long-term policy agenda. The first of those is in the area of retirement security.

We all know the headlines at the moment on private pensions and 401(k) plans, but in general we need to think about retirement security in the United States, which has been a three-legged stool of private saving that we do on our own for retirement, private pensions and Social Security. The Report tries to review the strengths and weaknesses of our system and tackles the issue of personal accounts, which we believe will be a very fruitful discussion this year in the aftermath of the Social Security Commission's report on personal accounts.

A second institution that we believe is worthy of serious discussion is the importance of getting competition policy right. One of the ways in which our economy prospered in the 1990s, and historically, relative to perhaps other regions is a very strong and vibrant competition policy that realizes the need to innovate both in how firms are organized and in how policy is organized. And in that regard, we particularly talk about the issue of dynamic competition that comes up in industries ranging from software on the one hand to pharmaceuticals on the other, where leap-frogging of innovation leads to the need to perhaps think strongly about competition policy.

A particularly exciting institutional discussion, I think, in the Report has to do with health care. The President, from early days in the campaign, has put forth a vision for health care that is very different from the debate we often have over budget policy and guarantees of access, and is centered more on patients - patient-centered care and outcomes in the health care system. The health care chapter of the Economic Report talks about the institutional underpinnings that we would need to move toward a system in which we focus on health care outcomes and information and not simply just budgets.

Another area of discussion in the Report has to do with federalism, long a strong feature of our country's institutions. As you know, the President believes that it is very important for the not-for-profit sector generally and faith-based organizations in particular to play an important role in social securities in our country. What the Report does is to review partnerships between the Federal Government and state and local governments on the one hand and between governments and not-for-profit organizations on the other, and to talk about how one might design incentives for better outcomes. A particular area of interest there is obviously education and the need to focus on outcomes in education as exemplified in the "No Child Left Behind" legislation.

The final two institutional pieces of the Report are, for lack of a better term, reaching out beyond the basic economic concerns of the domestic economy. One addresses building institutions for a better environment. As you know, there has been a sea change in economists' thinking over the past couple of decades about the powerful role that markets can play in environmental policy, and all of that is true. But that simply won't work for us without the right institutional underpinnings. So we talk about institutions for trading systems and information that

have helped existing pollution policies and also the upcoming policy discussions on global climate change.

The final section of the Report highlights the topic you identified, which I believe is extremely important, Mr. Chairman, on the need for supporting global economic integration. This is usually cast in the trade area, and that is clearly very important. As I indicated, we are committed in the administration to the idea of free trade, and in particular to actual trade negotiations and the power of TPA. We shouldn't turn a blind eye toward international finance, as you mentioned; and here the President has two broad concerns that are highlighted in the Report. One is over the need to think strongly about the activities of the International Monetary Fund in its lending practices and how to give the right incentives for capital flows and the private sector role in those flows around the world.

The second piece of that has to do with the multilateral development banks' approach to development. There has been too much of an emphasis in the past, in the President's view and in the administration's view, on lending programs that have not, frankly, generated positive results. We would prefer to see programs that move toward more explicit grants, coupled with a kind of institutional reform in countries, ranging from anti-corruption regimes to emphasis on the rule of law.

All of this, if I can return to where I began, goes back to the importance of growth and, in particular, the importance of productivity growth. That is a lesson we have learned well. It is critical as a lesson for our trading partners in Europe and Japan and in the developing world.

To give you an example of the power: If you thought about even two-tenths of a percentage point change in productivity growth, which we would argue is consistent with the long-term gains from the administration's policy agenda, real GDP at the end of 10 years would be $1,000 higher per person, every man, woman and child in the country, and the budget surplus over that 10 years would improve by $350 billion again making the point both of the power of productivity growth and the strong link between the economy and the budget.

We believe that additional resources of this magnitude are well worth the effort to improve incentives and institutions. They have even greater value elsewhere in the world.

Thank you very much, Mr. Chairman, for this opportunity. I look forward to your questions.

[The prepared statement of Dr. Hubbard appears in the Submissions for the Record on page 26.]

Representative Saxton. Dr. Hubbard, thank you very much. We appreciate you and your colleagues being here to share this testimony and information with us.

Let me begin with something that you mentioned early in your statement; that is the effect of the 9-11 events as an economic factor. You mentioned that you believe that the terrorist attack actually pushed us over the brink into recession, and we share that view.

I am wondering about the long-term effects of that particular attack and the activities that have ensued relative to that specific attack. Are we recovering from it? Has the activity of the American security system, if you will, reacted in a way that has restored confidence from an economic point of view? And what do you think will be the long-term effects of the expenditures that we are making for security purposes, again in the context of our national or international economy?

Dr. Hubbard. Well, I think you have put forward probably the core question for policy this year and for discussions of the budget.

The President's view is that, first and foremost, we need to win the war, both the war against terrorism abroad and that at home - we will need to secure the homeland in the United States. The reason for that is not just the obvious security or military aspects, but the need to promote confidence in our economy. One of the reasons we saw declines in consumer and business confidence after September 11th was a sense of uncertainty about security. So that kind of security in defense spending is actually very important in creating an environment for confidence and growth in the country.

