- Shopping Bag ( 0 items )
America is in danger of going down the tubes, and the worst part is that nobody knows it. They’re all patting themselves on the back as the Titanic heads for the icebergs full speed ahead.—ANDY GROVE
The canary in our coal mine is the U.S. dollar. Since the end of World War II, the greenback has been the world’s main currency for carrying out international transactions. Oil and virtually all other commodities and products in international markets are bought and sold in dollars. In addition, like gold in the nineteenth and early twentieth centuries, the dollar is the main currency in which most countries now hold their monetary reserves—an arrangement that greatly favors the United States. For example, in order to buy oil, people in other countries must first produce and export something in order to earn dollars, which can then be used to pay for the oil. Americans, on the other hand, have only to print more greenbacks to get their oil. Nor does America have to worry like other countries about its trade balances. If other countries import more than they export, they must borrow dollars to pay for the excess. But that can get expensive, and sometimes no one will lend to them. So they are forced to get back into balance. In the case of the United States, however, it is only necessary to print more dollars to pay for an excess of imports over exports. As long as the world will accept dollars, there is no need for America to balance its trade. This phenomenon is a crucial support of America’s global military deployments. To pay for war in Iraq or Afghanistan or for fleets to patrol the oceans of the world or for troops in more than seven hundred bases around the world, America has only to print dollars—as long as the world will accept dollars in payment.
Recently and increasingly, however, the world is showing some unwillingness to accept dollars. In May 2007, Kuwait stopped pegging its dinar to the dollar in favor of a basket of currencies. Since then, the members of the Gulf Cooperation Council (Saudi Arabia, Bahrain, Oman, Qatar, and the United Arab Emirates) have been debating whether to link their planned new common currency to something other than the dollar. Indeed, former Federal Reserve chairman Alan Greenspan has noted that the OPEC (Organization of Petroleum Exporting Countries) countries are “already recognizing the value of shifting from petro-dollars to petro-euros.” But it’s not just OPEC. In the past few years, Russia, Thailand, Malaysia, and others have also reduced the dollar ratio of their reserves.
More recently, China, whose RMB is already a de facto currency in parts of Thailand, Russia, and Vietnam, and whose stash of dollar reserves now amounts to well over $2 trillion, has been calling for replacement of the dollar as the world’s reserve currency by the International Monetary Fund’s special drawing rights (SDRs), presently the unique internal currency of the IMF. At the same time, Beijing has been warning the United States against allowing any depreciation of the dollar and pressing Washington for a guarantee that the dollar will not depreciate further. China is also rapidly trying to diversify its holdings by using its reserves to buy oil fields and other commodity production sites around the world, to add to its gold stocks, and to buy companies and other assets.
The dollar was also at the top of the agenda at the October 2009 East Asia Leaders meetings in Thailand. As the dollar fell to new lows against almost all currencies, the new Japanese prime minister called for creation of an Asian currency that would replace the greenback. At the annual meeting of the World Economic Forum in 2010, French President Nicholas Sarkozy urged a new global currency solution.
In tandem with these developments, the September/October 2009 issue of Foreign Affairs featured an article titled “The Dollar Dilemma” in which University of California, Berkeley, professor Barry Eichengreen discussed how, as he put it, the world’s top currency faces competition. He concluded that the role of the dollar will inevitably diminish in the future, but that it will for some time remain first among equals in a system of multiple national reserve currencies. On the other hand, the UN special advisory committee on reserve currencies chaired by Nobel laureate Joseph Stiglitz is calling for creation of a new global reserve currency.
But it’s not just the dollar that’s falling. American power is falling as well. At the end of World War II, the United States was the dominant force in virtually every industry and technology and by far the richest country in the world. Indeed, it was the richest country the world had ever seen. It was also the strongest military power in the West at the moment of the outbreak of the Cold War. In light of this overwhelming economic superiority and the new geopolitical dangers, the country’s leadership took a dominant role in crafting a set of international agreements to spur the economic recovery of Europe and Japan and also assumed primary responsibility for the military policing of all threats to the free world. The mandates of national and global security took precedence over concerns about industrial competitiveness.
Consequently, the United States fell into the habit—and the addiction continues today—of making economic concessions in order to obtain geopolitical objectives. To obtain rights for military bases overseas or votes in the UN or troop contributions to American-led military expeditions, Washington would grant special tariff exemptions to trading partners or acquiesce in the virtual exclusion of U.S. goods from foreign markets.
Innocuous at first, when America enjoyed overwhelming competitive superiority, this practice became increasingly disadvantageous as other countries caught up. Now that America has fallen behind in many respects, the habit is positively deleterious both for U.S. competitiveness and for U.S. security. Consider the new restraint and even self-censorship with which America now treats China as compared with the past. During a 2009 trip to China, Secretary of State Hillary Clinton never mentioned the words “human rights.” This was in sharp contrast to the statements of such former secretaries of state as James Baker, Madeleine Albright, and Condoleezza Rice. Or take the speech of Treasury Secretary Tim Geithner at Beijing University on June 1, 2009. During the Q-and-A following his remarks, some students voiced concern over the possibility of a dramatic decline in the value of China’s hoard of dollar reserves if prospective U.S. inflation should lead to dollar devaluation. They warned Geithner that America must make every effort to avoid such an eventuality.
Now keep in mind that no one in America ever asked China to pursue the closed-market, export-led growth strategies that have resulted in the accumulation of Beijing’s dollar hoard. No one in America ever asked China to keep its RMB undervalued versus the dollar by intervening constantly in the currency markets to buy dollars. That China feels that it is stuck with too many dollars is at least as much China’s fault as America’s and probably more. But Geithner didn’t even hint at that fact. Rather he somewhat timorously assured the students that the dollar was solid and that the U.S. government would keep it that way. The students laughed—yes, they laughed—in response. Geithner listened politely and made no reply.
Or take the U.S. Treasury’s annual report to the Congress on exchange rate policies. Under IMF and WTO rules, countries are not supposed to keep their currencies undervalued in order to artificially promote exports. The Treasury is required by Congress to report every year on any such activity. It has been obvious to all observers for some time that China (along with others such as Taiwan, Korea, and Singapore) is pursuing such practices. Indeed, one of China’s first actions in response to the outbreak of the recent economic crisis was to take steps to reduce the value of the RMB against the dollar. Yet in its statement to the Congress on April 15, 2009, the Treasury asserted that China was not engaged in any unfair currency manipulation. All informed observers knew this to be untrue. Further, they knew that China’s policies could be damaging to the United States. Yet there was no outcry in the media and no uproar in the Congress. Nor during his November 2009 visit to China did President Obama publicly mention human rights or currency misvaluation. Indeed, he acquiesced to press conferences with no questions and to giving speeches that were not broadcast.
Indeed, rather than lecturing others, Americans are beginning to become accustomed to being lectured to by Chinese and other foreign leaders on the flaws of our form of capitalism. And if we look into the future, it is clear that we should expect much more of the same. China recently announced that it was investigating whether the U.S. bailout of GM and Chrysler constituted an illegal subsidy to U.S. auto exports to China. Now bear in mind that the United States exports virtually no autos to China.
