FEBRUARY 17, 1964
Our Economic Prospects and Policies
AN ADDRESS BY
Dr. Walter W. Heller
CHAIRMAN, PRESIDENT'S COUNCIL OF ECONOMIC ADVISERS
JOINT MEETING with The Canadian Club of Toronto
The President of the Canadian Club, Mr. Harold Rea
Today we welcome to what was once the outpost of Fort York, a gentleman from what is still Washington. Over 150 years ago, after the Americans burned Fort York (an event rarely mentioned by polite Torontonians), British and Canadian forces after starting a few fires in our guest's native city of Buffalo, proceeded to commit retaliatory arson in Washington and left enough scars on the Presidential mansion to necessitate several coats of white paint which resulted in the name "The White House". That episode is often recalled by our American friends, never or hardly ever mentioned by Canadians, and completely unknown to the British.
Not long ago a choleric American said to a phlegmatic Englishman, "We'll never forgive you Britishers for burning Washington." "Burning Washington," said the Englishman, "I know we burned Joan of Arc but I always thought Mr. Washington died in his bed." Our guest has visited Canada many times and has been extremely interested in Canada-United States relations. I know he rejoices with us that considerable progress has been made in our relations during the past 152 years, because at that time we were at war with each other and to put it mildly there was considerable unpleasantness between us. In fact a New York newspaper on July 4th, 1812, had this to say about Canada in its lead editorial:
"A peace that would leave Britain in possession of Canada would be worse than war. A smuggler, a pirate, a man-stealer, a corrupter of the morals of our citizens, a hirer of spies with a view to our injury in time of peace, a fomenter of Indian hostilities, a violator of our neutral rights, a subverter of the laws of nations, a government of despots and aristocrats; Canada certainly is not, will not, and cannot be a good and safe neighbour for the United States."
I think this editorial was probably contemporary with the saying that the world is divided into two classes--those who thanked God the Pilgrim Fathers landed on Plymouth Rock and those who wished to God the Plymouth Rock had landed on the Pilgrim Fathers!
Walter Wolfgang Heller--our honoured guest--is best known as the Chairman of the President's three-man Council of Economic Advisers. He has prepared for some years "The Economic Report of the President" which shapes the outline of the Budget and Financial policy of his Government. Inasmuch as the economic health of Canada is so closely interwoven with the financial fabric of the United States, we are extremely pleased to welcome to this forum one so well informed on the United States economy.
Professor of Economics at the University of Minnesota, associate and visiting professor at Harvard and Washington, he has written many scholarly books and pamphlets and served on many national and international committees. He has made many memorable speeches and has been the subject of so many analytical and commendatory articles in famous journals. You will soon know why.
May I end this introduction by telling Dr. Heller that when an American like him talks to Canadians like us, it is fitting to recall the words carved on a monument in the St. Lawrence Seaway -dedicated by Queen Elizabeth and President Eisenhower -
"THIS STONE BEARS WITNESS TO THE COMMON PURPOSE OF TWO NATIONS WHOSE FRONTIERS ARE THE FRONTIERS OF FRIENDSHIP, WHOSE WORKS ARE THE WORKS OF FREEDOM, AND WHOSE WAYS ARE THE WAYS OF PEACE."
It is a singular honour to address the doubly eminent memberships of the Canadian and Empire Clubs--and I am thrice blessed to do so at a time when both the Canadian and U.S. economies are expanding and both the Canadian and U.S. external deficits are contracting! It has been my repeated privilege over the years to study and profit by your Canadian fiscal experience. It was 25 years ago when I journeyed, first, to Ottawa and Toronto to view and admire the workings of your joint dominionprovincial income tax collection system and, later, to British Columbia to study its pioneering income tax withholding system and to draw insights which proved valuable in developing the U.S. withholding system in 1942-43.
And I also recall with pleasure serving as host to the Honourable Douglas Abbott in 1952 at the University of Minnesota. As Finance Minister, he shared with us some of Canada's advanced experiences with bold and flexible fiscal policy in a setting of budget surpluses. Which was cause and which was effect--as between bold policy and surpluses--is not entirely clear. But given today's bold U.S. policy of a tax cut in the face of persistent deficits, I hope--and indeed we have solid basis for believing--that bold fiscal policy is cause and surpluses will be effect.