As to the long-term consequences, a lot will depend on the pace of the war efforts and the speed with which we can win the war on terrorism. The President has indicated this is a long-term activity. It is going to be a costly activity, one which is really essential for our economic security. In terms of productivity growth, we think that as long as we don't overregulate the private sector, as we pursue security, productivity effects will be relatively modest.

Representative Saxton. Do you think that the expenditures themselves that we are making throughout the economy for security purposes will have effect?

Dr. Hubbard. Well, certainly in the short run the expenditures that are being made are providing some stimulus to the economy. In the longterm, I think the effects of those expenditures depend on how productive they are; and to the extent that they are for meaningful defense and homeland security, as the President has proposed, we believe again that creates a very positive environment for growth and is very positive for the country.

Representative Saxton. Here is my concern. You have correctly pointed out in your testimony that one of the reasons that we were successful in having a long period of robust economic growth during the 1980s and 1990s was that we were able to funnel investments in technology, which provided for increases in productivity and helped our economy grow.

It seems to me that, unfortunately, the necessary expenditures that we are making now in security don't have the same long-term effect in terms of increasing productivity. They are necessary. They are things that we all know that we must do, but from an economic point of view, aren't they less stimulating than the kinds of investment that we saw during the 1980s and 1990s in technology and productivity?

Dr. Hubbard. Well, certainly directly we would all prefer a world in which we could focus our energies on productive technology development in the private sector. I think it is important, though, not to lose sight of the security spending's role in promoting long-term growth.

We know, for example, that the U.S. defense buildup during the 1980s played an important role in a victory against one form of tyranny. It is very important to have a secure homeland and a secure world, and I think it is the President's view that this is an economic investment that we must make. So, properly managed, we believe this won't be that harmful for the economy.

Representative Saxton. Let me switch subjects and talk about our budget surplus.

There has been some debate relative to what caused the surplus to be diminished or to evaporate. Would you give us your thoughts on what you think happened in terms of a surplus? Did Congress go on a spending spree, or did we see some economic factors at play which were primarily responsible for reducing the surplus?

Dr. Hubbard. Well, certainly, as your question suggests, the largest contributing factor is really economic factors. This came both from the downward revision of the level of GDP - the national income accounts restatement - and also from lower economic growth. That would be the single largest culprit.

The spending increases have been very important in the budget surplus deterioration; the tax cut has actually played a very modest role, the tax cut enacted by the Congress last year and suggested by the President. For the current year, it is actually playing an extremely small role, maybe on the order of 15 percent. Over a 10-year period, its role would rise closer to 40 percent. But we believe that it remains sound economic policy.

So in terms of the decomposition, economics is clearly the largest single factor.

Representative Saxton. Some have suggested that the tax cuts that were enacted early last year be repealed because of the budget deficit situation.

Would you respond to that notion?

Dr. Hubbard. Well, sure.

I think it is important to start with a basic understanding of where we get surpluses. We get surpluses when we have a very healthy economy, not the other way around; that is, we don't save ourselves into prosperity through surpluses. The direction goes the other way.

So having said that, the tax cut provided a very important underpinning for growth in the second half of last year. The tax cut probably provided at least a percentage point underpinning to growth. For this calendar year, existing tax cuts should provide another half a percentage point underpinning to growth.

So in terms of thinking about the cost to our economy of repealing the tax cut, we would lose growth and, of course, the jobs that are associated with that growth.

Representative Saxton. The President has suggested that the tax cuts ought to be made permanent. Others have suggested that just the opposite should occur. Can you explain the rationale for making the tax cuts permanent, and what advantage you see in doing so?

Dr. Hubbard. It is very important that the President's tax cut be made permanent. It is important first, of course, for households and businesses to have a long-term environment for planning. It is also important because of the incentive effects, both for households and businesses, of having lower marginal tax rates. It would be an odd tax policy notion for us to think that it is a great idea to lower marginal tax rates for some span of a number of years and then suddenly increase them back to what they had been in the year 2000.

So we believe it is very, very important on the tax agenda.

Representative Saxton. Dr. Hubbard, in your testimony you made reference to retirement funds, and I think it is a very timely issue to address. We Americans are not accustomed to seeing our retirement funds diminished, at least we would like to think that we are not.

The daily reports on the Enron situation are concerning and sometimes even alarming. The latest news report this morning was that Enron management was actually siphoning off, or is suspected now of siphoning off, sort of, monies that were put away for employees' retirement purposes.

What, if anything, do you think the Congress should do in order to restore confidence in the private retirement system?

Dr. Hubbard. Well, while I don't want to comment on the Enron case as a particular matter, there are two very important points I think that your question tees up.

The President, as you know, asked for two working groups within the administration to be created on this issue, one to be centered directly on pensions and retirement saving, where he asked Secretary O'Neill to work with Secretary Evans and Secretary Chao. At the same time, he asked for a broader discussion of corporate financial disclosure to be headed up, again by Secretary O'Neill, but in the context of the President's Working Group on Financial Markets.

Some of the pensions recommendations have already come to the President, and the President and the administration have suggested these to Congress, having to do with allowing workers to diversify a little more freely in their accounts, but not requiring them to do so, and also placing restrictions on so-called blackout periods.

The Labor Department has under way a review of pension security, and we do believe this is a very important issue. The broader question that is teed up by this is really the whole issue of corporate financial disclosure and whether we, as investors in our pensions or investors generally, get the right kinds of information needed for investment