The history of the productive apparatus is a history of revolutions. So is the history of transportation from the mailcoach to the airplane. . . . This process of Creative Destruction is the essential fact about capitalism.
—Joseph A. Schumpeter, 19421
We believe that this country will not be a permanently good place for any of us to live in unless we make it a reasonably good place for all of us to live in.
—Theodore Roosevelt, 19122
In the early twenty-first century, Paterson, New Jersey, is a troubled city in a troubled country. The city that traces its origins back to Alexander Hamilton’s Society for Establishing Useful Manufactures (SUM) has lost most of its manufacturing businesses to other countries. Like other cities in America’s deindustrialized Rust Belt, Paterson has been plagued for decades by poverty, crime, and urban decay. Like other northern industrial cities, Paterson became a home of black migrants from the South just as many manufacturing jobs that provided ladders to middle-class status were disappearing. National shifts in demography are reflected in Paterson, where a majority in the city now consists of Latino immigrants and their descendants. Immigration has helped to revitalize the city, to some degree. But levels of poverty, illiteracy, and illegitimacy are high.
About twenty miles south of Paterson in Elizabeth, New Jersey, is something called Foreign Trade Zone 49. FTZ 49, established in 1979, is one of hundreds of special business districts created in recent years in the United States that provide special customs treatment for companies engaged in international trade. Operated by the Port Authority of New York and New Jersey, FTZ 49 is one of the largest contiguous foreign trade zones in the country. Its 3,587 acres include 2,075 acres in the Port Newark/Elizabeth Port Authority Marine Terminal; 41-acre Global Marine Terminal and 145-acre Port Authority Auto Marine Terminal, both in Jersey City/Bayonne; 125-acre Industrial Park at Elizabeth; 53-acre Greenville Industrial Park in Jersey City; a 23-acre site in Bayonne; a 40-acre tank farm and fuel-distribution system at Newark Liberty International Airport; a 407-acre industrial site in South Kearny; 316 acres in Port Reading Business Park in Woodbridge and Carteret; 115 acres in the I-Port 12 industrial park in Carteret; 72 acres in Port Elizabeth Business Park in Elizabeth; and 176 acres in the I-Port 440 industrial park in Perth Amboy.
FTZ 49 sponsors industries involved in manufacturing, pharmaceuticals, petroleum products, and special chemicals and hosts companies that include motor-vehicle importers and an importer of frozen-orange-juice concentrate. The industrial park is connected to world commerce by Newark Liberty International Airport and the ExpressRail Intermodal Rail System, with dedicated facilities at major container terminals in Elizabeth and Staten Island. Nearly ten thousand workers are directly employed at FTZ 49, while the multiplier effects of its economic activity create a far greater amount of indirect employment in the area and the nation.3
FTZ 49 is Alexander Hamilton’s SUM reborn. Power is provided by electricity rather than by water, and the products include many that did not exist when the United States was founded. Ingredients are brought in and products taken out by trucks, trains, and planes, not by boats and wagons. The purpose of American economic policy in the twenty-first century is no longer to catch up with industrial Britain, but to allow the United States to participate in high-value-added global supply chains in a world of transnational production, without sacrificing strategic industries. But the project of creative collaboration between government and private enterprise to ensure that America remains a land of promise is no different today than it was on that fateful day of July 10, 1778, when General Washington and Colonel Hamilton, enjoying a respite from war, admired the thundering falls of the Passaic and imagined what America might be.
The story of the American economy that has been told in this book can be summarized in a paragraph. When the United States won its independence and organized its Constitution, the world’s economy was still the preindustrial economy that had existed for millennia since the invention of agriculture—an economy in which human and animal muscle provided most of the power, supplemented where possible by the force of windmills and water mills, in which the burning of wood and other biomass provided heat and light, and in which passengers and freight were most efficiently moved by water. Within decades of the Founding, America began to be transformed by the industrial revolution, which has radiated outward from workshops and laboratories in three waves—the first industrial revolution based on steam and telegraphy, the second industrial revolution based on electric and oil motors, and the third industrial revolution based on computers. Each wave of technological innovation has destabilized existing economic, social, and political arrangements, forcing Americans to adapt by creating, in effect, a series of new republics while keeping, for the sake of continuity, the old name of the United States of America and the old federal Constitution of 1787, with formal and much more important informal amendments.
