We're No. 3 -- So What?; Hold the Hysterics: America's Economy Can Take a Licking and Keep On Ticking


Had economists and futurists of 20 years ago been confronted by the prospect of an economy in which productivity crept up by little more than 1 percent a year, where real hourly wages fell through the 1970s and 1980s, where poverty grew in absolute terms, and where the U.S. economy was by some measures slipping toward third-ranked status in the world, they would have regarded it as a disaster certain to trigger an angry political response. Yet that is the economy we've had. And it surely has produced no political upheaval. On the contrary, our economic performance today is broadly considered a success. Witness the role that economic contentment played in elevating George Bush to the presidency. It is natural to decry our national complacency, to condemn this age of diminished expectations in which most Americans appear willing to accept far less for themselves and their children than anyone would have imagined only 20 years ago. But before we demand action, it is important to understand that there are good reasons why policy makers choose simply to let problems drift. We haven't attacked our stagnant productivity growth or the persistent poverty of the underclass, we accept a "natural" rate of unemployment well above that which we used to find tolerable, because the answers to these problems look too uncertain or costly. And the dangers on the horizon do not loom as large as many suppose -- there is less of a case than is commonly believed for ending our trade deficit, for resuming our half-won war against inflation, or even for fearing the consequences of a trade war.

This, of course, is not to suggest that Americans should welcome these problems. We obviously would be far better off if we could rid ourselves of them all, and there are advocates of every stripe who will be happy to pull out their favorite remedies for doing just that. But the question is whether it makes sense on the whole for the nation to resist the advocates' rallying cries -- to prefer drift to the available alternatives. Consider, briefly, the evidence: Productivity. A nation's ability to raise its standard of living over the long run depends almost entirely on its productivity. But since 1973, America's output per worker has stagnated -- not only in comparison with our economic rivals but also relative to our own previous performance. The 1970s and 1980s were, in fact, our worst productivity decades of the century. As a result, there has been no gain in real take-home pay for the median U.S. worker since the first inauguration of Richard Nixon. Unfortunately, nobody really knows why productivity growth has slowed to a crawl. There are, as always, a number of theories, but these amount to little more than sophisticated cocktail party chatter.

Ignorance of the causes of problems, though, has never prevented people from proposing cures. The orthodox economist's prescription is simple: Suffer. Consume less now so that more resources are available for investment in plants or education. You may live worse today, but in 10 years -- or is it 20? -- our productivity will be sufficiently higher to make up for your sacrifices.

This remedy has not exactly inspired fervent political support -- especially since our productivity slump is not obviously tied to declining investment. In fact, we put about as high a share of our resources into capital investment in the 1970s and 1980s as we did in the 1950s and 1960s -- and we spent a larger share on education, especially higher education. The money just didn't do the trick this time. It is certainly sensible, then, for Americans to resist sizable sacrifices today for efforts that may not produce a better tomorrow.

Unorthodox formulas have also been advanced. From the right have come the supply-siders, who preach that getting government out of the marketplace will unleash private sector dynamism. When they were in power during the Reagan years, however, the supply-siders delivered far less productivity growth than they promised. So declining to follow their battle cry now is rather logical.

From the left, meanwhile, have come the industrial policy advocates, who propose to get government more deeply into the marketplace. At a time of persistent federal budget deficits and pervasive distrust of government competence and integrity, they want to give bureaucrats and politicians added billions to subsidize favored industries -- though there is nothing resembling agreement on which enterprises merit help. In coming years Americans may accept some small industrial policy tests, but any large-scale program seems completely out of bounds. The trade and budget deficits. Everyone would like to see an end to the massive trade deficits that became chronic in the 1980s. Yet the trade deficit cannot be cured without a substantial rise in national saving, and the only reliable way to achieve this is by moving toward balance in the federal budget. That means a combination of spending cuts and tax increases on the order of $ 100 billion to $ 150 billion -- pain that the public seems unwilling to bear.

One reason may be that the gain is not worth the pain. For example, many people see plants close because of competition from imports and workers laid off as export markets dry up. But in the 1980s, as the trade deficit grew, so did U.S. jobs. Had the trade deficit somehow been prevented, the United States would have done little, if any, better on the employment front -- and possibly a bit worse.

The trade deficit does, of course, lead directly to growing foreign debt. But relative to our immense national income, the U.S. debt burden is small. It would remain tolerable even if we continued borrowing at current rates for the rest of the century. It is thus easy to see why the public pays little attention to pleas for painful spending cuts and tax increases. Inflation. The tight money policy that reduced our underlying rate of inflation from 10 percent to 4 percent inflicted a cumulative loss of more than $ 1 trillion in output. Finishing the job would require another recession costing the economy hundreds of billions more, with many workers losing their paychecks. And for what? As far as economic analysis can tell us, a steady inflation rate of 4 or 5 percent does very little harm. We could live very nicely with it forever. The trick, of course, is keeping the rate steady, not letting it get out of control. But that is a very different matter from eliminating inflation altogether. Small wonder that Americans don't take zero-inflation advocates seriously. Trade conflict. Like the trade deficit and inflation, trade conflict is less of an evil than commonly believed. Protectionists claim that foreign competition is a serious threat to our economy. Free traders argue that protectionism is a major menace. Neither side is right. While the United States has some legitimate grievances against other nations -- and faces a particularly difficult problem dealing with Japan's relatively closed society and economy -- foreign competition is only a minor factor in our disappointing economic performance. Restrictive trade practices by all other nations combined reduce our national income by no more than a fraction of 1 percent.