In the geopolitical sphere, the U.S. relationship with Taiwan is of particular interest. For over half a century, a bedrock principle of U.S. foreign policy has been to maintain Taiwan’s independence and to tie its economy tightly to that of the United States. Indeed, without access to Taiwan’s semiconductor foundries and other high-tech centers, many U.S. industries, including defense industries, would be in deep trouble. Yet today Taiwan has become an extension of the Chinese economy. Taiwanese businesses have invested more than $100 billion in the mainland economy and more than a million Taiwanese live in Shanghai alone. Taipei and Beijing are negotiating to make the Taiwan dollar and the RMB mutually convertible, a step that would bind Taiwan closer to China while loosening its ties with America. Although the United States has on several occasions gone to the brink of war with China in order to protect Taiwan, it is today inconceivable that Washington would do so again or that it could be successful if it tried. Now let me emphasize that this is not necessarily a bad development. But it is nevertheless a measure of the shift in the balance of power.
Another indication comes from Japan. The long dominant and U.S.-dominated Liberal Democratic Party (LDP) was finally displaced in October 2009 after nearly sixty years of one-party rule. An immediate priority of the new prime minister, Yukio Hatoyama, has been to reduce the U.S. military presence in Japan, to call for greater development of ties with China and the rest of Asia, and to push for an Asian economic union that would have its own currency and that would not include the United States. Finally, the United States is slowly but steadily losing its freedom of action and even a degree of sovereignty. From the Declaration of Independence in 1776 to our refusal to accommodate the Barbary pirates of the early nineteenth century to our rejection of the legitimacy of the International Criminal Court, America has always insisted on controlling its own destiny. Yet in truth, over the past thirty years, without even a debate in the Congress or a cabinet meeting on the topic, the United States has ceded a significant degree of its sovereignty to China, Japan, the Middle East oil-producing countries, and other major funders of the ever-mounting U.S. debt. The fact is that Americans are not really paying for U.S. military actions in Iraq, Afghanistan, or Pakistan or other U.S. deployments around the globe, or even for tasks like the rebuilding of New Orleans.
While these enterprises are included in the U.S. government budget, the very low rate of U.S. savings and the chronic, large budget and trade deficits mean that they are actually financed by sending U.S-dollar-denominated IOUs to China and the other major international lenders. Thus, if America is pursuing policies that our debt holders find unacceptable, they have the means to put discipline on Washington. Of course, there is truth in the old adage that if you owe the bank $1 million, you may have a problem, but if you owe the bank $1 trillion, the bank may have a problem. Neither the Chinese nor the other major U.S-debt-holding countries can be sure that the United States won’t generate inflation or act in other ways that might destroy a large part of their national wealth. So the nature of the relationship is one of Mutual Assured Destruction. Nevertheless, it signifies a major loss of U.S. freedom of action in both the economic and geopolitical spheres.
Behind this erosion both of the dollar’s position and of U.S. influence is the increasingly rapid erosion in recent years of the economic, industrial, and technological leadership on which U.S. prosperity has long been based. Once upon a time, the United States could mobilize quickly to overwhelm Germany and Japan with planes, tanks, and ships. It could build the world’s most modern and extensive highway system, send a man to the moon, pioneer global aviation, and give birth to the information age. Its families could live a middle-class lifestyle, send the kids to college, and retire comfortably on one income. Now, we have trouble getting house trailers to New Orleans, and anyone who has walked through a foreign airport, made a cell phone call in Beijing, or Cairo, or Seoul, or stayed at a business hotel in any international city outside the United States knows that America is falling behind.
We are accustomed to thinking of the United States as having the world’s biggest economy with the highest per capita income. While it is true that at $14.3 trillion America’s is the largest national economy (more than twice the size of China and nearly three times that of Japan based on purchasing power parity, or ppp), it is also true that the European Union (EU) has the largest single economy with a GDP of nearly $19 trillion. In per capita income, the United States ranks number 8 behind countries like Sweden, the Netherlands, and Australia. If we look only at large countries, the United States at about $47,000 income per capita appears to be way ahead of others such as Germany ($35,000) and Japan ($34,000). But if we take income disparities into account, the picture changes dramatically. In the United States, the top 1 percent of earners account for 15 percent of total income as compared to 4 percent or 5 percent in countries like France and Japan. So if we exclude the top 1 percent of earners in all countries from the comparison, we find that 99 percent of people in countries like Germany, Japan, the UK, and France actually have a higher income than 98 percent to 99 percent of Americans.
This is even truer if you look at hours worked and at vacation time. At 1,804 hours per year, the average American is working about 300 hours more than his counterparts in other developed countries where statutory vacation times range from two to six weeks. Indeed, the number of hours worked per worker in America has steadily risen over the past thirty years while it has steadily declined in other developed countries. Thus, if time is money, the leisure hours of the other major countries more than close any GDP per capita gap with the United States for the overwhelming majority of the population.
The U.S. growth performance has also been somewhat less brilliant than widely imagined. It is, of course, true that the United States’ GDP growth rates over the past twenty-five years have been well above those of the European countries and Japan. But one reason for this has been the fact that Europe and Japan have had stable or even shrinking populations, while immigration and high immigrant birth rates have driven substantial U.S. population growth. A second factor has been rising debt and associated asset bubble wealth effects. Since 1980, the United States has accumulated such large trade deficits that its net international credit position has shifted from that of the world’s biggest creditor, to the tune of about $2 trillion, to that of its biggest debtor, with net debt of $2.5 trillion and borrowing growing at the rate of $400 billion to $800 billion annually. Think of this as resembling the performance of a highly leveraged corporation such as Enron, whose sales climbed rapidly and steadily, but whose financial viability eventually evaporated. Especially for the past ten or fifteen years, the dotcom bubble and then the housing and financial bubbles made everyone feel rich and engendered enormous buildups of debt that masked the true deterioration of the underlying economy. Thus, we really need to discount U.S. GDP by about 20 percent in order to account for the accumulation of debt. That would drop the United States well behind Japan and the major European countries in terms of growth and GDP per capita.
Over the past several decades, there has been much schadenfreude in America over Japan’s so-called Lost Decade of growth during the 1990s. But in that decade, Japan accumulated trade surpluses and international investments that are now helping to fund its rising health care and pension costs. In contrast, the United States accumulated large debts that will make it much more difficult to fund health care and pensions for its now retiring baby boomer population. We might well ask who actually lost the decade.
As for productivity growth, after many years of lagging behind Europe and Japan, the United States surged ahead between 1995 and 2005 with a rate of about 2.5 percent compared to 1.5 percent for Europe and about 2 percent for Japan. This was largely attributed to the cumulative effect of years of investment in and wide adoption of information technology equipment and services. No doubt that played an important part. But it is also true that the United States changed the way it counted productivity to what is called hedonic scoring. For example, let’s say that Dell sold computers last year with 3,000 megahertz of computing power. Now let’s say you buy this year’s model at the same price but with 6,000 megahertz. In theory, at least, you can now work twice as fast or do twice as many things as last year. So did you buy one computer or two? The Europeans and Japanese would say you bought one. But the U.S. statistical authorities would say two, meaning that they statistically increase the actual number of computers produced to account for the greater power of the new machines. Of course, this makes Dell appear to be very productive, and it also makes computer users appear very productive. This is not a case of one side being right and the other wrong. You can argue either way. But what you can’t do is claim that U.S. productivity growth is better than that of Europe or Japan on any meaningful apples-to-apples basis without making the adjustment for the different scoring. In fact, there is not much difference in productivity between the United States and other top countries like France. Furthermore, productivity varies dramatically among industries. For example, Japan’s overall productivity is lower than that of America, but in export industries such as autos, consumer electronics, and machine tools, it is much higher. Thus, in terms of international competitiveness, America may be falling behind despite a possibly higher rate of growth of overall productivity. Where America clearly does rank behind is with regard to income equality.