Because we are on the very threshold of a 20 per cent Federal income tax cut, I believe it is safe to forecast that the most important precondition of satisfactory U.S. Cana dian economic relations in 1964-65 will be satisfied: that your companion economy to the South will do its fair share in maintaining the prosperous expansion of the North American economy. Indeed, we are now completing 36 months of unbroken expansion. And with the aid of the tax cut, we expect to topple all peacetime records, not just for strength but for length, of U.S. economic expansions.
It is against the backdrop of tax reduction that I want to review with you today the performance, the policies, and the prospects of the U.S. economy--not denying myself, in this process, a few observations on U.S.-Canadian economic relations.
The Tax Cut
The nearly-$12 million net income tax cut which should reach the President's desk within the next ten days is:
- a milestone in the development of U.S. fiscal policy;--the keystone of U.S. economic policy for 1964;
- the cornerstone of the U.S. economic outlook for 196465.
So let me take a moment to review its major dimensions. I shall here deal only with the tax-cutting core of the bill and not with its many structural improvements which, among other things:
- recapture several hundred millions by tightening the tax base;
- provide new special exclusions for those with low incomes;
- reform the individual rate structure and drop the starting rate from 20 to 14 per cent and the top rate from 91 to 70 per cent.
The net cut for individuals will come to over $9 billion, or nearly 20 per cent of present liabilities.
The net cut for corporations will be $21/a billion. Adding this to nearly $21/2 billion of business tax reduction in 1962, via the investment tax credit and liberalized depreciation, corporations will also have roughly a 20 per cent cut.
Although part of the cut will not take effect till next January, the great bulk of its impact will be felt this year. Early next month, the income tax withholding rate on wages and salaries will drop from 18 to 14 per cent. For 1964 as a whole, $8 billion less will be collected from individuals. And corporate liabilities will be cut nearly $11/2 billion for 1964 and another $1 billion for future years as the rate drops:
- from 52 to 48 per cent On net income over $50,000;--from 30 to 22 per cent on net income under $50,000.
To round out our fiscal picture, I should note that Federal purchases of goods and services will rise only moderately this year, tapering off in the second half of the year as President Johnson's austere budget for fiscal 1965 takes effect. And the budget deficit will be cut in half from fiscal 1964 to fiscal 1965:
- from $10 billion to $5 billion on an administrative budget basis;
- from $5.5 billion to $2.8 billion on a national-incomeaccounts basis.
Yet by virtue of the deep cut in income taxes, the Federal Government will in 1964 provide a greater net fiscal stimulus to the U.S. economy than in any previous peacetime year. With the tax cut virtually in hand, 1964 is truly a year of great expectations.
The 1964 Outlook
For 1964, we expect a growth of perhaps $35 to $40 billion in gross national product against $30 billion last year. Or, in constant prices, we look for a year-to-year growth of GNP of about 5 per cent in 1964 against just under 4 per cent in 1963. Private forecasts cluster a little below ours, but not as far below as in January a year ago, when we foresaw a 1963 GNP of $573 to $583 billion. Actual GNP came to $585 billion. High as we were, we still fell a bit short. This January, our projection centered on $623 billion for 1964, based on these expectations:
- consumer spending, fueled by an extra $8 billion of after-tax income, will take the lead;
- business will not be far behind as it raises its plant and equipment investment by about 10 per cent in response to the double impact of lower taxes and higher operating rates;
- inventory building should increase as sales rise;
- state and local purchases are counted on for their regular $4 billion annual increase;
- residential building should roughly match the record level of 1963. With these gains, we expect to renew our inroads on unemployment. In the first year or so of our present expansion (from early 1961 to the spring of 1962):
- real GNP advanced at an average annual rate of 71/s per cent; and
- unemployment steadily declined from 7 per cent to 51/2 per cent of the labour force.
But since then:
- real GNP advanced at an average rate of only 3.9 per cent; and
- our unemployment rate has been stuck at or near 51/2 per cent.
This contrasts sharply with Canada's progress in shrinking its unemployment from 7.9 per cent at the end of 1960 to 4.9 per cent today.