American history shows a recurrent pattern: a thirty- to forty-year time lag between technology-driven economic change and the modernization of political and legal structures to deal with its consequences. During this period of misalignment, such as the 1830s through the 1860s, the 1890s through the 1930s, and the 1970s through the 2000s, the institutions of the economy and the polity drift further and further apart. Nostalgic Jeffersonian politicians like Andrew Jackson, William Jennings Bryan, and Ronald Reagan who idealize a smaller-scale past often win wide support in these eras of drift and stagnation. Finally, after three or four decades of misalignment between economy and polity, there is a crisis—the Civil War, the Great Depression, the Great Recession. The crisis provides an opportunity for reformers to reconstruct the economy and political system in an attempt to realize perennial American democratic and liberal ideals in forms adapted to the new technological era. The Hamiltonian tradition enjoys a revival, in light of the urgent need for large-scale, ambitious programs of national development based on collaboration rather than conflict between government and private enterprise.
If American history is any guide, the cycle of Jeffersonian nostalgia and partial regression that began with Carter and Reagan will give way at some point to a neo-Hamiltonian era of nation building—or, to be more precise, nation rebuilding. Eventually, however, the next political-economic order will be obsolete. As long as technological progress continues to transform the way we work and live, the economy and the polity inevitably will become misaligned again, challenging new generations of reformers.
THE GREAT RECESSION AND BEYOND
The Great Recession that followed the global financial crisis of 2008 is best thought of as a depression whose worst effects have been contained by governments that learned the lessons of the 1930s. Stimulus programs funded by deficit spending in countries from the United States to China have sought to compensate in part for the collapse of private consumer and business demand. Systems of social insurance like unemployment insurance have ameliorated the effects of unemployment. And from the failures of the 1930s, governments in the 2000s learned the importance of the state as a lender of last resort during an economic collapse.
However, by ameliorating the effects of the Great Recession, the policies and institutions put into place after the 1930s may have disguised the severity of the present crisis from political classes, if not members of the public, in the United States and other nations. That, along with a mistaken understanding of the crisis as a severe but normal recession rather than a near-depression, may explain why in the United States and Europe the focus of elites turned almost immediately, in the years after 2008, to the long-term problem of deficit reduction, away from the short-term crises of mass unemployment and the household-debt overhang.
In the United States, the unwillingness of federal leaders to engage in much greater stimulus spending and much more energetic restructuring of home-mortgage debt resulted from an irrational fear of “big government,” stoked by a Republican Party that had abandoned its northern Hamiltonian roots for the right-wing Jeffersonianism of its new regional base, the former Confederacy. It is difficult for the United States to have a rational response to the Great Recession when the opinion leaders of one of the two national parties believe that Herbert Hoover was too progressive. All too many of America’s leaders have learned nothing from the mistakes of Hoover and Franklin D. Roosevelt in their premature attempts to balance the budget during the Great Depression, which backfired by contracting demand and plunging the economy back into crisis. In Europe, the misguided attachment to austerity policies on the part of Germany, the largest economy, has harmed both Europe and the world.
It can take years or decades for countries to recover from the aftermath of asset bubbles in housing or stocks that burst, leaving financial systems burdened with worthless debts that will never be repaid.4 The long stagnation of the Japanese economy shows that policies that are too timid or too favorable to creditors who refuse to write off worthless debt can cause a nation to keep sliding back into the hole before it manages to crawl out. Moreover, previous financial crises since the Depression have been national, like late-twentieth-century crises in Japan and Sweden, or regional, like the Asian financial crisis. Those countries and regions recovered, but it is not clear that they provide precedents when the crisis is global and all countries are trying to recover at the same time, using the same methods, such as expanding exports while moving toward budgetary balance. The historians of the future will probably render a judgment on today’s policymakers similar to that rendered on those of the 1930s: excessive fears of deficits and national debt, along with excessive optimism about the self-healing powers of the market, led governments to do too little, not too much.
GLOBAL REBALANCING
Whatever lies beyond the Great Recession, it will not resemble the bubble economy that caused the crisis. It is doubtful that chastened American consumers would engage in another multidecade spending spree, and even if they did the public debt overhang built up during the Great Recession would severely limit the ability of the federal government to respond to another, perhaps even greater, crisis.
Both the Great Depression and the Great Recession were preceded by periods characterized by global imbalances in trade and finance and by the maldistribution of wealth. During the Golden Age that followed World War II, both of these problems were corrected. After World War II the United States, which had worsened global imbalances by becoming the world’s lender while refusing to import goods from its debtors, abandoned protectionism for reciprocal trade (which, because of Cold War considerations, mutated into a quite different system of unilateral free trade). At home, the extreme inequality of the 1920s was replaced by a compression of incomes, with incomes at the top limited by customary norms and taxation and with minimum-wage laws, unionization, and restricted immigration putting a floor on wages at the bottom. A similar combination of global rebalancing and a more equitable distribution of the gains from economic growth will be required, if America and the world are to move beyond the bubble-economy pattern of asset bubbles followed by collapses and rising inequality of income and wealth.