The Gini index measures the extent of the difference with scores from 0 (everyone has the same income) to 1 (all the money is concentrated at the very top of the society). With a Gini score of 0.37, the United States ranks highest among the OECD countries, which have an average score of 0.29, while Sweden’s is the lowest at 0.23. By way of reference, top-scoring Brazil and Mexico are around 0.45, putting the United States closer to them than to its OECD peers. In short, it seems that more of the money in the United States is held by a smaller group of very rich people than in other major countries. Indeed, the very top 0.1 percent of U.S. earners receives about 8 percent of the country’s total income as compared to about 2 percent in countries like France and Japan. Recall also the much higher costs Americans pay for health care, double or more than in other leading countries, and approximately 15 percent of Americans do not have health care coverage.
The bottom line here is that for all our pride in being the “wealthiest nation on earth,” we Americans do not generally enjoy as high a standard of living as the average citizen of Europe, Japan, and several other Asian countries. We are not nearly as rich as we think.
But the devil is always in the details, and to get a more specific understanding of the U.S. condition, we must look at the details of critical sections of our economy.
A couple of years ago, I was in Seoul, South Korea, and had to travel on to the city of Busan, at the tip of the Korean peninsula. Having never had the opportunity to see the Korean countryside, I decided to take the train ride along the spine of the country. I was traveling, of course, on a bullet train and it proceeded so smoothly at about 200 miles per hour through the tunnels and around the mountains that nary a ripple disturbed the surface of the water in my glass. Why, I wondered, can’t I have a train like this between Washington and New York? If I could, I would abandon the energy-inefficient air shuttle instantly.
I was tired from jet lag and tried to sleep, but the passenger across the aisle was driving me crazy with his constant cell phone chatter. I had to suppress a strong urge to grab the phone and stuff it down his throat. But then I realized that this was really amazing and interesting and that I should be taking notes instead of becoming irritated and angry. Why? Because we were in the mountains and continuously passing through long tunnels, and the speaker never lost the call. Unbelievable, I thought. When I call my wife while driving from Washington’s Dulles airport, I am sure to lose the call several times. As for calling from the so-called high-speed Acela train (less than 100 mph) from Washington to New York—forgettaboutit. Finally, the guy shut up and I heaved a huge sigh of relief and settled back to try sleeping again. But there was no way. He had switched the phone to video and was watching his favorite soaps at top audio—all the way to Busan.
Tired as I was, I couldn’t help being impressed. You couldn’t do that in America.
In his recent proposals for revitalizing the U.S. economy, President Obama has called for plans to develop high-speed rail lines in dense population corridors of 500 miles or less such as between Washington and New York or Los Angeles and San Francisco. This is part of his effort to create green jobs while also taking steps to abate global warming. High-speed rail is a great idea because everyone knows that such trains are far more energy efficient, sparing of greenhouse gas emissions, comfortable, and speedy than cars or airplanes for those distances. In fact, it is such a good idea that Japan began building its Shinkansen bullet train network in 1964 and now has 1,360 miles of special track carrying 300 million passengers a year at average speeds of 188 mph. France initiated its Train À Grand Vitesse (TGV) in 1981 and now carries 100 million passengers annually over 1,180 miles of track at 199 mph. Germany didn’t get started until 1988 but now carries 67 million riders over 798 miles of rail at 186 mph. Spain also has a similar network, and China, which started in 2007, now operates trains at 186 mph over 588 miles of high-speed track. It is building out its network so rapidly that by 2012 it will have the world’s largest high-speed system. The only American entry to date is almost embarrassing. The Acela (made in Sweden and Canada) operates (when it works) between Washington and New York and Boston at top speeds of 125 mph. But the track is so poor that the speed on many stretches is under 70 mph and sometimes as slow as 20 mph. It carries only 11 million riders. To make things more embarrassing, the South China Morning Post of October 25, 2009, reported that the planned U.S. high-speed line from Los Angeles to Las Vegas would be supplied by the South China Locomotive Corp.
Okay, you say, but trains are so nineteenth century. Our forte is high tech. After all, who invented the internet and email, and Twitter, and Facebook? Us, right? Yes . . . but, in a way that just makes the present situation in the United States look worse. Ten years ago, America’s internet was the world’s most extensive, fastest, least expensive, and most heavily used. Today, the United States stands at number 15 in the international broadband rankings. Its broadband penetration is a little over half that of Korea, well behind the likes of Finland, Australia, and Canada, and just about the same as France, the UK, and Japan. Its average speed of 3.9 Mbps compares embarrassingly to the 63.6 Mbps of Japan, the 49.5 of Korea, the 17.6 of France, and even the 16 of Germany. As for the prices, a month of that blazing Japanese broadband will cost you $.13 per Mbps. In Korea, you’d pay $.37, in France it would be $.33, and in Germany $1.10. All much better deals than the $2.83 you’d have to pay for the snail-like speeds of American broadband.
This would be funny if it weren’t so important. The U.S. lag here literally means that there are whole classes of work and research being done in Korea, Japan, and even France that simply can’t be done in the United States. For example, to do normal telecommuting requires about 2.0 megabits per second. Fine, Americans can do that. But videostreaming and high-definition television over the network require 15 to 20 megabits per second. No sweat in Korea, Japan, and France, but no can do in America. So anybody developing products or services relating to high-definition TV or videostreaming has to go outside the United States to get the work done.
The situation is pretty much the same with regard to cell phones. The United States ranks forty-second in cell phone penetration, but even more significant is the fact that it has fewer than a million 3G (high-speed third-generation) subscribers as compared with more than 40 million in Japan and the 10 million in the EU. This isn’t just a matter of consumer convenience. It means that new kinds of businesses and products, such as banking by phone, can be developed in those countries but not in America. Or it means they can do things faster and more efficiently than the Americans can. The bottom line is that lack of adequate high-tech infrastructure is seriously impairing America’s ability to compete, and especially to compete in the very high-tech sectors upon which most Americans think the future of their children depends.
Nor is the picture much brighter in the realm of traditional infrastructure. The Minneapolis bridge that collapsed in August 2007 was just the tip of the iceberg. The American Society of Civil Engineers estimates that more than one in four of the nation’s bridges are structurally deficient or functionally obsolete. It would take $17 billion annually to bring all the bridges back into safe operating condition, but only $10.5 billion is being budgeted and spent. Interestingly, despite this serious assessment and shortfall, the society gives our bridge infrastructure a passing grade of C. So imagine what the D grade for the aviation infrastructure means. If you wonder why your flights are always late, and delayed, and why U.S. airports always look and feel so awful when you return from the bright, airy halls of Singapore’s Changi Airport or Hong Kong’s Chek Lap Kok or Shanghai’s Pudong International, now you know.
