and
            the poor. It built an air traffic control
            system, sent astronauts to the moon,
            and funded the National Science Foun-
            dation when we deemed such expendi-
            tures essential to the national agenda.
            Today, however, it has become
            increasingly difficult, thanks to the
            deficit, to undertake new efforts as
            they come to the fore.

            It is worth considering some of these
            issues and the challenges they pose for
            our future.

Education   It is increasingly evident that we are
            falling behind other nations in the
            quality of the education provided to
            our future work force and that this
            will have profound implications for

            Page I4
the challenge of
the Deficit

our productivity and international
competitiveness. In considering this
problem, we need to look beyond
school systems, and how much we
spend on them, for two reasons. First,
it is not just performance in schools
that is important; we need also to be
concerned about students’ transition
into the labor force. Second, successful
school performance is not just a mat-
ter of formal schooling. Many fac-
tors-social, cultural, and economic-
are involved. Such problems as teen-
age pregnancy, welfare dependency,
crime, and drug abuse both hamper
students and reflect the consequences
of poor schooling. Albert Shanker,
president of the American Federation
of Teachers, points out that the educa-
tion of poor children is often affected
by housing, transportation, and health
care. Shanker also notes that schools
restructured to be run by teams of
teachers, administrators, parents, and
other community representatives
would make them more responsive to
student needs and would foster com-
munity support.

The question of technology also enters
the equation. How well we adapt com-
puters to the classroom (and ensure
that such technology is available to
poor as well as wealthy schools) will
certainly play a role in improving edu-
cation and preparing young people for
better performance in the work force.

Page 16
the Deficit

These factors, as well as the quality of
teaching itself, are all part of the edu-
cational context.

We can also learn from others. GAO
has been studying education and train-
ing in four countries: England, Japan,
Sweden, and Germany. We have found
that young adults in foreign countries
have higher literacy rates than we do.
Foreign countries also emphasize the
obligation of educating all students,
rather than accepting the notion that
many will lag behind. In Japan, for
example, schools stress student effort
for all rather than only for the gifted.

The United States tends to tilt its edu-
cational expenditures toward college,
investing more than twice as much in
those who go to college than those
who do not. The four foreign countries
we reviewed invest a higher propor-
tion of their national income in precol-
lege education and spend more to help
young people enter the work force.
The foreign countries we’ve studied
also seek to systematically guide a stu-
dent’s transition from school to work,
while many young people in our coun-
try drift aimlessly from job to job-or
from job to unemployment-after
leaving school.

For a variety of reasons reflecting dif-
ferent cultures and traditions,
approaches that work in another
nation may not be directly transfer-
able to our own educational systems.
But these are the nations with which

                   the Deficit

                   we must compete. If they succeed
                   where we fall, as they do in achieving
                   near universal literacy and a success-
                   ful transition from school to work, it
                   will affect our ability to compete. If
                   we are to be competitive, we must
                   identify those differences and search
                   out our own ways to match the suc-
                   cessesof our competitors.

                   The quality of American education
                   and the utilization of our work force
                   have a tremendous impact upon our
                   ability to meet the competitive chal-
                   lenges we face. What is important for
                   the future, however, is to build on our
                   strengths and successesand to over-
                   come our failures. Head Start, for
                   example, has been a demonstrated
                   success. But we have yet to implement
                   this program on a nationwide basis, an
                   effort that would cost about $12

    The Drug War   Drug use continues to be a national
                   crisis, one that must be dealt with
                   cooperatively at all levels of govern-
                   ment. The cost of drug dependency in
                   terms of lost productivity, health care,
.                  and law enforcement resources that
                   could be better devoted to other prob-
                   lems is staggering.

                   At the federal level, top priority has
                   been given to law enforcement. Yet,
                   many experts believe that treatment
                   and prevention are of equal or greater
                   importance. With a whole generation
                   of children at risk of growing up in

                   Page 17
              the Deficit

              drug-filled environments, we cannot
              afford a lengthy debate on who should       ,
              do what. Without adequate federal
              support now, the future cost of deal-
              ing with this generation will be enor-
              mous. Moreover, the related cost
              associated with the spread of AIDS
              (acquired immune deficiency syn-
              drone) is similarly disturbing.

