Last month in this space we heard the voice of pragmatic Republicanism. This month we turn to the Democrats. And of all the Democrats running for President in 1988, we've found that Bruce Babbitt has the clearest fix on how business works, and what government can -- and can't -- do to help it.

If things had gone according to plan, Babbitt might now be running one of his family's successful ranching and trading enterprises in northern Arizona. It was a love of geology that led Babbitt away from Arizona and business to the mountains of Bolivia, and it was the poverty he found there that led him back home to a career in politics and public-interest law.

As the Democratic governor of a conservative Republican state, Babbitt's politics were, of necessity, more practical than ideological, his social initiatives framed in the context of government efficiency and economic growth. He was among the first public officials to preach the folly of chasing after big business with tax breaks and subsidies, concentrating on building up the state's infrastructure -- highways, water resources, educational systems -- so that Arizona could grow its own businesses. And it worked -- so much so that when Babbitt retired from office early this year, he had won the solid support of business, the grudging respect of labor, and the enduring admiration of environmentalists and social activists.

An awkward speaking style, a grasp for detail, and a disdain for the Democratic Party establishment have prompted many to compare Babbitt with an aspiring and little-known governor of an earlier era. But where Jimmy Carter was a cautious and calculating politician, Babbitt is given to candor and risk taking, with a genuine flair for political leadership. He spoke with INC. senior editor Steven Pearlstein and writer David Osborne at his law office in Phoenix.

INC.: Your party will have been out of the White House for 16 of the past 20 years. What does that mean for you as a Democratic candidate?

BABBITT: Democrats, I think, have to wrestle with one fundamental question: how is it that we put forward a coherent view of a world in which you balance the need for economic growth with traditional Democratic concerns for equity and justice? In the recent past, the party has drifted away from the issues of economic growth and gotten itself in the position of reslicing a static pie. The view of government was of a giant check-writing machine. What I've learned is that a genuine, aggressive emphasis on growth and economic development, if successful, generates one hell of a lot of political support and fiscal support for social programs. I'll admit that sometimes there is conflict between those two goals. For Democrats, the question is: how do we hold both within our vision simultaneously?

INC.: A cynic -- or a Republican -- might say that all you've really done is adopt the platform of the other party. Why bother with the imitation if you can have the real thing?

BABBITT: Because the real thing, as you call it, isn't real at all. Right now, after nearly seven years of Reagan, the economy has been growing at something like 3% in real terms over the past few years -- not much to crow about there. And we have unemployment nationally of more than 6%, which is twice the level of previous decades -- and, to me, unacceptable. Budget deficits are up, trade deficits are up, productivity is down, savings are down. So I'd have to disagree with you on the premise of your question. The Republican Party has hardly proven itself to be the party of economic growth.

What the Reagan people have said over the past seven years is, basically, that poor people don't work because they get too much money, and rich people are loafing around because they don't get enough money. And so they have set about devising a very simplistic answer that says if we slash marginal tax rates, the marketplace will take care of everything else. Baloney. What we have instead, is an orgy of speculation going on. The gap between the rich and the poor has widened. The gap between labor and management has widened. The trade gap has widened. And the Republican Administration simply hasn't stepped up to those issues. We get sermonettes -- and no policies.

INC.: You criticize the Administration's position on trade, and yet, until recently, you essentially were in agreement with what might be loosely termed a freetrade policy.

BABBITT: Here is how my thinking evolved on that. I'm a classic free trader in the sense that I believe that industry-specific protection sows the seeds of destruction of that industry. Cars, steel, shoes -- we agonize over what protections we are going to offer, we finally offer them, and what happens? The industry only gets less and less competitive. So in that respect, I have not moved from my original position.

Over the past couple of years, however, as the trade deficits with certain countries continued to mount, I kept running into a conceptual problem: why didn't all those deficits result in a steeply devalued dollar? Under classic trade theory, that's what should have happened. Then I read an article by Peter Drucker in Foreign Affairs magazine that explained clearly something that I was coming to realize on my own -- namely, that capital flows are now an important part of the picture. If you run a country that builds up a big pile of dollars, you use those dollars to buy equity. You buy Wall Street. You buy American real estate. The Japanese have already bought up much of midtown Manhattan, and now they're loose in Arizona, of all places. It's a deliberate policy to maintain an export-driven, trade-surplus economy in perpetuity, without devaluing all the dollars and property and stocks they already own.

In the old days, that didn't happen -- if you added up all the trade deficits and surpluses between countries, they pretty much balanced out. But with the tremendous currency flows, that's no longer true. And so what you must do if you are a free trader is ask, how do you reestablish the premise of the free-trading system, which was a rough multilateral balance?

INC.: And how does a Democrat answer that question?

BABBITT: I think it is time to revisit Bretton Woods and rewrite the rules of international economics, top to bottom. And what those rules have got to say is that these kinds of multilateral imbalances can't be tolerated -- that countries that don't correct them voluntarily, either by limiting their exports or increasing their imports, will find themselves facing sanctions by all their major trading partners.