As we have seen, the fable that following the Cold War the world repudiated statism and embraced free-market capitalism and moved toward a borderless global market bears little resemblance to reality. What really happened is that, following the fall of the Berlin Wall, the United States sought to extend the Pax Americana system beyond its allies to incorporate formerly hostile and neutral powers, including giants like China and India. During the Cold War, the United States had offered to provide the public goods of security, the dollar as a reserve currency, and one-way access to American consumer markets to its former enemies Japan and Germany, on the condition that they accept the military leadership of the United States and concentrate on civilian industrial production. The United States turned a blind eye to their mercantilist export-promotion policies, sacrificing its own industries in the interest of alliance unity and specializing in military spending and finance.
Already by the 1970s, with the recovery of Japan and Germany, this bargain no longer benefited the United States. As it wound down the Vietnam War, the Nixon administration engaged in a policy of strategic retrenchment, while retaliating against Japanese mercantilism and abandoning the Bretton Woods fixed-exchange-rate system in an effort to help American industry. But first Jimmy Carter and then Ronald Reagan denounced Nixonian Realpolitik in favor of a vision of American foreign policy based on human-rights idealism or crusading anticommunism. The abandonment of the Bretton Woods system allowed the United States to borrow vast sums from abroad, even as its merchandise trade deficit swelled. Public borrowing enabled Reagan and George W. Bush to build up the military while cutting taxes, while private borrowing allowed Americans to live better even though their wages stagnated for a generation.
Having been strained by Japanese and German export-oriented mercantilism, the economic order of the Pax Americana was finally shattered by the attempt to admit post-Communist China to the system on terms similar to those that had been offered to the defeated Axis powers. The form that globalization took severed the link within the United States and other nation-states between domestic mass consumption, domestic investment, and domestic economic growth. On both sides of the Pacific Ocean, wages failed to rise to track productivity growth. Wage-led growth in the United States was sacrificed to debt-led growth, while in China, wage-led growth was sacrificed to investment-led growth. When debt and investment dramatically outstripped wage-based aggregate demand, a painful readjustment became inevitable.
BEYOND THE PAX AMERICANA: POSTHEGEMONIC AMERICA IN A MULTIPOLAR WORLD
By the early twenty-first century, the American consumer market, even though it was still the world’s largest, was not big enough to serve as the engine of growth for the rest of the world. And even before the crash of 2008, the American public had wearied of the wars in Iraq and Afghanistan and the costs of commitments to protect the interests of other countries, allowing them to focus on economic growth instead of military spending.
Predictions that China will replace the United States as the hegemonic global power, based on straight-line extrapolations, may prove to be as premature as predictions in the 1980s that Japan would soon be “number one.” By shoveling state-controlled credit at its export-manufacturing sector on the basis of political rather than economic logic, China has saddled its banks with bad debts, while by hoarding surpluses in order to keep its currency undervalued, it has set off a domestic real-estate bubble and inflation. The deflation of China’s investment-led bubble economy, the corollary of America’s debt-led bubble economy, may condemn China to Japanese-style stagnation, or worse. On the other hand, the sheer scale of China, along with the vast numbers of rural Chinese yet to be brought into the modern economy as workers and consumers, may allow China to transition successfully to domestic demand-led growth, an option not available for Japan, with its aging population, low fertility, and low immigration.
Whatever happens, at some point in the next few decades, the size of the Chinese economy is likely to surpass that of the US economy, which has been the world’s largest since the 1870s. The average Chinese will continue to be poorer than the average American for generations. But a world economy in which America is number two will require a radical rethinking of American economic engagement with the rest of the world.
To begin with, the Pax Americana strategy will no longer serve American interests. It was one thing for the United States, as the largest economy and the greatest military power in the global system, to provide its dependent allies with military protection, unreciprocated access to American markets, and the use of the dollar as the global reserve currency. But why should the number two economy sacrifice its taxes and the blood of its soldiers to protect the overseas interests of the number one economy? China, which borders on Afghanistan and Pakistan, has far more vital interests in the region than does the United States. Likewise, China, Japan, and Europe are far more dependent on Middle Eastern oil than the United States. Should American soldiers continue to protect their interests in the Middle East, when the United States is merely one of several great powers in a multipolar world?