Health Care   The United States spends over half a
              trillion dollars in health care-almost
              12 percent of GNP and more than any
              other country. Over 41 percent is pub-
              licly financed. For this, many of us get
              the world’s best medical care, but still
              the U.S. infant mortality rate is much
              higher than that in most industrialized
              societies, and our average life expec-
              tancy ranks 13th among these coun-
              tries. Furthermore, more than 30
              million Americans lack health insur-
              ance, public or private.

              It is very hard to deal with these
              issues of quality and accessbecause
              costs continue to escalate. By the year
              2000, they are projected to absorb
              roughly 15 percent of GNP. Health
              care expenditures have grown at more
              than double the general inflation rate
              for nearly three decades.

              Some of the expenditures reflect an         ”
              aging population and advances in
              technology, but much of the increase
              reflects incentives for inefficiency that
              are built into the ways we pay for and
              deliver health care. If changes in our

              Page 18
                 the Challenge of
                 the Deficit

                 health care system could, by the year
                 2000, reduce the share of GNP spent
                 on health from 15 percent to 14 per-
                 cent, we would save nearly $70 billion
                 a year, of which the Treasury could
                 save about $15 billion a year.

                 Much has been tried to moderate these
                 cost trends, but piecemeal efforts have
                 failed. We need strong national leader-
                 ship to achieve comprehensive reform.

The              Gridlock has threatened progress in
Transportation   the skies and highways. Airline pas-
Infrastructure   senger travel has nearly doubled in
                 the past decade. According to Federal
                 Aviation Administration (FAA) esti-
                 mates, airline travel delays in 1986
                 created $1.8 billion in extra operating
                 expenses for airlines and cost passen-
                 gers $3.2 billion in lost time. U.S.
                 motor vehicle travel reached nearly 2
                 trillion miles last year, racking up 722
                 million hours in delays. All this is cost-
                 ing the U.S. billions of dollars in lost
                 productivity and wasted fuel.

                 CBO estimates that total federal
                 spending on the transportation infra-
                 structure amounted to $26.5 billion in
                 1988-yet we are falling far short of
                 the needed investment. The Depart-
                 ment of Transportation has estimated
                 that between $25 billion and $39 bil-
                 lion is needed annually to restore and
                 maintain the current federal-aid high-
                 way system through the year 2005.
                 And at least $27 billion will be needed
                 through the year 2000 to fund FAA’s

                 Page 19
                  the Challenge      of
                  the Deficit

                  air traffic control modernization

The Environment   The federal government seemsto have
                  less capacity to deal with the environ-
                  ment than it did 20 years ago. We
                  decided then, for example, to clean up
                  the nation’s waterways, and since
                  1973, the federal government has
                  invested $50 billion in grants to states
                  and localities to build sewage treat-
                  ment plants. But although the Envi-
                  ronmental Protection Agency has
                  estimated that the country has addi-
                  tional water treatment needs that will
                  cost $75 billion to meet, the federal
                  government is now turning the pro-
                  gram over to states and local govern-
                  ments, hoping that they will somehow
                  find the money. The Congress also
                  enacted additional requirements for
                  safe drinking water supplies, but the
                  costs will be borne by local

                  Some costs simply cannot be shifted to
                  other levels of govenunent. The fed-
                  eral goverument will be forced to bear
                  the costs of cleaning scores of feder-
                  ally owned facilities, where toxic and
                  radioactive wastes have seeped into
                  soil and groundwater. Cleaning up
                  these facilities, including the nuclear
                  weapons plants, and bringing them
                  into compliance with environmental
                  laws could cost some $200 billion.
                  Even if we could continue to devote

                  Page 20
                  the Deficit

                  $4.5 billion a year toward these prob-
                  lems, as the administration has pro-
                  posed for next year, it would take at
                  least 40 years to correct existing prob-
                  lems at this rate of expenditure.