The shortfall in needed upgrade spending on U.S. aviation infrastructure over the next five years is estimated at $40.7 billion. Then there are the dams, or maybe I should say there might be the dams. They get a D, too. The Society puts the number of deficient U.S. dams at 4,000 with 1,819 in the high hazard category. Moreover, this number is rising rapidly as a result of the fact that the average age of the 85,000 dams in the United States is fifty-one years. The drinking water infrastructure is in even worse shape with a D– and an annual investment shortfall of $11 billion just to replace aging facilities that are now leaking 7 billion gallons of drinking water a day, never mind the growth in demand for drinking water over the next twenty years. But it’s the roads that cost the real money. A third of major roads are in poor or mediocre condition, and 36 percent of major highways are badly congested at a traffic cost to the economy of $78.2 billion a year—$710 for every motorist. But the current spending of $70.3 billion annually for capital improvements is far below the $186 billion the Society estimates is needed. So roads earn a D– as well. Add to these a D+ for energy, D– for levees, D for hazardous waste, D– for inland waterways, D for schools, D for mass transit, D– for wastewater, and C+ for solid waste. The total five-year investment shortfall for all of these comes to $1.176 trillion.
A key element of any measure of standard of living is health. You cannot enjoy your wealth if you are sick or dead. Here the U.S. performance is woefully inadequate. According to the CIA Fact Book estimates, the United States ranks number 50 among nations in terms of life expectancy at birth. The U.S. figure of 78.11 years puts it just ahead of Albania and Taiwan and far behind the 82.22 years of Japan, the 81.23 of Canada, the 80.98 of France, the 80.20 of Italy, the 79.26 of Germany, and the 78.72 of South Korea. Particularly embarrassing for the United States is the fact that a far lower percentage of its babies survive than in other leading countries. The U.S. infant mortality rate of 6.26 per 1,000 births puts it number 46 in the international rankings, just behind Cuba and Guam and far behind the 2.31 of world leader Singapore, the 2.79 of Japan, the 2.92 of Hong Kong, and the 3.33 of France. Yet even though they are less likely to survive as infants and even though they die earlier, Americans pay twice or more as much as other leading countries for their medical care. Singapore, for example, spends only about 3 percent of GDP on medical care, and France spends about 8 percent, while the United States is now spending about 17 percent. And unlike most other countries, America leaves about 15 percent of its people without medical care, except for what they can get as a last resort in hospital emergency rooms.
As a kid I often traveled by train from Wilmington, Delaware, where I lived, to Philadelphia, where my dad worked. Along the way the trains passed through the then thriving manufacturing town of Chester, which had proudly painted a sign in the railway station proclaiming that “What Chester Makes Makes Chester.” Today, Chester is a sad derelict of a city, sunk in poverty and languishing next to the broken-down shipyards and factories that closed long ago. Today, Chester doesn’t make anything, and there isn’t much left of Chester.
Unfortunately, Chester is a metaphor for the United States and a pointer to many of the reasons for the rotting of the country’s infrastructure and the hollowness of its apparent wealth. Like Chester, America doesn’t make much anymore. Specifically, it doesn’t manufacture the vast range of consumer and industrial goods on which its wealth and power were originally built. Like Great Britain before it, America has turned to nontradable services, home construction, and finance to earn its living as its manufacturing has migrated to other climes.
Keep in mind that manufacturing accounts for about three-fourths of America’s corporate Research and Development (R&D) and pays average wages 20 percent above those in service industries. Manufacturing also has a job multiplier of 4 to 5, meaning that each manufacturing job creates 4 to 5 other jobs in the economy, as compared to a services industry job multiplier of 1 to 1.5. Manufacturing jobs also offer above average health care and pension benefits. And the sector enjoys productivity gains one third above the national average. Even more important, it is the source of most of the economies of scale that are the real drivers of wealth accumulation. It is, thus, a very good thing to have a significant manufacturing sector in your economy if you can. Unfortunately, it increasingly seems that America can’t.
From 24 percent of GDP in 1980, manufacturing has fallen by more than half to less than 12 percent of GDP today. To some extent this is a natural development as all developed countries tend to create larger service sectors as their economies mature. But the relative shrinkage of the U.S. manufacturing sector has been extreme in comparison to countries such as Japan (18.3 percent of GDP), Germany (22 percent), France (15 percent), and even the UK (13 percent). The U.S. decline has been particularly brutal in the past eight years, during which it has lost about a third (from 17 percent to 11.8 percent) of its share of GDP as 40,000 manufacturing plants closed their doors. For instance, the American steel industry that produced 97.4 million tons in 1999 managed to do only 91.5 million tons in 2008 even as Chinese production rose from 124 million to 500 million tons over the same period. Between 2000 and 2008, 270 major U.S. furniture factories closed as the industry lost 60 percent of its production capacity and the market share of imports rose from 38 percent to nearly 70 percent. The U.S. machine tool industry—the backbone of any industrial economy and essential to defense production—produced only $3.6 billion in equipment, less than 5 percent of world production, down 30 percent from 1998, and only about half of U.S. consumption. In contrast, Germany, Japan, and even Italy currently produce more machine tools than the United States. Chemical plants are another essential element of an industrial economy. In 2008, 80 major plants costing in excess of $1 billion were being constructed somewhere in the world. None of them was being constructed in the United States.
There are many reasons for this long-running trend. The one usually mentioned in popular commentary—inexpensive labor—is the least important. Of course, that has played a role, particularly in industries like apparel that are very labor intensive. But machine tools, steel, and chemical plants are not labor intensive, and developed countries like Japan, Germany, and France have managed to hang on to them. These industries are leaving or have left the United States because the dollar is being managed both in Asia and in America to be overvalued versus many pegged or only partially floating currencies like China’s RMB and Taiwan’s dollars. Imports of products from these countries are thus artificially cheaper than they would be under truly open-market conditions.
The second major reason is the tax holidays, capital grants, free infrastructure, labor wage agreements, and regulatory exemptions that many countries use to entice investment by targeted global companies and that the United States does not match. The third reason is political pressure from countries like China who make it clear that if a global company wants to do business there it had best demonstrate that it is a friend of China. The fourth reason is corporate tax rates. U.S. rates are the highest in the world except for Japan’s. The fifth reason is onerous and complex U.S. regulatory procedures. A sixth reason is the difficult labor union–management situation in some U.S. industries. Pure cheap labor is usually (not always) the last reason. Thus, the key to global manufacturing dynamics lies much more in the realm of policy than in the realm of economic fundamentals.
These dynamics have resulted in the dramatic loss of manufacturing jobs and in a depression of manufacturing wages. U.S. manufacturing wages that once were tops in the world are now tenth, and if we compare at nominal exchange rates, U.S. wages rank sixteenth in the world. Worse is the fact that this drop in manufacturing employment and wages also depresses wages economywide.
Those National Institute of Standards and Technology chief economist Greg Tassey has labeled the apostles of denial among orthodox economists and commentators have maintained that this is nothing to get upset about and is just the natural evolution of a postindustrial economy. Analysts like Michael Porter of Harvard Business School and the Council on Competitiveness insist not only that the U.S. economy doesn’t need manufacturing, but, indeed, that its decline is an indicator of success. Thus, in one council report, Porter insisted: “We have to stop this notion of believing that manufacturing is essential. Such thinking is a real problem.” Between 1998 and 2007, that argument seemed plausible. First the dotcom bubble and then the housing bubble masked the deterioration of manufacturing. On top of that, Wall Street’s share of GDP grew to match the lost manufacturing share. America, argued the orthodox apostles, was moving to “higher ground” where its future lay in innovation, high technology, and sophisticated service industries like medical diagnostics and treatment, design, and investment banking. Indeed, in recognition of this expected development, a special category of U.S. trade statistics—Trade in Advanced Technology Products—was designated in 1989 to demonstrate how nicely the United States was shifting to a high-tech economic structure.