The use of the dollar as a reserve currency has allowed the United States to operate without the budgetary constraints imposed on other countries. It has used that privilege unwisely. The eventual replacement of the dollar’s reserve currency status by several currencies or a synthetic global currency would bring some painful but perhaps necessary discipline to the posthegemonic United States.
A posthegemonic America can no longer serve as the sole engine of the world’s growth. The China-centered model that preceded the Great Recession, in which industrial countries like Japan and Germany and South Korea sent components, while developing countries like Brazil sent resources, to China to be assembled into manufactured goods for American consumers is shattered beyond repair. Along with China and India, which will soon surpass China in population, the United States will be one of the three most populous countries in the world. All three continental states, along with Europe and second-tier countries like Brazil, must consume as well as produce and import as well as export.
The vision of a rule-governed global economy with free flows of goods, labor, and capital across borders will remain a fantasy in a world of sovereign states with conflicting national interests. However, the tradition of developmental capitalism, in which the government promotes growth in strategic industries, can take forms other than zero-sum trade wars. Just as countries can coordinate their exchange rate and stimulus policies, so in theory they could coordinate their industrial policies, by means such as market-share agreements or mutually agreed upon domestic content rules. In contrast, beggar-thy-neighbor mercantilist policies on the part of every country can only result in mutual impoverishment.
TOWARD THE NEXT AMERICAN SYSTEM
While particular economic interests have used the rhetoric of free markets when it served their purposes, laissez-faire economic policy has never been the American tradition. As we have seen, once the southern planter class was crushed in the Civil War, the United States successfully carried out a version of Henry Clay’s American System, which built on Alexander Hamilton’s vision of national economic development. On becoming the global economic hegemon, the United States shifted toward opening foreign markets for its exports and investments, as Britain had done when it briefly enjoyed industrial supremacy in the mid-nineteenth century. Today, as a former hegemon in relative decline, the United States is no longer served well by a simple-minded strategy of liberalizing trade and deregulating the economy. It needs a sophisticated, long-term national economic strategy—a new American System.
What would a twenty-first-century American System look like? Clay’s American System rested on three elements: infant-industry protection for American manufacturing; federal funding of internal improvements, or infrastructure; and a sound national financial system anchored by the Bank of the United States. At the time, the United States was catching up to Britain and Western Europe by borrowing or stealing science and technology. During World War II and the Cold War, the United States created its own government-funded research-industrial complex along the lines pioneered earlier by Imperial Germany. A twenty-first-century American System needs to have four elements: innovation policy; manufacturing policy; infrastructure policy; and financial policy.
THE NEXT AMERICAN SYSTEM: INNOVATION
In terms of real per capita income, Americans today are seven times richer than they were a century ago.5 However, this measure understates progress, because it does not factor in revolutionary inventions. While a middle-class American household spent 4 percent of its income on illumination in 1800, today it spends less than 1 percent of its income and enjoys one hundred times as much light—not from candles that are one hundred times larger than candles, but from electric lightbulbs.6
Economic growth is a miracle—but it is not a mystery. The observation of Adam Smith in the eighteenth century remains valid in the twenty-first: “The annual produce of the land and labour of any nation can be increased in its value by no other means, but by increasing either the number of its productive labourers, or the productive powers of those labourers who had before been employed.”7 Economic growth has two sources: increases in the quantity of inputs (resources and labor) or innovation, which may take the form of new technologies or new processes and techniques. According to the Office of Technology Assessment, from the Great Depression to the present between 60 and 80 percent of productivity growth has resulted from innovation.8
Between 1870 and 1992, the average US rate of growth in productivity was 1.8 percent a year.9 Since the middle of the twentieth century, in the United States per capita GDP rose the most during two periods of high productivity growth, 1949 to 1973 and 1996 to 1999, and the least during two periods of slower productivity growth, 1974 to 1979 and 1980 to 1995.10 In the early 1970s, US productivity growth, which had averaged 2.88 percent per year from 1949 to 1973, dropped to a mere 1.3 percent a year from 1973 to 1975. As a result, Americans in 1995 were only 70 percent as productive as they would have been if US productivity had continued to grow as rapidly as it had during the 1950s and 1960s. In the second half of the 1990s, however, US productivity growth returned to its earlier levels, growing at an annual rate of 2.8 percent from 1995 to March 2001 and remaining high.11 Some economists, however, argue that the federal government has overstated productivity growth, by counting the low prices of ingredients from China and elsewhere as improvements in productivity in the United States.12
Productivity growth is driven by innovation. Beginning in World War II under Vannevar Bush and his colleagues, the United States has assembled the world’s most successful system of innovation, based on federal funding, university-based research, and development of new technologies by entrepreneurs with the help of private and public venture capital. But the system that produced nuclear energy, computers, satellites, and the Internet depended heavily on military spending, which is likely to decline as the United States shifts from a role as global hegemon to a new role as one of several great powers. Federal civilian spending on research is inadequate and heavily skewed toward attempts to cure particular diseases like cancer. Like other discretionary spending, federal spending on R&D is likely to be among the first programs to be sacrificed during attempts to reduce deficits and the debt.
