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Robert B. Reich U.S. Secretary of Labor

Keynote Address to the Conference on the Economic War Among the States National Academy of Sciences

Washington, D.C. May 22, 1996

Early in our century, Woodrow Wilson wrote that "the relation of the States to the Federal government is the cardinal question of our constitutional system ... Every successive stage of our political and economic development gives it a new aspect, makes it a new question."1 As we look to the century's end, rapid technological change and global economic integration are defining this generation's version of the basic question of federalism: How can we ensure that the division of economic responsibilities across levels of government will prove an advantage, not a handicap, as we struggle to sustain America's magnificent postwar accomplishment of broadly-shared prosperity?

Before engaging this question in more detail, let me offer an update on the status of that struggle. Four years ago, the prospects for shared prosperity seemed bleak. Nine million people were looking for work, and the unemployment rate was 7.6 percent. President Clinton took office determined to make life better for people who work hard and play by the rules. He had an economic strategy to deal with unemployment. And he delivered. The jobless rate has dropped to 5.4 percent. He promised 8 million new jobs in his first term. And he delivered. The figure now stands at eight and a half million, and counting. He promised to cut the deficit, which had ballooned under his predecessors. And he delivered. For the first time since the Truman Administration, the deficit has declined for three years in a row. In fact, aside from interest payment on the federal debt, the budget has actually been in surplus for the past two calendar years. By the end of this year, the overall deficit will be half of what it was when the President took office.

Getting our fiscal house in order is already paying real economic dividends. The "misery index" -- the sum of the inflation and unemployment rates -- is at its lowest level in almost thirty years. Companies are doing well. Last year, the Fortune 500 enjoyed an average profit rate of 13 percent. The long slide in median wages for working men has been halted.

But the President has also said that this is a record to build on, not sit on. There's more to be done. The benefits of our economic renewal are still uneven, with a widening dividing line based on education and training. In 1979, a college-educated man earned about 49 percent more than his counterpart with a high-school diploma. In 1994, the gap had nearly doubled to 96 percent.

College-educated women, who in 1979 earned 44 percent more than high-school educated women, earned 85 percent more in 1994.

In spite of the economic expansion and restored upward mobility for many families, millions of working Americans aren't sure what they're going to get out of the new, high-tech, global economy. This is an era of extraordinary dynamism and change, comparable to the industrial revolution that moved people from farm to factory. And like that earlier transition, this one is perilous for many people.

The great challenge for the second stage of economic renewal is restoring wage growth and economic security for all working families, and making the American dream of opportunity a reality, for anyone who is ready to work for it.

Succeeding, together, requires us to equip all willing workers with the skills they need to advance in today's economy. There are many new jobs, but the good ones lie tantalizingly beyond the grasp of many working people. Those jobs call for more than the energy, good sense, and determination that most Americans possess in abundance. They also require technical or problem-solving skills, and the capacity to continuously acquire new skills.

In every advanced economy, the job market is rapidly shifting in favor of people with such skills -- and against people without them. The earnings of people with the right skills are rising, while the earnings of those without them are dropping -- or they simply become unemployed. As we all know, in a dynamic economy no one has job security. Those with skills can still command employability security -- the security of being reasonably sure that if they lose their job they can get a new one that's as good. The challenge is to extend this new kind of security to those who remain trapped in the old economy -- because they don't know what skills are in demand, or can't afford the costs of building skills, or feel too old to learn, or cannot find ways to sustain their families as they navigate economic transitions. We have to make the new economic dynamism work for more of our people.

Nothing has been more central to the Clinton Administration's long-term strategy than boosting investments in human capital. Among our earliest and most cherished successes were new laws promoting standards for high schools and occupational skills, and catalyzing innovations in school-to-work apprenticeships across America. But much remains to be done: We are working to change the nation's unemployment system -- originally meant to provide income support during temporary layoffs -- into a re-employment system designed to get jobless workers the training they need and move them rapidly into new jobs. The President has called for consolidating federal job-training programs into vouchers that unemployed or low-wage workers can use at community colleges or technical schools to get the training they need. The President is also proposing a fundamental change in the tax code, putting families' investments in skills on the same kind of tax-favored footing as business investments in machinery through a $10,000 per year tax deduction to offset expenses for post-secondary education or job training. The creation of a system affording lifelong access to education and training -- a system that relies on market forces, avoids bureaucracy, and puts individuals in control of their own skill investments -- is within our grasp.