Banking and       From the Great Depression until the
Capital Markets    198Os,we had a strong and growing
                  financial system. The flexibility of
                  that system and the efficiency and sta-
                  bility of our capital markets were the
                  envy of the rest of the world. The fed-
                  eral government has traditionally been
                  an important player in this sector of
                  our economy. Not only has it provided
                  deposit insurance for banking and
                  thrift institutions and ensured the
                  integrity of our financial markets, but
                  it has also promoted all kinds of finan-
                  cial innovations through such devices
                  as loan guarantees, secondary mar-
                  kets, and the establishment of autono-
                  mous government-sponsored
                  enterprises. Generally, federal partici-
                  pation in financial markets was either
                  self-sustaining or profitable. But
                  deregulation, combined with the 1982
                  recession and the collapse of oil prices,
                  changed the equation.

                  The first visible patient was the farm
                  credit system, which required several
                  billion dollars in assistance to keep
                  alive. This was, of course, merely
                  spring training for the savings and
                  loan crisis, which will take years to
                  accomplish. The $50 billion provided
                  by the Congress is just the begin-
                  ning-we really do not yet know the

the Lkfieit

full price tag. The latest estimates of
the total cost is over $300 billion.

What happened? Well, we learned one
basic lesson: deregulation permits peo-
ple to take risks. In the case of the
S&L crisis, many thrift owners, faced
with insolvency, gambled with tax-
payers’ dollars-not their own-and

More generally, the 1980s marked a
period of financial excess. Computer
technology combined with the ingenu-
ity of money managers to create an
endless variety of marketable finan-
cial instruments. From mortgage-
backed securities to zero coupon trea-
sury bonds (that the Treasury itself
never issued), it seemed that anything
with a dollar value could be turned
into a security and sold. Junk bonds
were only the most dramatic manifes-
tation of this, and even the govem-
ment got involved. The Navy leased
ships to avoid paying the full costs up
front. The National Aeronautics and
Space Administration guaranteed
lease payments for a Western Union
communications satellite. Most
recently one investment banking firm      t
floated a special security on behalf of
the National Archives to finance a new
building at the University of             I

Of course, I recognize that there is
value in having sophisticated, effi-
cient, and innovative financial mar-
kets. But I worry that we have put so

             the Challenge of
             the Deficit

             much of our creative energy into lnno-
             vative financing mechanisms that we
             are neglecting production innovations.
             No matter how efficient we are at rais-
             ing capital, our wealth depends on the
             value of what we produce. Leveraged
             buyouts financed with high cost
             money may keep managers on their
             toes, but surely we need to worry
             when vast sums are made from purely
             financial manipulation and corporate
             leaders worry more about hostile take-
             overs than they do about technology
             and the productivity of their work
             forces. These are issues that go to the
             heart of our ability to compete in
             world markets.

Conclusion   The long-term opportunities for the
             United States and the Soviet Union are
             potentially enormous. But just recog-
             nizing these opportunities does not
             mean that either country will auto-
             matically be able to deal with the chal-
             lenges that each must confront.

             The future of the Soviet Union is prob-
             lematic. It is still very much uncertain
             whether the Soviet empire will dis-
             integrate in the chaos of civil strife as
             individual republics seek to break
             away from Moscow’s rule or whether
             it will manage to find unity in a new
             or modified form of confederation
             based upon democratic principles.
             What is clear is that if the Soviet
             Union ceasesto challenge the United
             States for military superiority, it is

             Page 23
the Challenge of
the Deficit

hardly in a position to challenge us

But other nations-notably Japan and
an economically unified Europe lncor-
porating the enormously productive
German economy-are in such a posi-
tion, or soon will be. The question is
whether we are willing, and able, to
put our own financial house in order
in such a way that we can sustain the
political and economic leadership
we’ve come to exercise within the non-
Communist world for the past 45
years and to extend that leadership to
encompass those nations that have
traditionally been our adversaries.

Thus, the challenge we confront is
much easier to spell out than is that of
the Soviet Union. Internationally, we
must be able to compete. Internally,
we must be able to provide the ser-
vices and meet all the other needs that
Americans expect of their national
government. Both challenges are inevi-
tably linked to the folly of continued
reliance upon huge deficits.