On the other side, "protectionism" is less of a peril than widely thought. It is sheer nonsense, for example, to think that protectionism caused the Depression or that it could produce a similar collapse today. Even a severe trade conflict would have surprisingly modest effects: A tariff war that cut world trade in half would do no more economic damage than a mild recession [see box]. This is not to endorse trade wars, which certainly carry costs. The point simply is that those costs fall far short of the catastrophes many conjure up. Poverty. In the mid-1960s, the United States launched an expensive War on Poverty to help the poor work their way into the middle class. By and large, this effort was judged a failure, and the nation turned to other concerns. In the meantime, absolute poverty has increased -- by one estimate, from 1979 to 1987 the number of families living in poverty grew by 15 percent. Today, few believe that government can do much to help the poor become more productive. All it seems able to do is give them more money, either directly or through the tax system. And, in fact, some funds may be forthcoming in the years ahead for such conspicuous victims of poverty as the homeless. But in a time of budget constraints and largely static living standards for the average American, any major initiative to help the poor remake their lives seems quite unlikely, if only because almost no one thinks such efforts would succeed. Delay could easily produce many unpleasant consequences. The savings and loan bailout provides a classic example. Instead of spending an estimated $ 15 billion at the beginning of the 1980s, Washington repeatedly played "double or nothing," encouraging high-roller investors to take ever greater risks with publicly insured money. As a result, the final public bill for the S&L cleanup is likely to exceed $ 200 billion. A similar financial debacle could result from neglect of Third World debt, a burden that could be cut in half today at a cost to U.S. taxpayers of perhaps no more than $ 10 billion, but which may cost far more if neglected. Still the waste and folly of the S&L affair has not changed the general perception that the U.S. economy is performing adequately; the same will probably be true of the other unnecessary bills we are piling up.

Where, then, will the 1990s take us? Since there is such a brisk business in doomsday books, it might be useful to note first that we could be in for good news (though it would be through no fault of the policymakers). All it would take is modest good luck: an acceleration of productivity growth to something like the levels of the 1950s and 1960s. The history of productivity in this century suggests that a return in the 1990s to some higher rate -- 2.5 to 3 percent a year -- is quite possible. If this happened, many of our pressing economic problems -- stagnant living standards for the average American, misery at the bottom, the budget deficit, our weak national savings rate, trade tensions -- would decline or disappear.

Nor can we entirely rule out the possibility that there will be a calamitous day of reckoning. One can easily imagine our trade deficit worsening and economic nationalism intensifying -- resulting in a chorus of calls for restrictions on foreign investment. Fears of confiscatory U.S. policies could then easily trigger widespread capital flight and set in motion a Latin American-style hard landing. The conventional wisdom holds that this will not occur, but the truth is that we really don't know. We do know, however, that U.S. policy could continue more or less on its current course for many years without any crisis. The reason is simply that the U.S. economy is so huge, and the sins of economic policy so comparatively venial, that we can afford to be irresponsible for a long time. Judging by our behavior for some years now, that may be the most likely prospect.

In that case, the global economy in the year 2000 would look quite different from today's. Foreigners would own quite a lot of America, and our international economic influence would continue to ebb. An increasingly unified Europe would have a larger GNP than America's, and Japan, with a far smaller population, could have a GNP 80 percent or more of our own. Both Europe and Japan would have substantially larger exports than the United States and much larger investments overseas.

By these measures, America would sink to the No. 3 economic power. But the domestic economy, by contrast, would change relatively little. For various reasons, it's likely that median family income would do a little better than in the 1980s, that the underclass would grow further, that the unemployment rate would drift down a bit, and that inflation would creep up. Our economic performance would be at levels that would have been regarded as a calamity in the past, but so long as we do not encounter a severe recession or double-digit inflation, the public would probably continue to view economic policy as a "success."

In his 1971 novel, "Love in the Ruins," Walker Percy described the future as it looked in the politically apocalyptic but economically sunny 1960s: "The center did not hold. However, the gross national product continues to rise." Percy got it exactly wrong. The GNP didn't continue to rise -- at least not as fast as we thought it would. But things didn't fall apart, and the center held after all. And given the diminished expectations Americans now have for their economy, that is probably the way it will be for the next decade.

Originally published, 3.25.90