Lessons from America.

Britton, Andrew

In addition to our coverage of the United States as part of the world economy programme, four recent or current projects at the Institute involve comparisons between Britain and America. The main focus is on labour market institutions, productivity, training and education. This note draws on this work, and also on a recent visit to Washington to meet both policy makers and independent economists. It has benefited from discussion with the editorial board, but consists nevertheless of my own personal reflections.

Comparisons between economic policies and performance in Britain and the United States are often informative, and they are particularly so at the present time. Despite the proximity of Britain to the rest of Europe and our increasing integration into a single market, it is striking how closely our experience still seems to parallel that of the United States. In the heated debate which continues without let-up in this country about how closely Britain should be integrated into the European Union, the alternative, spoken or unspoken, which many of the opponents of such integration, especially those in the Conservative Party, have in mind must be assumed to be continued development along the American path. One reason for taking a closer look at the United States therefore is to see more clearly where that path is leading.

Another reason why the United States is of particular interest to us in this country at the present time is that the Clinton Administration, after two years, seems to be almost completely frustrated in its attempts at economic policy reform. In some respects the aspirations of the Democrats have been parallel to those now being expressed in this country by the leadership of the Labour Party. Can anything be learnt then about the problems which could beset a future Labour government, and how if at all they could be overcome?

The note is in three parts. The first is about macroeconomic policy, the way in which fiscal and monetary policies are conducted, and the control of demand and inflation. The second is about microeconomic policy and the measures which improve economic performance in the longer run, especially in the labour market. The third offers some general comments and conclusions.

Macroeconomic Policy

The timing of the recent recovery in America has been somewhat ahead of that in the UK. They too have been experiencing a very favourable combination of growth with low inflation. Indeed their recovery has in some respects been more impressive than ours, with a sustained rise in private investment as well as rapid growth in employment. The Administration there, like the Government here, has been taking credit for this happy situation, without however winning much applause thereby. Perhaps the time is passed in both countries when the public regarded the year by year changes in economic performance as being due to the wisdom or folly of the powers that be.

The Federal Reserve Board conducts monetary policy with a view to economic conditions generally and not solely with the goal of low inflation (although there are currently proposals in America to redefine the responsibilities of the central bank more narrowly). The Administration has no role in the setting of interest rates. Nevertheless the conduct of policy in Britain and America is now more striking for its similarities than its differences. In the early stages of the US upturn short-term interest rates were raised in anticipation of inflationary pressure. A very similar approach has been followed here, perhaps in conscious imitation.

An important difference between the two countries in the conduct of monetary policy concerns the role of the exchange rate. America, as a large economy relatively insulated from international markets, is able to take a relatively relaxed view of a falling exchange rate. Almost no-one in America cares about the external value of the dollar. The same can never be true of sterling in Britain; our monetary policy can never be conducted on a purely national basis.

The scale of public sector borrowing was treated for a time in the 1980s in America as if it too could be the subject of 'benign neglect'. It has fallen to the Clinton Administration and a Republican Congress to agree the measures necessary to rectify earlier extravagance. Fiscal reform may have contributed to the fall in long-term bond yields around 1993 and hence to the economic recovery. In 1994 however long-term rates rose again. On a much smaller scale, something rather similar has happened in this country. The fiscal prudence of the earlier Thatcher years was followed by a miscalculation in the late 1980s which led to excessive public sector deficits for a period in the early 1990s. This has now been put right by some tough budget measures, which have cost the Major government much in terms of political popularity. A Labour Government would therefore inherit a rather better fiscal position than did the Democrat Administration in America.

In both countries the constraints on borrowing and on taxation must limit very severely what action can be taken either in macroeconomic or microeconomic terms. Many of the ambitions of the Clinton Administration have come to nothing simply because no money is available to implement them. The same constraints are now recognised by the Labour leadership in this country. One could argue precisely how tight they need be, what ratio of debt to GDP is really improvident, but in both political and market terms the margins for manoeuvre look small.