INC.: So in that respect you are now in agreement with Representative Richard Gephardt and the more protectionist Democrats in Congress?

BABBITT: On the sanctions, yes. But not on what triggers them. Because all the talk in Congress is about bilateral trade imbalances -- the United States with Japan, the United States with Korea. But what I'm saying is that bilateral imbalances are the wrong measure -- and that's a key distinction. Japan, for example, has huge multilateral surpluses -- considering trade with all countries combined, the Japanese export much more than they import. It's the same with Taiwan. But Korea is another story -- it is the classic case of an emerging industrialized nation. They have a big trade surplus with the United States, but they have a huge deficit with Japan. As a result, their current balances are about even. So they are not offenders.

INC.: Changing the rules of international economics may make the playing field more level, but it won't necessarily make better competitors of U.S. firms. How do you see U.S. industry becoming more competitive?

BABBITT: The core issue is productivity, and from the government end of things there are a number of things we should do. I think we have to revisit the tax code and talk about incentives for savings and capital investment.

INC.: On the personal side or the business side?

BABBITT: Both. On the personal side, the big issue is the savings rate. I think the situation argues very strongly for moving away from the income tax and toward a consumption tax -- a tax on the income you spend, but not on the income you save and invest. That's a radical change.

And on the business side, I think we have to reconsider some form of incentives for modernization and technological development. I am somewhat ambiguous about both the old investment tax credit and the credit for research and development. But I think it is possible to invent more targeted versions of those tax incentives -- ones that generate new activity rather than simply provide a windfall for a lot of activity that would have happened anyway.

INC.: And business taxes?

BABBITT: It was a bad judgment last year to transfer net tax burden from the personal side to the business side. That was the price of the political consensus to pass the tax-reform act, but in economic terms, it was too high a price. Actually, as far as small business is concerned, I would probably eliminate the income tax altogether.

INC.: Why small business?

BABBITT: Because that is where job creation is taking place right now.

INC.: But if small businesses are doing such a good job at producing jobs without tax incentives, why do you think tax incentives will make any difference?

BABBITT: Because if you find a strong job-generating segment of the economy, I think it makes sense to give it an even bigger push.

INC.: And what makes you think that if you were to eliminate taxes for every small business, the money would go into job creation and growth as opposed to higher salaries, better benefits, more perks?

BABBITT: It would take a philosopher wiser than me to know for sure whether a marginal economic gain goes into business expansion or into personal income. But I read the climate of small business as being pretty aggressive in saying that if you can lower marginal costs, you'll get expansion.

INC.: Let's play devil's advocate on that a bit further. If, all of a sudden, the growth in the economy were to shift from small business to big business, and all the new products and jobs were coming out of that sector, would you then favor reimposing a tax on small business and eliminating the business income tax for big business?

BABBITT: No, because there is undeniably a populist component to the idea of not taxing small business. As a matter of social policy and political preference, I'd want to maintain a more progressive system, one that still tilts in favor of the little guy.

INC.: You've addressed the issue of productivity in terms of savings and investment. For Democrats, the more difficult issue is labor costs. There are those in business who say the best thing you could do for American competitiveness is just get rid of labor unions.

BABBITT: Well, I don't subscribe to that notion. Unions have played, in my judgment, an important role in the evolution of this economy by raising the standard of living for everybody. But what we need to do is to change the culture in which labor-management relations have evolved. That culture has been one of adversarial relationships in which both sides seek short-term gain at the expense of long-term cooperation. And, if my limited experience is any indication, the problem is 10 times worse than what you read about.

INC.: What experience was that?

BABBITT: Last summer, I stepped in to mediate the talks in the western copper industry. And these talks were a real eye-opener for me. On one side you had management saying, "We want across-the-board, 25% wage cuts," while at the same time they were raising their own wages and bonuses. And on the labor side, I was listening to absurd arguments about why electricians had to be called in to screw in a new light bulb. It was madness.

As the mediator in the middle, the solution seemed pretty obvious to me. Labor would ease up on some of its work rules and take a pretty sizable pay cut, while management would agree to some form of profit sharing. Labor was interested. They understood that their wage gains over the years had outrun productivity of individual businesses and were threatening those companies with bankruptcy. And they were prepared to give that up. So I turned to management and said, "OK. They're going to take a cut, ease up on the rules. Why don't we deal them back in when times are good?"

And do you think management went for it? No way. They acted like it was socialism. And you know, after we finally settled it, I walked away from there telling myself that the American copper industry is doomed to disappear.

INC.: What would President Babbitt do about all that?

BABBITT: I think a President can create an environment that fosters flexible bargaining and this idea of gain sharing -- having workers who share in good times and bad. Ultimately, these aren't things you can force on people. But aside from jawboning and speech making -- which can be very effective -- there are a few specific things that might be done. You can take a look at the labor-relations laws, which are built on a whole set of protocols based on the adversary model, and which could be revised. The tax code might be used to provide tax incentives for certain kinds of deferred compensation. And I think the tax code could be changed so that executive bonuses would not be allowed as a deductible business expense in companies that do not offer some sort of profit sharing or gain sharing to all their employees. That seems only fair.