For the next twelve years, as expected, Advanced Technology trade statistics showed a respectable (though not huge) surplus even as the deficit in the rest of U.S. manufacturing plunged to new depths. But then, in 2002, Advanced Technology swooned as well, with a deficit of $17 billion. By 2008, that had grown to $61 billion as the dynamics of decline in traditional manufacturing began to repeat themselves in high technology.
Just as no chemical plants are being built in the United States today, so only 2 percent of all new semiconductor fabrication facilities under construction in the world in 2007 were under construction in the United States. Thirty percent were being built in China, 25 percent in Taiwan, and 22 percent in Korea. Japan, Korea, and Taiwan dominate the development and manufacture of the liquid crystal display (LCD) panels that have become the world’s preferred viewing surface. China’s BOE Technology Group and Korea’s LG Display Co. have both announced they will locate new $3 billion–plus LCD factories in China, and Samsung Electronics said it is considering a similar move. There are no LCD plants in the United States.
America is also losing out in the latest generation (300mm) of the semiconductor wafers that eventually are sliced and diced into the chips that go into your computer. In 1999, 36 percent of global production of such wafers was in the United States. By 2004, that was down to 20 percent and today it is around 15 percent. Recently there has been much talk of “green industries and green jobs” as part of the recovery from the economic crisis. But there is only one American company among the world’s top ten producers of photovoltaic cells. Germany’s Q-Cells is the world’s leading producer, while Japanese and Chinese producers each have about 30 percent of the global market. In the area of solar concentration and collection equipment, the Germans dominate.
Similarly, the only U.S. company among the ten largest in the wind energy industry is GE with a share of only about 16 percent of a world market that is dominated by Danish, Chinese, and German producers. As for batteries, a series of U.S. government grants was announced in August 2009, totaling $2 billion to boost research by several U.S. battery producers. But this looked less than impressive in the face of an announcement by Toyota that it was forming a consortium with Sanyo and Panasonic not only to develop but also to produce advanced batteries.
Even more discouraging for those who have long argued that America’s salvation lies in its unique innovative capacity was a recent report by the Information Technology and Innovation Foundation, which ranked the United States dead last among leading countries in improvement in innovation capacity and only number 4 in absolute overall innovation capability.
A recent headline in Manufacturing & Technology News read “America’s Oldest Printed Circuit Board Company Closes Its Doors.” The story reports that after fifty-seven years, Bartlett Manufacturing Co. can’t make it anymore. Ten years ago, U.S. makers accounted for 30 percent of the global market. Today, that is down to under 8 percent and with the demise of Bartlett it will be substantially less. In 2008, total U.S. PCB industry revenue fell to $4 billion, down from $11 billion in 2000. Over that same period, Asian output has climbed from 33 percent to more than 80 percent of the global total. Says Bartlett chairman Doug Bartlett: “The U.S. industry has been crippled beyond repair. Our kids are going to be fluffing dogs and doing toenails while the Chinese are making leading-edge devices.” In this, Bartlett echoes the concerns we saw expressed earlier by former Intel chairman Craig Barrett.
What bothers Bartlett and Barrett is what triggered the Defense Science Board to report that: “Urgent action is recommended, as the industry (semiconductor) is likely to continue moving in a deleterious direction, resulting in significant exposure if not remedied.” This only echoed the 2003 report of the Pentagon’s Advisory Group on Electron Devices (AGED) that said U.S. technological leadership “is in decline” and warned that the offshore migration of semiconductor chip foundries “must be addressed” because it “will potentially slow the engine for economic growth.” It further emphasized that the Department of Defense “faces shrinking advantages across ALL technology areas” and noted that as U.S. industry shifts its production offshore, it “assigns those nations political and military leverage over the United States.” It urged that the U.S. government needed to counter the “massive financial and tax investments” being made by foreign governments to lure U.S. companies to relocate their production away from the United States. AGED chairman Thomas Hartwick told Congress that “the structure of the U.S. high-tech industry is coming unglued with innovation and design losing their tie to prototype fabrication and manufacturing.” This broken link leaves inventions “on the cutting room floor because they cannot be manufactured.” Hartwick concluded that if dramatic action is not taken the United States faces the “destruction of U.S. innovation centers.”
In 2004, the President’s Council of Advisors on Science and Technology (PCAST) sounded similar warnings, noting that the loss of production capacity will quickly be followed by loss of research, development, engineering, and design capability as well. Said the council: “The continuing shift of manufacturing to lower-cost regions, and especially to China, is beginning to pull high-end design and R&D capabilities out of the United States.” It warned that the “research to manufacturing process is not sequential in a single direction, but results from an R&D-manufacturing ecosystem consisting of basic R&D, precompetitive development, prototyping, product development, and manufacturing” all operating in such a way that the “new ideas can be tested and discussed with those working on the ground. Thus, locations that possess both strong R&D and manufacturing capabilities have a competitive edge.” PCAST warned emphatically that “key elements of the innovation ecosystem” are eroding rapidly and said that only dramatically different U.S. government policies could halt and reverse the erosion.
This warning was echoed again in 2006 by the National Academy of Sciences. Its report—“Rising Above the Gathering Storm”—said the United States can no longer afford research in areas like telecommunications because it has lost its ability to compete in commodity products. A final warning along these lines came in a 2009 analysis of the defense industrial base by University of Texas professor Michael Webber. His conclusion is that among the sixteen fundamental defense foundation industries, the U.S. position is seriously eroded in thirteen, holding steady in one, healthy in only two.
In the face of the decline of U.S. manufacturing and high tech, many economists, business leaders, and policy makers have embraced the notion that America’s future lies in the service industries.
But the numbers just don’t work. While it is true that the United States had a services trade surplus of about $140 billion in 2008, that made only a small dent in the goods deficit of $840 billion. To get anywhere near a trade balance, the services surplus would have to grow by more than five times. But it isn’t growing at anything like that rate, which brings us to the second point. It is not at all clear that services won’t also go the way of manufacturing and high tech. Aside from travel, the big American service industry has been finance. But, as I have said, that industry just blew itself up and is going to have to contract as a percent of GDP. The real trend here is that noted by former Federal Reserve board member and Princeton professor Alan Blinder, who has forecast that as many as 29 percent of all jobs could be offshored over the next few years. On top of that are the numbers we already have in hand for job shifts taking place domestically. Over the past ten years there has been a massive loss of 8 million manufacturing jobs. That has been accompanied by substantial job creation in the services industries, but the bulk of the new jobs are in retailing and food service, which pay far less with far fewer benefits than manufacturing.
The big news in services is India, not America. I recently had a brain scan at Suburban Hospital in Bethesda, Maryland. The radiologist was reading the scan from his offices in Bangalore. The accounting firm that handles my taxes recently moved its whole back office to Bangalore. Reuters news has moved much of its editorial operations to Mumbai. When you make airline reservations, chances are you’re talking to someone in a suburb of New Delhi, and that is definitely true when you call the help line for assistance in fixing your computer. Or let’s look at a comparison of IT services firms. Infosys and Wipro of India both have sales of about $2 billion compared to $25 billion and $15 billion respectively for U.S.-based EDS and Computer Sciences Corp. The Indian companies have profit margins of more than 20 percent while the U.S. companies are in the 3 percent range.
