Economics 101 with Robert McTeer
Dallas Fed President and CEO Gives Lesson on Issues Behind Economic Growth
by Scott Burns
The Dallas Morning News
Oct. 17, 1999

Robert D. McTeer Jr. is president and chief executive officer of the Dallas Federal Reserve Bank, one of the 12 regional banks that make up the Federal Reserve System. His region includes all of Texas, northern Louisiana and southern New Mexico, a territory whose activities range from subsistence farming in New Mexico to the highest levels of technology development in Dallas and Austin.

He is also a member of the Federal Open Market Committee, the Fed's primary body for making monetary policy and a group that is now second-guessed, credited, blamed and otherwise speculated about because of its influence on interest rates and financial markets. I visited with Mr. McTeer last week and came away with what amounts to a personal tutorial on the issues and factors behind economic growth.

As a person, he is a studious man with a sense of humor that is, at once, robust, subtle and infectious. During a recent speech to the Greater Dallas Chamber of Commerce, Mr. McTeer joked: "The Dallas Fed has always been for sound money, and plenty ofit." While I visited with him he noted that he was about to leave for Lubbock to make a speech. He was looking forward to visiting Buddy Holly's grave, where he intended to leave, as many have, a guitar pick.

"But what should I have left when I was in Scotland and visited the grave of Adam Smith?" he asked.

"An invisible hand," he answered. In fact, Robert D. McTeer Jr. believes Adam Smith's invisible hand has been put to work in America.

Listen.

Q. As an economist, what indicators and tools do you use?

A. We have access to all the government statistics. Of necessity, they are backward looking—but there is such a thing as momentum. The economy doesn't turn on a dime. In addition, the Board of Governors has somesophisticated models…although even they are, of necessity, backward looking.

Wealso keep a lot of contact with people on the ground. They're called regularly about prices, inventories, backlogs, etc.—everything that gives a "straws in the wind" sort of feel. They're not official statistics, but when you're at a turning point, this is where you're likely to get signs faster.

Our economists [at the Dallas Federal Reserve] don't try to duplicate the Board of Governors' economists. For instance, we have two energy economists. We also have a unit that specializes in Mexico and Latin America. And we're trying to beef up and learn about the New Economy—how different it is and whether it really is, as some say, "a new paradigm."

In that area the big question is about productivity [and its relationship to economic growth].

(Taking a pad of paper, Mr. McTeer made two columns, labeling one "productivity" and the other "labor," and started to show sums.)

In the '60s we had productivity growth of around 2.3 percent. But there was a change—the inflection point is around 1973—and productivity growth slowed. From 1973 through 1995 it was about 11 percent.

What happened in 1973 to change things? We had the first oil embargo. There was another in '79. It also coincided with turning the dollar loose from gold, but no one really knows what caused anything. We also know that we were developing and investing in new technology all along—but couldn't see it [in productivity growth].

One possible explanation is from a technology historian, David Paul. Apparently, all new technologies take longer than we remember. Factories, for instance, had to be redesigned after the development of the steam engine because earlier factories had been designed to use gravity.

Now we're seeing a lot of new innovations that have come together. Productivity has been rising. From 1996 through the first quarter of 1999, productivity growth has averaged 2.5 percent. You need to understand that isn't just an increase from 1 to 2 percent, that's a doubling. It's not a minor change.

The big question is whether this is a new trend or an anomaly.

We've been going through two decades of restructuring—[economist Joseph] Schumpeter's "creative destruction." This is very different from the European economies, which are less flexible. Our workers are now getting the protection of a growing economy while European workers are trying to get protection through law.

Q. Was there a key event that created this difference?

A. It was probably early in the Reagan administration when he fired the air traffic controllers. But it could have been other things as well. Before that there was a kind of hopeless feeling about flexibility [in this country]. The most important thing is that we got an early start on deregulation. The point is that we have allowed things to change in this country and, ultimately, that has protected workers more.

(One bit of evidence comes from the counties along the Texas border. Mr. McTeer observed that the unemployment rate in the border counties had fallen below 10 percent—for the first time in two decades.)

Q. What are the limits of productivity increases?

A. This is an extremely important issue. When [Federal Reserve Chairman Alan] Greenspan was expressing doubts about the growth of productivity, he was talking about the second derivative. That's not the rate of growth for productivity, but the rate of growth for the rate of growth. Most people didn't understand that.

Q. Do you think there are limits for productivity growth?

A. Can the 2.3 percent productivity rate of the last few years go higher? I think it can, I'm pretty optimistic.

But you may not be able to have labor increase by the same amount [as in recent years]. We got here by reducing unemployment rolls. We also reduced welfare rolls.

Q. What's the long-term sustainable rate for labor growth?

A. That's about 1 percent. To get the 2 percent rate we've been reducing unemployment. And that's one of the reasons I think we ought to allow Social Security recipients to work without penalties.

We also need to admit more foreigners to fill some of our high-tech jobs.

Another thing to understand is that the two sources of economic growth—productivity and labor hours—aren't the same. It's better to get the growth from higher productivity because that's the long-run key to rising living standards.

Q. A recent issue of The Economist characterized the U.S. economy as suffering from "asset inflation" and being in a bubble. What do you think of that?

A. Their view is that we're in a bubble. They may be right or wrong. I don't know. To say that they are right means that you know more than all the people who are buying stocks. More than the market. I don't think that's my business. What can I tell you is that historical studies show that there have been a few stock market bubbles, alone, that have been harmful. They appear to be dangerous only when they are coupled with real estate.

Q. What would you do if you could be an economic dictator?

(He smiles at the very concept)

A. Oh, I'd dictate a higher rate of savings, lower marginal income tax rates, a zero capital gains tax rate and a zero estate tax.

Capital gains tax cuts are about as close as you can get to a free lunch—they almost always pay for themselves.

The Arithmetic of Economic Growth

Column A Column B Column C Column D Period Productivity plus... Hours worked equals... Economic growth Long-term past 2.3% 1.0+% 3.3+% Slump, 1973–95 1.1% 1.0% 2.1% 1996–99 2.3% 2.0% 4.5%   Future 2.5%? 1.0%+? 3.5%+?

Source: Robert McTeer's notes

Reprinted with permission of The Dallas Morning News