Microeconomic Policies

The avowed aim of policy under the Clinton Administration is to 'expand the nation's productive capacity', by encouraging fixed investment, research and development, vocational education and training. What most strikes a British observer, however, is the very limited powers which the Federal Government actually has at its disposal to influence any of these activities. To the extent that industrial policies exist in the United States they are operated at the State or local level, and vary greatly from one region to another. Moreover the tendency in most States is for the involvement of government with industrial planning of any kind to diminish rather than to increase and there are few examples of successful initiatives in recent years. Indeed, those who favour regional economic policies in America look with some envy at what has been achieved in Scotland.

The US vocational education and training system still reflects the needs of capital-intensive mass production methods with only a small minority of production workers undergoing formal apprenticeships to recognised craft or training standards. Instead there is a high rate of participation in higher education and some US universities have developed close links with industry. Problems of intermediate skill formation arise because informal, on-the-job training is expensive in both supervision time and output foregone. This has contributed to increasing difficulties in the school-to-work transition since many US managers prefer to recruit experienced workers. The experience of the US in using university graduates instead of apprentice-trained supervisors and technicians is relevant to the current situation in this country, where the supply of graduates has increased sharply. Most graduates lack the practical experience of those who acquire skills through employment-based training. They can help to compensate in part for a shortage of intermediate level skills in the workforce, but it is an expensive way of tackling the problem.

The proposal for a levy in America to fund vocational training is in abeyance. The role of government is confined essentially to supporting the training of disadvantaged groups, such as recent immigrants or those made redundant. The transition from school to work is a subject of particular concern in America, as indeed it is here. The Federal Government is supporting various schemes to strengthen links between high schools and local employers. It is reported that the motivation and achievements of the pupils, typically those who are not expected to go to college, have been much improved by these links. (It is a good example of the differences between the USA and the UK that a pioneering scheme of this kind was initiated by a group of hospitals in Boston who foresaw a need to expand their skilled labour force. Could that happen in the National Health Service?)

The labour markets of the United States are undoubtedly more flexible than those of Europe and even of the UK. There is substantially higher mobility between regions, despite the much larger geographical distances involved. This flexibility is generally accepted as one reason for the lower level of structural unemployment in America than in Europe, and for the creation of far more new jobs in the last ten or twenty years. One reason for this difference may be the relative weakness and declining influence of trade unions in America, but a more important consideration is the relatively short duration of unemployment benefits. After just six months the unemployed in America are, with a few exceptions, left to fend for themselves.

Whilst this already seems a harsh regime by European standards, the mood in America is clearly to make welfare provisions even less generous. The main group now being targetted are single parent families which are the main recipients of longer-term benefits. Under current proposals they may have their period of eligibility curtailed or they may be obliged to work in return for their welfare payments. At the same time greater responsibility for operating the welfare system may be transferred to State governments, whose approaches to the problem will vary greatly. The danger is recognised that states may simply compete with one another to reduce the costs of the welfare system to local industry or taxpayers, with little regard for the implications for hardship or poverty.

The dispersion of wages has widened quite markedly in the United States, as well as in Britain, but not in Continental Europe. There have been particularly sharp rises in the earnings of college graduates and experienced workers compared with less skilled groups. Various explanations have been suggested including 'skill-biased' technical progress, international competition and the decline in unionisation. These factors would presumably affect all industrial countries, but in Continental Europe their effects may be reduced by better opportunities for education and training or by the existence of a statutory minimum wage.

The debate over minimum wages in this country turns in part on the interpretation of American experience. Few studies seem to establish a strong negative effect on employment. However it is important to distinguish American minimum wages, which are generally low relative to the median and which are targetted on specific groups in specific locations, from the relatively high and uniform SMIC in France. The Americans have not tried to halt or reverse the widening of wage differentials, which is generally viewed as a necessary market adjustment. What they have tried to do is minimise its effect on the poorest groups.