In view of this, whose future do you think more likely lies in services? In June 2006, IBM said India’s. It held a meeting with Wall Street analysts in Bangalore, where it announced adoption of the Indian offshore outsourcing business model, explaining that it believed the talent pool of India and other low-cost countries would continue to deepen. IBM said it would be investing $6 billion to expand its Indian operations. Its head count in India, which was 6,000 in 2003, is projected to hit 110,000 in 2010. This compares to a U.S. head count of 120,000 and falling. In 2007, Accenture outdid IBM by actually increasing its Indian head count beyond that of its U.S. operations.
Discussions of U.S. competitiveness always eventually get around to the notion that America has the best universities and the most and best R&D in the world, and that if we just maintain and extend that, everything will be all right. Okay, it’s true that of the world’s top twenty universities, seventeen are generally agreed to be in the United States. That is definitely a huge asset, but not as decisive as you may think. For one thing, it is increasingly the case that at the graduate level these institutions educate as many non-Americans as Americans. The proportion of all U.S. university doctoral degrees awarded to foreign students is now more than 40 percent, up from 35 percent in 1987. In the sciences, math, and engineering, that number is now close to 50 percent for all master’s degrees and more than 50 percent for doctoral degrees. This would not be a matter of much concern if, as in 1987, more than 80 percent of those foreign students remained to work in the United States. But that is no longer the case. Today, more and more return home after receiving their degrees. Now, there is nothing wrong about educating foreign students. Indeed, it has many potential benefits. Nevertheless, the excellence of U.S. higher education is increasingly being used not to underpin the future development of the U.S. economy, but that of other economies.
An important reason for this is that U.S. secondary education is not so great. All the comparative international tests show American students of whatever grade level performing far below the top levels attained typically by such as the Japanese, Koreans, Finns, and French. Particularly disturbing is the fact that U.S. students who score in the respectable 85th percentile in science and in the 55th percentile in math in the fourth grade, have slipped to zero in science and the 10th percentile in math by the time they get to the twelfth grade. Thus, European and Asian students who come to even the best American high schools find themselves from one to two years ahead of their American classmates. But it’s not just that American students are often a bit behind their foreign peers. It is also that they avoid going for degrees in science and math because they know the jobs probably won’t be there. As one Santa Clara University professor told me recently, “Enrollment in engineering is falling by 30 percent a year because the kids have figured out that most of the jobs in those disciplines are going to be in Asia.”
As for research, the 2.68 percent of GDP the United States is currently spending on R&D is less than the 2.83 percent it spent in 1963–67 when it had virtually no economic competition from other countries. From number 1 forty years ago, America has fallen to number 7 in R&D intensity behind the likes of Japan, Korea, and Sweden. Further, the great research centers of the past—Bell Labs, IBM Watson Labs, Xerox Palo Alto Research Center—have either disappeared or been turned into product development operations. U.S. basic research today is mostly done in universities where it is much less coordinated and connected to the industrial world. Because of the size of its economy, the United States is, of course, by far the biggest spender in actual dollars. But the trends are creating a much more competitive environment to which the United States has yet to respond.
Another cause for serious concern is the state of U.S. higher education, the long-running excellence of which is increasingly not underpinning the future development of the U.S. economy. One reason is that many leading American universities have gone global in the same sense that U.S. corporations have gone global. Indeed, we need to remember that the universities are also corporations. Like any corporation, they need revenue, and while they don’t have to make a profit, they have limited borrowing power and thus must break even over time. Most universities were strapped even before the present crisis. Now they are more so. It turns out that foreign students are not only a source of revenue, they are the best source of revenue. They pay full fare. No need-based financial aid for them. Many of their governments are so anxious to get the benefit of U.S. higher education excellence that they not only pay the full room, board, and tuition, they also pay all of the students’ travel and living expenses. Furthermore, the students are typically coming from the ranks of the top 0.5 percent of the students in their often very large countries, meaning that they are really, really smart. Think close-to-perfect SAT or Graduate Record scores. If you picked the class solely on the basis of test scores, you’d fill it almost entirely with foreign students. So here the universities have the opportunity to enroll a lot of extremely bright students, none of whom need financial aid. What would you do if you were a university president? Take a lot of them, right? So they do.
But beyond this is also another powerful factor. The university presidents think of themselves as true globalists with a mission to educate the world. Indeed, many have opened campuses in other countries and commute between their various international establishments just as the heads of IBM, Intel, and other global companies do. They pride themselves on being citizens of the world and think of themselves as having a fiduciary responsibility to their global students and funders rather than specifically to U.S. students. Like their corporate counterparts, they also tend to be very responsive to authoritarian governments.
A final point about education is that it’s not necessarily all it’s cracked up to be. India was long known for having a large educated population for which there were few appropriate jobs. It wasn’t until new economic policies came along in the 1990s that these people turned productive. Henry Ford’s auto workers weren’t better educated in a formal sense than any other Americans. But they became more productive by dint of working in an environment that gave them good tools and organization and that taught them skills on the job. China’s workers today are not on average as well educated as U.S. workers. But the jobs are moving to China because the corporations can up-skill them on the line and make them highly productive. By the same token, just because the jobs are moving to China or elsewhere, American workers are to a certain extent being down-skilled as they move to more menial work in retailing or food service.
The bottom line here is that there is also no special education-genie that is going to bring salvation to America.
It is of the utmost importance to understand the revolutionary nature of the shifts under way in today’s global economy. We are accustomed to thinking that developing countries with a lot of inexpensive, unskilled labor will focus on production of labor-intensive goods like apparel, shoes, and toys while we dominate capital- and technology-intensive industries. It is true that India and China do control many of the labor-intensive industries. But because of their large populations, even a small percentage is a lot of people. These countries each have 50 million to perhaps 150 million people who are highly skilled. They can therefore also compete in the advanced industries as well as in the sophisticated services and R&D. Thus, while the U.S. share of global R&D is steadily shrinking, China’s and India’s are rising.
China now spends 1.5 percent of GDP on R&D and is steadily increasing that effort with the aim of matching the entire EU by 2010. Much of this is being driven by U.S. and other global companies who are putting major R&D facilities in these countries. Since 1999, foreign corporations have established 1,160 research institutions in China while also making major commitments in India. For example, GM, Intel, Pfizer, Microsoft, and GE, to name only a few, have all established major labs and research centers in both India and China. This is in addition to their large and growing investments in advanced production facilities. Particularly important in this context is the fact that most of those foreign students getting their PhDs at top U.S. universities are Indians and Chinese. On top of that, both countries are making a prodigious effort to increase their numbers of scientists and engineers.
What lends all this particular power is the impact of the internet and air express logistics by the likes of FedEx and UPS. Anything digital can be delivered from India or China to anywhere in the world in two seconds. And anything made of atoms and molecules can be delivered in thirty-six hours. For all practical purposes these new challengers are across the street.
