Q&A: Edward Lazear

Tuesday, June 19, 2007

James Pethokoukis interviewed Hoover senior fellow Edward P. Lazear for U.S. News & World Report:

Concerns about income inequality and slow wage growth have blemished what perhaps has been President Bush’s greatest success: presiding over an economic boom that’s in its sixth year and has created more than 6 million new jobs during the past three years. It is Edward Lazear’s job, as chairman of Bush’s Council of Economic Advisers, to help keep the good times going and to make sure more Americans participate in them. Luckily, that’s his specialty. Before joining the Bush team, he was a labor economist at Stanford University and specialized in how pay structures motivate workers.

Pethokoukis: Are you surprised that the economy performed as well as it did last year despite the housing bust and the spike in oil prices?

Lazear: To be honest, the resilience does surprise me but not because the fundamentals aren’t there. The reason the economy is so resilient is that we have the kind of flexibility built into our system that is really necessary to have a robust economy. You’ve got flexible job markets; you’ve got flexible capital markets. The housing market decline was offset by nonresidential construction to a significant degree. It was also offset by export growth, which is great.

Pethokoukis: How about now, with the stock market drop and a string of weak economic reports?

Lazear: Our forecast [of percentage growth in gross domestic product] for this year was the upper 2s, and I think we stand by that. This quarter might be a little below that, simply because we are still living with the effect of the decline in the housing market.

Pethokoukis: Alan Greenspan has suggested that we are closer to the end of this expansion than to the beginning. Is that how you see it?

Lazear: I am not a believer in “what goes up must come down.” I think that if the fundamentals are strong, we can have continued high levels of growth for a very prolonged period. In the early ’80s, we had a couple of recessions almost back to back. Then we went for, what, eight, nine years before a recession, and then we went 10 years. . . . As you look way, way into the distant future, there are some fundamentals that are inherently going to slow our growth. Our labor force isn’t going to grow as fast, so what that means is that the total growth rate will be lower. The per capita growth rate could actually be higher. So we may be richer and be growing relative to the individual at a higher rate in the future, but in terms of the size of the overall economy, the demographics are going to catch us.

Pethokoukis: Are you worried about inflation?

Lazear: I think the Fed is doing a good job. I don’t see that we’re going to have significant inflation.

Pethokoukis: How big a problem is China and the trade deficit?

Lazear: It is certainly the case that China is a significant portion of our trade deficit, about a third right now, about $230 billion out of $800 billion. It’s a chunk, but it’s not the whole picture. The reason for the trade deficit is primarily, to my mind, the capital accounts surplus. People want to invest in the United States. In order to invest in the United States, they have to give us something. . . . And so what they are giving us is their goods in return. So I basically think of the trade deficit as funding their desire to invest in our capital, which is why I think of that as a good thing.

“I am not a believer in ‘what goes up must come down.’ I think that if the fundamentals are strong, we can have continued high levels of growth for a very prolonged period.”

Pethokoukis: The budget deficit is running at less than 2 percent of GDP. Is that an economically significant number?

Lazear: Certainly it’s economically significant, and that’s why the president wants to eliminate it within a few years or so. We had a variety of unanticipated events that caused our short-term expenses to go up. One was 9/11 and the subsequent global war on terrorism. We had some hurricanes. We had a recession. The question then becomes what’s the best way to finance those expenditures over time. The market basically tells you if we are not paying [the debt] off quickly enough. The way you know that is to just look at interest rates. . . . Interest rates have just not gone up. If interest rates are low, what that tells us is that government borrowing is not out of hand.

Pethokoukis: Will the president raise taxes to fund Social Security or reform the alternative minimum tax?

Lazear: The answer is no. The president has said that he does not believe that higher taxes are either necessary or good for the economy.

“People want to invest in the United States. . . . I basically think of the trade deficit as funding their desire to invest in our capital, which is why I think of that as a good thing.”

Pethokoukis: Are Americans really worried about income inequality?

Lazear: We certainly worry about equality. We know that if you look at the numbers over time, there has been about a 25-year increase toward, I would call it, disparity between wages at the top and wages at the bottom. It’s not that wages at the bottom have been declining so much or even at the middle have been declining; it’s really that they’ve been relatively flat but that wages at the top have been growing. That’s a good thing. It’s a good thing when wages at the top grow, because what that means is that investments in skills are paying off at higher rates than they paid off in the past. We like it when our investments pay higher returns. What we don’t like is if people are precluded from making those kinds of investments. So the way I think about inequality is more on the opportunity side than on the outcome side.