[Nasional-e] A shot in the arm or in the foot?

Thu Jan 9 23:48:03 2003

EDITORIAL

A shot in the arm or in the foot?

The economic package unveiled by U.S. President George W. Bush on Tuesday,
coming on top of a huge tax cut announced last summer, is proof that the
Bush administration is determined to revive the U.S. economy, which is still
ailing from the collapse of a stock-market bubble. The stimulus plan is also
good news for the stagnating world economy. As things stand, though, it is
unclear whether the plan will show its intended effect.

The 10-year $674 billion package aims, among other things, to eliminate all
taxes on corporate dividends paid to shareholders and speed up scheduled
reductions in income tax rates. With the Bush administration preparing to
attack Iraq, it is difficult not to regard these and other stimulus measures
as a preemptive move designed to minimize the economic fallout if war breaks
out.

Prospects for the U.S. economy, the main engine for global growth, are of
acute concern, particularly to Japan and other countries that depend on the
huge U.S. market for exports. The Japanese economy, the second largest in
the world, now appears to be sliding back into recession. However, Japan
will be gambling if it takes a U.S. recovery for granted. Wall Street on
Tuesday showed a lackluster reaction to the tax relief plan -- as if to
support the view that its effect on U.S. growth may be limited.

The fact is that the U.S. economy is suffering a deflationary blow from the
bursting of its bubble, much as the Japanese economy has been deflated. It
is estimated that total asset value in the United States has shrunk by $6
trillion, a sum equal to about 60 percent of its gross national product. If
Japan's experience is any guide, it will take a long time before the U.S.
can recover fully from its postbubble slump.

The Bush administration, which recently installed a new economics team,
seems to have another compelling reason to stimulate the economy: President
George W. Bush faces re-election in 2004. It is easy to imagine that Bush
wants to avoid the "mistake" made by his father, former President George
H.W. Bush, who won the 1991 Persian Gulf War but lost his re-election bid
because of domestic economic problems.

Two pillars support the latest package aimed at achieving an economic
recovery:

First, stimulating consumer spending, which accounts for 70 percent of the
GDP, and luring investors back into the stock market. The job situation -- a
major factor affecting consumer confidence -- holds the key. At the moment,
though, employment in the nonfarm sector remains depressed as companies
continue to lay off workers to cut payroll costs.

Second, abolishing dividend taxes. This is not likely to provide much help
to the economy, either, because investors seeking capital gains are probably
not as interested in a tax incentive. Nor is it likely that making dividends
tax-free will really help to bring overseas funds back into the U.S. stock
market, although it will eliminate a form of double taxation.

Another concern about the tax-cut plan is that it may inflate the already
bulging budget deficit. The administration's goal of bringing back a budget
surplus in fiscal 2005 now looks like a pipe dream. With the current account
deficit reaching $500 billion a year, the nightmare of "twin deficits" is
coming back to haunt the U.S. economy. As a result, international confidence
in the U.S. dollar will likely diminish, notwithstanding the Bush
administration's pledge to keep it strong.

It is true that housing investment remains firm thanks to successive
interest rate cuts by the Federal Reserve. The downside is that home prices
are rising faster than worker incomes. If the trend continues, the boom in
this key sector will probably fizzle out. With little room left for further
monetary and fiscal action, the Bush administration's economic policy may
come to a dead end -- something the Japanese government has experienced in
recent years.

In this context, U.S. calls for a drastic monetary easing in Japan are
worrying. Reportedly administration and Federal Reserve officials want to
see the Bank of Japan purchase not only new government bonds but also stocks
and land. In theory, such moves may provide an interesting case study of an
antideflation exercise, but in practice they represent an experiment too
dangerous to try.

With regard to a war with Iraq, if it occurs, at the very least a temporary
economic slowdown will be unavoidable. However, it would be optimistic to
think that once the hostilities ended, economic conditions would lead to a
robust recovery in due course. It seems more likely that the depressing
impact of war would linger longer than expected. The "spillover" effect of
the Persian Gulf War, it should be remembered, was not great enough to turn
the U.S. economy around.