Nor can we afford to continue to tut-tut about Europe and Euro-sclerosis. We have already noted the EU’s superiority in such areas as high-speed rail, internet service, and technology for solar- and wind-sourced energy. Europe is also the leader, along with Japan, in nuclear energy, and the French Ariane rocket has become the world’s preferred launch vehicle for satellites. The EU is now on track to grant nearly twice as many PhDs in science and engineering as the United States after 2010, and it has formally adopted the target of surpassing U.S. R&D spending by aiming to achieve a level of 3 percent of GDP for future R&D support across the EU. Of course, some of its members, like Finland and Sweden, already far surpass that. More important than the numbers, however, is the recognition of reality. First, the EU—like India, China, Korea, Japan, and most other leading countries—has understood that a nation cannot maintain a high standard of living without a technology-based growth strategy. Second, it has recognized its weaknesses and set out to correct them and to surpass the United States.
In short, the age of effortless American supremacy is over.
To consider what the continuation of this loss of competitiveness might mean, let’s fast-forward to a moment in the spring of 2020 for a plausible scenario of how our power and prosperity may have changed by then. U.S. troops are long gone from Iraq, and Baghdad has become a kind of satellite of Tehran’s anti-American Shiite regime. U.S. and NATO forces have also been out of Afghanistan for several years, and the Taliban is once more in firm control, strictly enforcing both sharia law and a ban on poppy growing and opium trading. Pakistan has managed to keep its Taliban-allied tribes under control, but only by dint of support from China in the wake of the U.S. withdrawal of military and economic support back in 2010. The United States’ Fifth Fleet remains in the Persian Gulf, but only thanks to an annual subsidy from the government of Saudi Arabia.
The Seventh Fleet abandoned its Japanese home port, Yokosuka, in favor of new moorings in San Diego and Pearl Harbor in 2015 after the Sixth Fleet returned to Hampton Roads from the Mediterranean in 2012. The remaining U.S. bases in Japan, Germany, and Korea were also closed after that, bringing to an end three-quarters of a century of occupation and peacekeeping. The fate that befell the Soviet empire in 1991 (and before it the British, Spanish, Dutch, Venetian, and Roman empires) has now befallen the quasi-U.S. empire as well. It has become overstretched and simply can no longer pay the bills at home while also maintaining far-flung global deployments.
The Great Recession that followed the 2008 financial crash caused a dramatic shrinkage of world trade and a halving of the U.S. external deficits. For a while, as cash-strapped homeless Americans cut their consumption and the price of oil fell from $140 to $40/barrel, the U.S. trade deficit fell and it seemed that a more balanced pattern of global growth might emerge from the crisis. Massive government public works spending and the slashing of interest rates by all major countries had managed to restart growth. But once that happened, the old pattern of accumulation of external deficits by the United States and of dollar surpluses by the Asian exporting countries, Germany, and the Middle East oil-producing countries repeated itself.
Meanwhile, U.S. federal budget deficits soared, topping 10 percent of GDP. Economic stimulus expenditures, health care costs, a surge of baby boomers taking their Social Security, and the need to subsidize cash-strapped California and a number of other state governments had pushed federal spending to what for America were the unprecedented heights of about 40 percent of GDP.
By 2013, U.S. public debt had topped 100 percent of GDP. Foreign dollar holdings were now more than $10 trillion; inflation was beginning to roar as Washington printed more and more money. This, of course, occurred as civil war in Nigeria and the near complete collapse of the mature Mexican oil fields dramatically reduced global oil supplies and sent prices soaring to nearly $200/barrel. The situation was exacerbated by the lingering drought connected to global warming that reduced world food supplies and sent food and other commodity prices soaring as well. Countries with big dollar holdings, like China, Japan, and Germany, had begun to get extremely nervous about the growing likelihood that the value of their dollar reserves would be inflated away. For this reason, they had begun to conclude deals among themselves in nondollar currencies, thereby further reducing the value of the dollar, the U.S. standard of living, and the ability of the United States to remain the dominant power.
Then the Persian Gulf oil producers, led by Saudi Arabia, had announced they would no longer accept dollars for oil. Instead they wanted euros or yen or RMBs or Canadian dollars or Swiss francs or combinations of the above in exchange for a barrel of oil. The Asian exporting countries had quickly followed suit, and that had put the United States in a wholly new, humiliating, and extremely challenging position. It could not sustain its foreign deployments if it could not pay with dollars. Washington approached its allies for assistance, arguing that U.S. forward deployments were in the interest of friends like Germany, Japan, and Korea.
The negative response came as a surprise and a shock. But years of U.S. unilateralism had alienated even its closest friends. So America had to face the hard, cold fact that it was no longer a superpower, but only one of several powers that included China, India, the EU, Russia, and Japan.
The British had had a similar experience when they were forced to withdraw their forces and support from much of the Mediterranean in the 1940s because they simply could no longer pay the bills. Especially in 1956, Britain had been forced to withdraw from its occupation of the Suez Canal (in response to its nationalization by Egypt) when Washington threatened to dump the pound sterling on international markets, a move that would have bankrupted the UK. Now it was America’s turn.
That scenario may seem extreme, but the point is whereas five years ago it would have been unthinkable, today it is not completely out of the question. Note that even in this time of the Great Recession, the United States runs a trade/current account deficit of more than $500 billion annually. This has to be financed by inflows of capital from China, Japan, Saudi Arabia, and other foreign lenders. Just to keep running smoothly and normally, the U.S. economy must have a net inflow of foreign capital of about $2 billion every single day of the year. But since some foreign and domestic capital also leaves the country, that means that there must be a gross inflow of foreign capital of $5 billion per day. Just a small decrease in that flow could result in skyrocketing interest rates and crippling of the U.S. economy.
So how did the United States morph from the world’s dominant economic, industrial, technological, financial, diplomatic, and military power into a nation no longer in control of its own fate? And how can it regain its competitiveness and secure a powerful, if not so dominant, role in the new era that is breaking rapidly upon us? To answer those two questions is the mission of the rest of the book. But here is a summary of key points.
Six false doctrines have combined to put us in this dramatically weakened position. By far the most important has been our fixation on our geopolitical interests at the expense of our economic interests. In addition, consumerism, market fundamentalism, simplistic free-trade globalization, globalization of corporations, and our unquenchable thirst for cheap oil have all contributed mightily.
After 9/11 and again during the war to depose Saddam Hussein in Iraq, President George W. Bush called on Americans to support their economy by shopping and consuming more. This exhortation was in glaring contrast to the calls of other presidents during previous wars—for citizens to save more and buy more government bonds to help finance the wars—and thus dramatically signaled a fundamental shift in the U.S. economy over the past half century. Consumption has not only displaced investment as the main driver of U.S. economic growth. It has become virtually the sole driver.
By the early years of this century, the American household savings rate turned negative. It has rebounded a bit in the wake of the recent economic crisis, but household debt is still much too high. And, of course, the government’s debt is a runaway train. This is not a recipe for competitiveness or for securing a good long-term standard of living when countries like China, Singapore, and Germany are saving from 25 percent to 50 percent of GDP and investing heavily in the latest infrastructure and technology while producing far more than they consume and earning more than they spend.
As I will demonstrate in this book, much of our current dilemma stems from the 1980s embrace by U.S. leadership of what financier George Soros has called “market fundamentalism.” Ronald Reagan rode to the White House by repeating, “Government is not the solution to our problem; government is the problem.”