Though the tax cut will put us back on the road to full employment, it will not occur overnight. Indeed, our expectations--though not our hopes--will be fulfilled if we break through the 5 per cent unemployment barrier by the end of 1964, as you did by the end of 1963. If that seems a modest achievement, we should remind ourselves that it has been 75 months since the U.S. unemployment rate last fell below 5 per cent. And it has been 81 months since unemployment last touched 4 per cent.
Side by side with renewed improvement in the unemployment picture, we expect continued improvement in profits. Fears of profitless prosperity -based on past U.S. experience when productivity and profit advances typically tapered off or went into reverse in the second or third year of expansion--have not materialized this time. Corporate profits before taxes rose from $44 billion in 1961 to $47 billion in 1962 and $52 billion in 1963. Another rise--to $56 billion--is in prospect for 1964. Given the added factor of more liberal depreciation under the 1962 actions and lower taxes under the 1964 tax act, the profits picture is bright indeed. What makes this record the more remarkable is that it is being achieved in a setting of essential price stability. It is the product of growing volume, rising productivity, and falling taxes.
Except to say that the 1964 outlook for continuing reasonable price stability is very good, let me postpone for a moment further discussion of our price, wage, and balance-of-payments prospects.
The New Setting of Economic Policy To add not only to your knowledge but to your understanding of U.S. economic developments, one must go behind economic acts and facts to economic thinking and policy. Surely, it is something rather new under the U.S. economic sun when:
- a large tax cut is mounted in the midst of a sustained upswing and in the face of a sizeable budget deficit;
- a Democratic Administration lays heavy stress, in both word and deed, on tax stimulants to investment;
- balance-of-payments considerations play a major role in the economic policy and, in particular, raise the relative priority of price and cost stability as policy objectives.
These changes in policy emphasis grow out of a set of conditions hitherto unknown in modern U.S. economic history. Its central feature is the existence, side by side, of
- a stubborn balance-of-payments deficit externally;
- stubborn unemployment, excess capacity, and price stability internally. This combination is not unfamiliar to you in Canada. And in many ways it has posed even more acute problems for you than it has for us -though the instrument of devaluation which you successfully used in 1962 cannot and will not be used in the United States.
Our domestic situation calls for expansionary policies--such as monetary ease and tax cuts (and did I not hear a ministerial echo from Edmonton late last month on an eventual Canadian tax cut?) to boost demand and incentives, create jobs and bring us up to our full potential. At the same time our external deficits point the other way: toward restrictive policies, at least short-term, e.g., boosting interest rates or imposing penalty taxes to keep U.S. funds from flowing abroad, and tying foreign aid to purchases within the U.S.
These opposing pressures in the past six years have touched off a searching reappraisal of U.S. economic policy. Our economists and policy-makers have, perforce, broken out of their previous insularity in dealing with domestic policies for economic stability and growth. We have moved from a pre-1957 situation in which we could largely act as if we were in a closed economy to one in which we must act, in an open economy.
This tug-of-war between internal and external requirements of policy has generated an intensive, and surprisingly successful, search for economic policies that could serve both masters at once. The result has been a significant shift in economic philosophy, policy, and practice. Let me illustrate.
One shift came early in the Administration in the form of the "nudge" or "twist" in monetary policy. This policy has pushed up the rates on short-term, fluid funds that might otherwise run out of the country in response to higher rates abroad--and has thus cut down our balance-of-payments deficit. At the same time, it has successfully sought to hold down the cost of funds that flow into long-term investment in housing, public capital, and plant and equipment--and has thus facilitated economic expansion. By close TreasuryFederal Reserve cooperation, this new two-way approach to monetary policy has achieved results initially scoffed at by the disbelievers.
An even more basic policy emphasis is on the stepping up of productivity, "the great reconciler". Increases in productivity--in output per unit of input, which of course translates into lower costs--are the royal road not merely to faster domestic growth but to a stronger position in world markets. As we install modern cost-cutting machines, equipment and plant; as we speed the advance of technology, and of research and development; as we invest more in human brainpower through education and training--we serve to reconcile domestic expansion with external balance.
Thus a growing concensus has emerged on the need for more investment in both human and material resources. Yet, actual outlays for business fixed investment have dropped from 10-11 per cent of GNP in the early post-war period to only 9 per cent recently. The policy response has been a dramatic rise in the priority of investment stimulation as an objective of tax policy. These considerations led a Democratic Administration to provide special tax incentives for investment in 1962 and an added cut in corporate tax liabilities this year.