Yet important as it is to reform the federal role in education and training, the states and localities do the heavy lifting. The most recent data, for the 1992-93 school year, show that the federal government's share of all public education spending, from kindergarten through college, was only about 8 percent of the $369 billion total. Education is the biggest single task of state government today. Figures from the National Council of State Legislatures show that during the last fiscal year, K through 12 education claimed fully a third of state appropriations, and higher education accounted for another 12 percent.

Our future depends to a great degree on the capacity of states and localities to maintain or expand investment in education and job-training, and to improve the impact of their human-capital spending. Keeping faith with America's tradition of education and training policy centered on the states--instead of being centralized in Washington--can ensure a more innovative, diverse and accountable education system.

But there are some disturbing signs that the dark side of federalism may threaten human-capital development. As states and localities rush to attract business investment through tax cuts and subsidies, it can become harder to sustain spending on education and training. Other big-ticket claims on resources, like welfare, infrastructure, medicaid, and prison-building, are unlikely to shrink very much or very soon. The risk is that when something has to give in the budgetary arithmetic to make room for benefits to business, what gives may be education and training.

There's a poignant irony at play here. Human capital is increasingly the linchpin of competitive strategy in the private sector. Whether motivated by enlightened self-interest or a corporate citizen's concern for America's future, businesses have a deep stake in improving workforce skills. More and more companies are acting on this stake: Some contribute computers to classrooms; others send executives to help manage the schools. The recent national conference on education standards--indeed, the whole national movement to create meaningful standards for schools--has been powered by the prudent concerns of corporate leaders.

The irony, and potential tragedy, is this: Even companies that know full well that the education system is the pipeline for their most important productive assets are pressing states and localities for financial benefits that risk blocking that pipeline. But state and local officials, under short-run pressure to attract or maintain jobs, can be tempted to sell out the future by short-changing education and training. Consider just a few examples:

  • An Albuquerque suburb called Rio Rancho proved hugely successful in using location incentives to attract industry, including a 1993 deal with Intel. Rio Rancho tailored its $114 million package of benefits to edge out competing bids from California, Arizona, and other states, landing a $1 billion chip-making plant and expansions to an existing plant. But the deal left Rio Rancho without enough tax revenue to build a high school, or even maintain adequate elementary-school capacity.

  • Tennessee rightly celebrated when it won the competition for General Motors' huge Saturn plant. But last year the plant's school district reported that it was 100 classrooms short of what it needed to meet minimum state standards.

  • And in the background materials for today's conference, Melvin L. Burstein and Arthur J. Rolnick of the Minneapolis Federal Reserve reported that one city had closed 11 schools while assembling an incentive package for a football team. Even if you're a football fan, there's something repellent about that kind of tradeoff.

The sum of tactical decisions by corporate managers and state and local officials -- each decision rational in its own way, within its own boundaries of space and time -- can lead to a disastrous pattern of national under-investment in our nation's capacity to learn, innovate, and adapt. And as it becomes harder to master the global economy's competitive pressures, private-sector profit margins, and state and local budgets, will come under even more strain, intensifying incentives to press for every possible short-term advantage no matter what the broader costs. A vicious cycle; a zero-sum game.

How can we change the rules of this zero-sum game? How can we break the vicious cycle and bring businesses of all types and sizes, and government at every level, together into a virtuous cycle of mutual investment for mutual prosperity?

Let's start with the Federal responsibility. Today's conference raises some intriguing issues, and I'll be interested to see the results. But beyond the new topics on the table today are some policies already in the works.

One key federal responsibility is to affirm and support business investments in worker skills. A new Administration initiative was announced by the President at last week's conference celebrating responsible businesses, and may have been too little noticed amid the clamor of this political season. Until a year and a half ago, the tax code encouraged companies to reimburse their employees' tuition expenses. Congress let that provision die at the end of 1994. Last week, the President declared his strong support for reinstating that spur to skill-building, and for going the old law one better: He proposed adding a new federal tax credit for smaller firms--who typically spend less on their workers' skills, and who have a harder time developing in-house training programs --covering ten percent of the cost of tuition reimbursement. Coupled with the President's proposed $10,000 deduction for families' investments in education and training, this new initiative represents a resoundingly positive-sum tax incentive. Congress should waste no time in turning these proposals into realities.