Some success can be claimed for two more positive policy changes in America. The negative income tax, which is paid only to those in work, does have the potential to relieve the poverty of families dependent on low earnings and hence to improve the incentive to take a job. The main problem seems to be that the assessment is based on annual income, so that it cannot respond quickly to the needs of those whose circumstances change month to month. This incentive has been reinforced by job placement schemes which have had support from the Federal Government. They appear to have been successful in speeding up job search by benefit recipients without changing greatly the kinds of jobs which they ultimately secure.

There is one area of policy where the US administration has much more power than government in the UK. Trade policy is now conducted more by the EC than by its member states, whilst in America this is one role which belongs unambiguously to the Federal level of government. In fact the most significant policy measures affecting the economic performance of America introduced in the first two years of the Clinton Administration have been trade liberalisation, in particular through GATT and NAFTA, but also through new initiatives in Asia Pacific. Even under an administration more sympathetic than most to active intervention by government in the economy, free international trade is still regarded as the best regime to stimulate growth in America. The assumption is that a rather small, but extremely productive, manufacturing sector in the US will continue to benefit from expanding markets, and that this matters more than the continued decline of more traditional exporting industries. Moreover they see great advantage to them, as well as their trading partners, from extending the free market to internationally traded services. The aim of US policy is to encourage regional trading blocks, but to reduce the barriers to trade between such groupings as well as within them.

Conclusions

The trends in America towards greater market flexibility, less government intervention in the economy and more faith in individual enterprise all continue unabated. The philosophy of the Clinton Administration is rather different, and it won popular support for a time, but its influence is now much diminished.

The American system sustains a very high level of productivity and a very high standard of living for most of the population, although the rate of growth has not been very high. For a significant minority, productivity and living standards are low even by our standards, and the dispersion of incomes is likely to widen further. Despite its outstanding performance in most respects the system may ultimately prove unsustainable because it involves the creation of groups antagonistic to society as a whole. This possibility is, of course, a source of anxiety in America itself, and one reason for the political support which the Democrats enjoyed a few years ago.

The failure to build much on that popular support is partly attributable to institutions peculiar to America. The separation of powers between the Administration and Congress, and between federal and State levels of government, largely accounts for the inability of would-be reformers to make substantial changes. However, historically the same Constitution did not altogether thwart the ambitions of reformers who enjoyed continued popular support, for example in the 1930s. The American constitution does not necessarily underwrite the existing economic system at all times and in all respects. The failure to achieve substantial change at the present time must partly rest on the lukewarm popular support for it, when it comes to practicalities and increasing real costs as opposed to rhetoric.

The economic philosophy of a future Labour government in Britain would be similar in some ways to that of the Clinton Administration. There would be a similar degree of commitment to the market system, with the same sort of qualifications about the need for a positive role for government action as well. The aspiration to 'expand the nation's productive capacity' would be the same, and the hope that in the process the problems of poverty and social exclusion could be mitigated. There are sound economic as well as political arguements in support of such an agenda. (The advisers to the Labour Party and the Democrats have read the same academic literature on growth theory and drawn similar conclusions.)

The British constitution allows much more freedom of action to a reforming government than does that of America. This is true both of macroeconomic policy (as long as the Bank of England is not independent) and microeconomic policy (including especially training and education). On the other hand the need to preserve confidence in international financial markets is a more pressing concern in Britain, affecting the scale of borrowing as well as some issues of regulation. But a determined government with strong popular support can sustain market confidence where a weaker one would be open to attack.

What the American example demonstrates is ultimately the need for popular support, not of a party or its leader, but of its policy proposals. This involves a willingness to accept changes in regulations which cannot always benefit everyone. It also involves a willingness to pay for new public expenditure in some areas either by taxation higher than it would otherwise be, or by reductions of spending elsewhere. The detailed proposals for a future Labour government are gradually becoming clearer. The success of the leadership in presenting those plans may not be crucial to the result of the next election, but it will nevertheless be crucial to their achievements in office if they in fact win it.