The tax cut itself represents a new breakthrough in economic attitudes, on two main scores. First, with respect to deficits, it represents a recognition -
- that the persistent budget deficits of recent years have been the result of economic slack and slow growth, brought on in part by the hobbling effect of excessive Federal taxes;
that deficits themselves have no economic motive power; rather, it is tax cuts (or expenditure increases) which create more jobs, income, and profits;
that cutting taxes can so stimulate the economy as to offer the best road back to budgetary surpluses in a balanced economy.
Second, with respect to balance-of-payments effects of tax cuts, it is now recognized that rising imports in response to higher incomes will probably be more than offset by:
- productivity gains that will make costs and prices of U.S. exports more competitive;
- improvements on capital account as returns rise on capital invested at home.
Indeed, these considerations led our colleagues in OECD repeatedly to urge the United States to adopt more expansionary budget policies in the face of deficits both in our domestic budget and in our external accounts.
The Price-Wage Problem and Monetary Policy
This is not to say that the tax cut is without its critics or that the economy in 1964 is without its problems. Recently, a rather vocal minority-in part consisting of critics who earlier said the tax cut would be ineffective--has charged that the tax cut will overheat the economy and thus lead to inflation, boom, and bust.
In part, this fear grows out of the impressive advances the economy has already made:
- a rise of $100 billion in GNP, 16 per cent in real terms, in less than three years;
- an increase of 23/4 million in employment over the same period;
- an increase of 23 per cent in industrial production; a better "tone" in U.S. business today.
But this view overlooks several compelling counterpoints:
Even with the dramatic rise in GNP, our total output still falls $30 billion short of our readily available potential (at a 4 per cent unemployment level). Unemployment stands at 5.6 per cent of the labour force--the cold fact is that in the fourth quarter of 1963, unemployment was slightly higher than 1962 in spite of a spirited advance in GNP.
Industrial production has been on a plateau for six months, and the average operating rate in manufacturing holds at 85-87 per cent against a preferred operating rate of 92 per cent.
The better "tone" of business reflects in good part (a) the expected tax cut and (b) the reassurance of President Johnson's firm and understanding leadership.
It is clear, then, that ample capacity exists to meet a new wave of tax-induced demand. And it is worth remembering that this wave will be a gradual swell, not a tidal burst. So it is most unlikely that rising market demand will generate inflationary pressures in 1964. But economic expansion does increase the temptations for unions or managements to take wage and price actions that might reactivate the price-wage spiral that has been dormant for the last six years.
Like almost every other advanced country except Canada and Switzerland, the United States has attempted to avoid or curb the wage-price spiral through the develop ment of an "incomes policy"- in our case called "guideposts" for noninflationary wage and price behaviour. In their present explicit form these guideposts were first presented in the 1962 Report of the Council of Economic Advisers, and have been restated in both our 1963 and 1964 Reports. Under the urging of the guideposts and faced with generally slack markets for goods and labour, wage costs and prices in the United States have been remarkably steady in recent years. We used to say steadier than in any other major industrial country except Canada. Now we do not even make that exception.
Our price stability has both depended upon and been consistent with wage rate advances--advances that in general, and on the average, have not exceeded the rise in labour productivity in recent years. Business has increasingly seen that--if it avoids unnecessary price advances--labour can and will moderate its wage demands as it finds that it need not struggle to keep ahead of a rising cost of living. Labour has increasingly seen that--if it avoids wage advances in excess of the average rise in productivity--business can and will pursue a policy of generally stable prices, for unit labour costs will tend to remain stable.
If, unexpectedly, price stability began to be eroded by irresponsible wage or price behaviour, strong pressures would surely develop for monetary policy to move toward higher interest rates and reduced availability of credit. But tighter monetary policy could not police inflation without arresting production and employment.
It would clearly be a major loss if we were forced to give up some of the expansionary benefits of our tax cut in the year ahead in order to put indirect pressure on irre sponsible price and wage makers. This is why President Johnson recently:
(1) Underscored the wage-price guideposts, renewing his appeal to the parties--and to the public--to recognize their vital contribution to our healthy economic expansion.