INC.: It appears that most of your economic program involves providing incentives for activity you think is worthwhile. Do you envision a more direct role for government in helping manage the transition the economy is now going through?

BABBITT: In an economy such as ours, you can lead managers and workers to water, but you can't make them drink. And I think that's the way it ought to be. The notion about industrial policy that was fashionable in some Democratic Party circles a few years back, that there would be these tripartite bargaining councils made up of business, labor, and government, allocating credit and government subsidies -- that just runs against the entire American experience. And it also runs against the tides of history.

INC.: History?

BABBITT: We are in the middle of an economic revolution right now -- a revolution of decentralization. It is decentalization being driven by technological breakthroughs in telecommunications, data processing, even manufacturing. And it means that it is increasingly possible to do most any function in any size business in almost any place in the United States. So the notion that big business and big labor and big government can sit down around a table somewhere and work out the direction of the American economy is at complete variance with the reality of where the American economy is headed. I mean, it's like dinosaurs gathering to talk about the evolution of a new generation of mammals.

INC.: How to make the transition to the new economy is the tough issue for the Democrats. What do you do about the displaced steel worker or miner who once represented the Democratic majority?

BABBITT: I think for those people we have to move very aggressively into a system that defines job training and retraining as something that everyone is entitled to.

INC.: And who pays for that entitlement?

BABBITT: In one sense, we are already paying for it, and I think you have to take a look, first, at a whole range of existing programs that perhaps are not being used as effectively as they might be -- from the unemployment compensation system and job-training programs all the way over to state-funded vocational schools and community colleges. And in the private sector there are a number of big companies -- the phone companies are the most interesting -- that have worked out job-retraining provisions as part of their labor agreements.

I know people in Washington have been talking about a change in the tax laws to allow some sort of individual training account modeled on the individual retirement account. And in California, they have put a surtax on their unemployment compensation system in an effort to nudge it more toward a job-retraining system.

Right now, I'm not prepared to say how all those pieces ought to come together. But I think we're moving toward some consensus that every worker ought to be entitled to a job-training voucher that can be used in a variety of different settings, with the cost shared by government and employers.

INC.: You also favor government vouchers for day care.

BABBITT: I think that's the ideal way of going about it, yes. We already have some tax credits for day care, but we probably have to have additional assistance to those most in need. And I think we should continue to look for ways to encourage the business community to offer day-care arrangements as part of a flexible benefits package.

INC.: Are you speaking of on-site day care?

BABBITT: There are obviously work environments where employer day care is a great idea. But not always. I think I learned not to make too many generalizations about day care from my friends at America West Airlines. They began looking at their needs in 44 cities, over three shifts and 24 hours, with a young and mobile work force. And they came to the conclusion that having a day-care center on premises in every city for every shift was a long way away. So they did something that I thought was incredibly innovative. They went out and looked for people who wanted to take care of one to four kids in their houses at various times of the day. They were interviewed, checked out, and a wage scale was negotiated. And then all their employees were told, if you want day care, here's a list of people who have been checked out, and we'll subsidize the cost.

What I learned from their experience is that day care is a complex issue, and there ought to be pluralism, diversity, and parental choice involved in the system that evolves. The role of government should be to provide some financial support for those parents who need it most, through vouchers, but not to build a national day-care system or mandate services or benefits in every company.

INC.: Job-training vouchers, day-care vouchers -- here you are, another Democrat adding to the list of entitlement programs.

BABBITT: And that's why we have to face up to the issue of making these programs truly progressive. The fact is that there are millions of Americans today who benefit from a whole range of federal programs when they have no need at all for government assistance. How do you justify David Rockefeller or Malcolm Forbes claiming the same measure of medicare benefits as a destitute widow in a cold-water flat in New York City? You can't.

One way we could trim the cost of those programs, and target them to those who need them most, would be to subject entitlement payments -- medicare, veterans' benefits, Social Security, the whole range of them -- to the progressive federal income tax. That's a simple, progressive way to recapture some of the costs of these programs. And it is one that can be done without affecting the benefits of the poor and without eroding the middle-class constituency for the programs themselves.

INC.: Don't you think it could be political suicide for a Presidential candidate to talk about increasing taxes for large numbers of voters?

BABBITT: I think President Reagan has done such a disservice to the country by trying to make that position politically untenable. And what a lost opportunity -- a popular President who will never have to run in another election, and he doesn't have the nerve to step forward and forge some sort of solution for this horrendous budget problem. It's incredibly irresponsible.

INC.: Right now, of course, you have the luxury of running against Ronald Reagan. But if you are the Democratic nominee, you'll be running against some other Republican this time next year. Who will it be?

BABBITT: I suppose either Robert Dole or George Bush would be the most formidable candidate. But Jack Kemp is the person I'd most like to run against. He's the perpetrator, the person who talked the Republicans into all this supply-side mythology. All his cheery language about massive tax cuts that would generate more rather than less revenue, about painless budget cuts and miraculous economic transformations -- it's a lie. You know it. I know it. Your readers know it. And Jack Kemp is still peddling that stuff.