We need action.

To begin with, we must ceasecompet-
ing with the future. By continuing to
borrow money to meet present obliga-
tions, we are robbing the future of the
resources that our children and
grandchildren will need in their gener-
ations to sustain a position of Arneri-
can leadership.

Page 24
                                     the Challenge of
                                     the Deiictt

                                    In 1980, our gross federal debt, which
                                    includes the debt held by the social
                                    security and other trust funds, was
                                    $800 billion. This year, it will top
                                    $3 trillion, and CBO projects that by
                                     1993, without policy changes, it will
                                    reach $4 trillion. Interest on that debt
                                    is now costing us $260 billion a year
                                    and has become the second largest
                                    item in the federal budget. It has now
                                    surpassed social security and is gain-
                                    ing steadily on defense for the largest
                                    annual expenditure of the federal gov-
                                    ernment. Debt service buys us nothing
                                    except the right to pay even more next

 Figure 2: Total Gross Public Debt, 1970-1993’
 4909      Dollars in Bllllons                                                          1
 3200                                                                         /

   1970                                 1980                           1990       1993

*Figures   for 1970-1989     are actual. Figures for 1990-1993   areCEKIestimates.
                                    Page 26
the Challenge of
the Deficit

Fundamentally, the debt and deficit
crisis is as much a political issue as it
is an economic problem. But however
defined, it is a solvable problem. It will
take bipartisan compromise and a sus-
tained, multiyear commitment to get
the job done. That compromise-as a
matter of politics, equity, and simple
arithmetic-must      involve both sides
of the ledger, revenues as well as
expenditures; both sides of the aisle in
the Congress; and both ends of Penn-
sylvania Avenue-the Congress and
the White House.

Despite the severity of the numbers-
and perhaps because of them-1
remain optimistic.

When all is said and done, Americans
have traditionally risen to great chal-
lenges. We undertook vast reforms to
cope with the Great Depression of the
 1930s We shook off our innate isola-
tionism and built the greatest military
force in the history of the world to
fight World War II-and sustained
that military superiority at great cost
through the depths of the cold war.
We rejected the notion of revenge and
dealt fairly with Japan and Germany
after the war, setting each on the road
to recovery as the democratically gov-
erned economic powerhouses they are
today. If we could deal with the politi-
cal and economic ramifications of such
trials, we can surely deal with this

Page 26
    the Challenge of
    the Jleficit

L   Indeed, there are signs that attention
    is being refocused on the budget
    debate. Senator Moynihan focused the
    debate with his proposal to roll back
    social security payroll taxes rather
    than continuing to allow the social
    security surplus to cover spending on
    other government operations. Even
    the press, which has appeared bored
    over the deficit debate, paid attention.

    There are also signs of recognition
    that there is not an inexhaustible
    source of foreign money to continue
    borrowing to fund the deficit. The
    Europeans, especially the West
    Germans, may find it lucrative to
    begin shifting investment toward East-
    ern Europe and away from the United

    But ultimately, I think we’ll find the
    will and the way to work our way out
    of this crisis simply because Ameri-
    cans know that it is a problem they
    must confront. Average citizens may
    not understand the intricacies of the
    debate, but they do sense that some-
    thing is amiss when suddenly the most
    popular car sold in America bears a
    Japanese nameplate or when they
    read about highly publicized foreign
    purchases of American corporations
    or of symbolic structures, such as
    Rockefeller Center. The merits of
    these events aside, they are sympto-
    matic of the fact that our fiscal house
    is not in order. They strike a respon-
    sive chord among Americans who

    Page 27
the Chdlenge of
the Deficit

sense that our debt and deficit crisis is
at the heart of the problem.

So in the fiial analysis, I believe we’ll
devise the political compromises that
are needed to deal with the budget
deficit. It may yet take time and it will
not be easy, but we’ll get there if only
because we must.

We have little other choice if we want
to enter the 21st century enjoying the
same position of leadership in the
world we’ve exercised for the past 45

Page 28