This slogan had a foundation in the new academic theory of “rational expectations” and the efficacy of the unfettered market, which held that market participants consistently act rationally and that prices reflect the rational expectations of all market participants and are based on perfect information about what the prices should be. According to this thinking, the market can never be wrong over any extended period, and if it does become overheated, it will always adjust itself back to the appropriate level. Government intervention should be totally done away with as it distorts the smooth working of this self-adjusting market mechanism and does more harm than good.
The widespread acceptance of this philosophy led to substantial deregulation of markets and industries and a virtually religious taboo against anything that might smack of government management of business through an industrial policy. The spirit of the orthodoxy was captured by a popular economic aphorism at the time: “Potato chips, computer chips, what’s the difference? They’re all chips.” Taken to the extreme, this argument was also used to justify the deregulation and diminished oversight of financial markets under the Federal Reserve chairmanship of Alan Greenspan, who devoutly believed that “the self-interest of lending institutions would lead them to protect shareholders’ equity” and to police themselves through self-regulation. The 2008 financial crisis has revealed just how flawed this argument was.
Another key factor in undermining U.S. economic strength has been the similarly orthodox allegiance to unilateral free trade. This took hold in the wake of World War II. With U.S. industry emerging from the war as top dog in virtually every field, U.S. businesses, which previously benefited from high tariffs on imports, now wanted free trade. They came to believe that it was a sure route to continued dominance. The doctrine argued for an appealing win-win scenario whereby the United States opening up its markets would lead to both greater prosperity for America and recovery for Europe and Japan.
As it had been for Great Britain in the nineteenth century, the doctrine was now especially attractive to the United States. Essentially the doctrine holds that every country—based on its natural resources, the level of its technology base, and the skill of its workers—will produce some products or services better and more efficiently than others. So countries should concentrate on producing the goods they make best and trade with other countries for the rest. Under the assumptions underpinning the doctrine, this kind of trade leads automatically to the optimal level of production and consumption for each trading partner and also leads to the optimal levels for the global economy overall. A potential concern was that U.S. trading partners did not reciprocally open up their markets, but economists offered analysis that showed that this should not be a worry. Even if some trading partners decide not to play and instead protect their markets, the others are still better off by keeping their markets open and importing from the nonplayers. For a country with a wide variety of market-leading industries, which was also bent on fostering global recovery and attracting allies, this was a doctrine sent from heaven—as some of its proponents literally argued.
Although it at first seemed to work well and helped engender a so-called Golden Era of global growth from 1950 to 1975, the trade environment became increasingly problematic thereafter. U.S. trade went into deeper and deeper deficit, and many U.S. industries began to be displaced by imports with consequent unemployment and dislocations. But in the face of these developments, for reasons that I will explore—and refute—economists and policy makers continued to insist on the superiority of the U.S. open market strategy. The U.S. market remained relatively open to foreign imports while the foreign markets were relatively closed to U.S. exports. The eventual result was the loss of global market share by American producers and the offshoring of a great deal of American production overseas. This has resulted in more and more companies feeling less and less responsibility to their local communities and to the health of the American economy, with U.S. workers bearing the brunt of these developments. The effect on the overall U.S. economy is a matter of great dispute, and a key mission of this book is to resolve that dispute by showing how flawed the free-trade orthodoxy is in light of real-world conditions versus the idealized assumptions the theory is based on.
As I noted in the introduction, in the 1950s General Motors former chairman Charles “Engine Charlie” Wilson famously said that he always thought that “what is good for the country is good for General Motors and vice versa.” Although he was criticized for the remark, at that time, he was largely correct. American companies produced in America and exported abroad. If they increased production as companies, the GDP of the country also rose, and if U.S. demand increased, so did the domestic production of the companies. It was correct to think of the fate of U.S. companies and the fate of the U.S. economy as being tightly linked. Moreover, American CEOs tended to think that they needed to respond to all stakeholders in a company’s fortunes, not just to shareholders, and to have an obligation to the welfare of the local community and the country as a whole. Also, as a result of close collaboration with the government during World War II, they tended to have a highly developed spirit of patriotism, viewing the government as a partner rather than as an adversary. These CEOs were rightly seen as champions of American competitiveness.
The situation has changed dramatically over the past several decades as a new shareholder-oriented management philosophy took hold. Globalization has also played a role. U.S. corporations have become multinational, with not only production but also R&D all over the globe. They can thrive regardless of the performance of the United States. Moreover, the CEOs believe they have a dominant fiduciary responsibility to shareholders and feel themselves to be under no particular obligation to their local communities or to the country. They may feel such an obligation as individuals, but not as CEOs. Moreover, as heads of companies with operations in many countries, they must respond to the policies and pressures of those societies as well as to those of the United States. Indeed, one perverse aspect of globalization is that while American CEOs and corporations are big players in U.S. politics, they are supplicants in authoritarian societies like China. Thus, they are often more responsive to the wishes of the authoritarian countries than to those of the democratic countries, and they often act as representatives of foreign interests in lobbying Washington. Their advice must be understood as in the primary interest of their corporations and as little beholden to national allegiance.
As early as 1943 Secretary of the Interior Harold Ickes wrote, “We’re Running Out of Oil.” In 1948, America became a net oil importer and energy dependent for the first time since the initial arrival of settlers in Jamestown in 1607. The Interior Department proposed a $10 billion project to develop synthetic oil from Rocky Mountain shale. But the effort was quickly abandoned in the face of the ready availability of inexpensive oil from abroad. This cycle of concern, alternative energy project proposals, and retreat in the face of cheap oil imports has been repeated over and over again during the past sixty years. At the completion of each cycle the United States has become more dependent on imports, has accumulated a bigger trade deficit, and has sent more dollars to oil producers, of whom some are friendly but many are unfriendly. In either case, some of those dollars eventually find their way to al-Qaeda and other organizations whose sole mission in life is to kill Americans.
So the American oil addiction is financing America’s bitterest enemies while also increasing the U.S. national debt, fouling the environment, exacerbating global warming, and ultimately diminishing U.S. welfare. This is not to mention the young American troops who become casualties in wars ultimately connected to oil. All this we do in the name of cheap energy. But with the Dutch, perhaps we should ask, “How expensive can cheap be?”
In his 1980s bestseller The Rise and Fall of the Great Powers, the historian Paul Kennedy notes that each of the three former great powers—Rome, Spain, and Great Britain—had created costly military forces and taken on far-flung geopolitical obligations even as they allowed their economic power to decline. Eventually they couldn’t afford their empires, armies, and obligations, even many obligations to their own people. As Kennedy puts it, these empires were suffering from “Over-Stretch” and from it they collapsed.
As I have indicated, America today is seriously over-stretched. Indeed, we are in the odd position of actually paying our clients for the privilege of defending them or of borrowing from them to pay for that defense. We are protected for the moment by the unique role of the dollar, but this cannot last forever; it may not even last for another decade.
It is clear that if we are to avoid the fate of prior dominant world powers, we must quickly change many of our ways, as I shall discuss in my last chapter. Here I should like to make just one key point about the role of government. We need to stop kidding ourselves with the notion that government intervenes minimally in our economy. The fact is that government has and always will have a large role in it. Our problem is that while our government does play a large role, it does so without having sensible economic or industrial strategy to guide and control it. Our forefathers had just such a strategy, one brilliantly conceived. We need to reread our own history, and that is where the rest of this book will begin.
© 2010 Clyde Prestowitz
Posted October 15, 2013