(2) Stressed the companion importance of maintaining monetary conditions that will be conducive to expansion.
Our high stake in price stability derives not only from domestic considerations. Like Canada, the United States has a recent history of balance-of-payments difficulties. We have made heartening progress on this front since mid1963, largely through halting the excessive outflow of U.S. portfolio and short-term capital. A less-noticed development of even greater long-run significance has been the slow but steady growth of our current export balance, facilitated by a reduction Of our relative price level vis-a-vis Europe.
And the power of relatively minor shifts in price relationships to alter the balance of trade has once again recently been demonstrated by the effects of your own modest devaluation. Since the United States, as a reserve-currency country, will not and cannot consider devaluation, the key importance of improving our cost and price position is evident.
Canadian-U.S. Economic Relations Although Canadian-American economic relations are not my subject today, let me take a moment to say
- that this is an enormously important subject for both countries;
- that it is too often neglected with resulting misunderstanding and irritation;
- and that we all can be glad, therefore, that new efforts are afoot to give it joint and thoughtful study.
The dominant characteristics of the economic relations between us, of course--the characteristics overwhelmingly apparent to any dispassionate third party viewing us from afar--are their strength and harmony.
We are far and away each other's best customers. Our political-economic systems are highly similar. We share common technologies, forms of business organization, and living standards. Our people, our commodities, our capital all move back and forth over our 3,000 miles of unfortified boundary with a degree of freedom that knows almost no parallel. And our economic destinies are tied together in the long run as well as the short.
All the same, the fabric of this close, mutually beneficial, largely harmonious economic relationship is fraught with paradoxes:
There is the basic paradox, for example, that the economic grain of the North American continent tends to run North and South, while its political grain runs East and West.
There are those paradoxes that may be inherent in the juxtaposition of two similar nations with populations of such unequal size. For instance, some of your countrymen in their strong and natural concern to preserve their national identity have suspected mine of take-over designs on Canada--whereas, in fact, our greater sin may be that of inattention and inadvertence growing out of a sense of security and close friendship.
There is a paradox that while economic isolation from the other would be disastrous for either of our countries, further economic integration is viewed with suspicion by strong and persuasive groups on both sides of the border.
There is a paradox that Canada apparently wants to maintain a strong continuing inflow of U.S. capital, but would prefer to avoid some of its typical consequences. That is, you would prefer to reduce American ownership of Canadian enterprise and to diminish the inflow of net imports that ordinarily accompanies a net inflow of capital.
In this connection, I cannot but lament the announced 20 per cent withholding rate on dividends from corporations with less than 25 per cent Canadian onwership. It hardly seems consistent with the spirit of our relationship to change the rules of the game, ex post, on U.S. equity investments in Canada. And I look with sorrow, rather than anger, at the chain reaction such a move might touch off. The paradox and the objective underlying it are understandable, but the measure itself is not.
This list of paradoxical differences in our mostly robust Canadian-American economic relations could be greatly enlarged. It could be made more specific. And in the eyes of the hypothetical, dispassionate third party I mentioned earlier, it would include some items where adjustments in Canadian thinking would seem to be in order, some items concerning which American rethinking seems to be most needed, and a number of instances in which both of us need to do some accommodating.
The point, however, is that both countries recognize the tensions that sometimes arise between us as minor, compared with the overwhelming benefits we draw from our economic relationship. And we both are determined to adjust these minor tensions sensibly and amicably--and, of course, to do it ourselves, not at the behest of any third party. It is for these reasons that we can all be gratified at the new efforts under way to submit our economic relations to joint and careful examination.
Bilateral discussions of economic issues often have been usefully pursued in the past, of course--especially by business, labour, and other private groups. Moreover, like the other U.S. members of the Joint United States-Canadian Committee on Trade and Economic Affairs, I greatly prize our frank and searching periodic discussions of economic conditions and policies.
But at the government-to-government level, there has been comparatively little recent consideration of the underlying principles, purposes, and basic interests that should guide our economic relationship. Hence, the joint Working Group set up by the Prime Minister and the President last month to study these matters is both timely and promising. For it can spotlight anew the many principles and interests that unite us and the very few that divide us.
Thanks of the meeting were expressed by Mr. Arthur J. Langley, President of The Empire Club of Canada.