The federal government must reform and strengthen education and training policy, and encourage business to play its own proper role in building skills. And it must also forestall the diversion of federal funds into zero-sum competition. Past abuses have led to tightening safeguards on grant programs, including those we administer at the Labor Department, to prevent federal tax dollars from becoming fuel for interstate bidding wars. The current enthusiasm for turning federal programs into block grants to the states must be tempered by an awareness of this possibility, and further curbs against interstate bidding must be built in.

This issue already has triggered a controversy in what otherwise could be a model bipartisan reform effort. The CAREERS Act, now taking final shape in a House-Senate conference, in many ways mirrors the re-employment reform proposal the President unveiled in 1994. The legislation has the potential to revolutionize job-training policy, making it more efficient and more closely geared to the needs of the marketplace and the priorities of individual workers. But in this crucial conference phase, Congress must resist pressures to water down safeguards against hijacking scarce training funds for inappropriate purposes. Some versions of the draft law place too few limits on the share of funding that can be used for economic development, and "development" is defined with dangerous imprecision. The Clinton Administration strongly supports reform along the lines of the CAREERS Act -- but just as strongly opposes opening a loophole that would undermine the goal of targeted training, and risk triggering sterile interstate rivalry.

Ultimately, breaking the vicious cycle of zero-sum competition is a matter of corporate responsibility. State and local officials can't do it on their own. Efforts at forging compacts to bar destructive competition have a discouraging history of breaking down. So long as businesses continue to demand incentives as the price of adding new jobs, or preserving existing ones, such truces in the economic civil war are inherently fragile.

It is crucial, of course, to distinguish between zero-sum subsidy demands, and those carefully targeted incentives that are meant to boost investment in pockets of high poverty and unemployment. Responsible businesses can participate in these kinds of federal, state, and local programs with profit, and with pride. But pressing cities and states for the last possible dollar of tax breaks and subsidies must be seen as a violation of the code of corporate citizenship. Indeed, these can be among the most insidious kinds of corporate welfare -- often invisible to the average citizen, imposing competitive handicaps on firms that don't receive such largesse, robbing states and locales of scarce funds, and linked loosely, or not at all, to new jobs or other public benefits for the nation as a whole.

Corporate leaders can't have it both ways: Bemoaning the real-enough defects of the education system while siphoning off the resources required to fix them; arguing that market pressures prevent them from shouldering more of the common burdens of preserving a civilized society, while seeking special tax breaks and subsidies to shield them from the same market pressures.

Should the federal government act more aggressively to restrain this kind of rivalry among the states? I should caution you against awaiting short-term closure on long-term questions, especially in this noisy election year. But we must all remind ourselves that limiting destructive interstate competition is a long-standing American tradition. Indeed, it was one of the inspirations for our Constitution. The Articles of Confederation -- our first draft at nationhood -- left the separate states in control of commerce, including international trade. In 1783 the Pennsylvania legislature predicted that the "exercise within the States of the power of regulating and controlling trade can result only in discordant systems productive of internal jealousies and competitions, and ill-calculated to oppose or counteract foreign measures...."2 And indeed, other countries quickly learned they could play states off against each other to get the best possible deal on trade. The spectacle of weakness through division led Thomas Jefferson to write in 1785 that the "interests of the States ought to be made joint in every possible instance, in order to cultivate the idea of our being one nation."3 And so they were, in the magnificent Constitution of 1789 that curbed commercial rivalry among the separate states in the name of promoting their common welfare.

As Supreme Court Justice Benjamin Cardozo said in 1934, our Constitution "was framed upon the theory that the peoples of the several states must sink or swim together, and that in the long run, prosperity and salvation are in union, and not division." Precisely. As you continue your work today, I applaud you for your effort to advance the conversation about how to ensure prosperity and salvation in the long run, through union, and not division.

Thank you.

1 Constitutional Government in the United States (New York: Columbia UP, 1921), p. 173

2Quoted in Allan Nevins, The American States During and After the Revolution 1775-1789 (New York: The MacMillan Company, 1927) p. 563

3Quoted in Curtis P. Nettels, The Emergence of a National Economy 1775-1815, Vol. II of The Economic History of the United States, (New York, Holt, Rinehart, and Winston, 1962) p. 73

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