Most state and local governments use taxation to finance ordinary expenditures, while borrowing money to pay for capital investments like roads and school buildings with large up-front costs but benefits spread over many decades, and there is no reason why the federal government should not do the same. R&D is exactly the kind of productivity-enhancing investment that should be financed by borrowing. As I have proposed elsewhere, the United States should consider creating a federal R&D bank, which issues bonds in order to raise funding for basic R&D that individual companies will not fund because they cannot monopolize the benefits of breakthroughs.13 Some of the projects could be self-financing, by means of royalties on patented discoveries or inventions, but others need not be. Because breakthroughs in science and technology benefit the economy as a whole, it is legitimate for bondholders to be repaid out of general revenues. The R&D bank could partly replace the historic role of the military in funding American innovation.
THE NEXT AMERICAN SYSTEM: MANUFACTURING
The United States should not adopt across-the-board protectionism or pursue a mercantilist trade policy except in retaliation. But a posthegemonic America needs to rebuild some of the manufacturing capability that it allowed to be lost to East Asian and European mercantilism during the latter decades of the Pax Americana. Even if, as a result of automation, domestic manufacturing in the future were to directly employ as few people as are employed today in industrialized agriculture, the United States needs to preserve its domestic manufacturing base. If the dollar ceases to be the reserve currency, the United States will have to pay for imports with exports, rather than with low-cost debt.
The most important reason for maintaining a world-class industrial base is national security. Even Adam Smith admitted the need to protect militarily relevant industries, on the grounds that “defense, however, is much more important than opulence.”14 When the United States was by far the dominant military-industrial power, it could afford to cede some of its industries to its allies as bribes, in the interest of maintaining the Cold War alliance against the Soviet bloc. But in a multipolar world with other independent centers of power, the United States must resume the concern with military and industrial independence that dates back to George Washington and Alexander Hamilton and Henry Clay. While enjoying the benefits of trade with other great powers, it must ensure that it does not become overly dependent on them for essential manufactured goods or raw materials. In the decades ahead, American defense strategists should devote more attention to ensuring that the United States has adequate manufacturing capacity in the event that one or more other great powers becomes a military rival.
Since the industrial revolution began, no empire or nation has been able to be a major military power without being a major manufacturing power. That will be as true in the twenty-first century as it was in the nineteenth and twentieth. If the United States allows itself to be deindustrialized, as a result of the mercantilist policies of other countries or the offshoring decisions of its own corporations, it will cease to be a military power of the first rank. The architects of the Confederate States of America were content to project a future in which their country would forever be a second-rank military power, specializing in the export of cotton, food, and other commodities to industrial countries—a sort of large, English-speaking Brazil or Argentina. The majority in the United States rejected that option in the 1860s, and should always reject it. Americans should look for guidance in trade policy not to Jefferson Davis but to George Washington, who, in his first annual address to Congress in January 1790, declared that “a free people ought not only to be armed but disciplined” and that “their safety and interest required that they should promote such manufactories as tend to render them independent of others for essential, particularly military, supplies.”
GOVERNMENT AND BUSINESS: PARTNERS, NOT ADVERSARIES
Rethinking American manufacturing policy means rethinking the relationship between the American nation-state and the multinational corporation. There are two possible options. The United States can select certain US-based multinationals as “national champions” and favor them over foreign corporations. Or it can treat all multinational enterprises, no matter where they are chartered, as American to the extent that they carry out production and employ people in the United States, and foreign to the extent that they have activities elsewhere. In a multipolar world, America’s decisions about how to treat corporations must be influenced by the policies of other countries. If other nations rely on state-owned enterprises or national champions, the United States may have no choice but to compete by using similar methods.
In promoting American manufacturing, the United States, in the future as in the past, within the limits of trade treaties that can always be amended or ended, will have a variety of methods to choose from, ranging from public ownership and tax incentives to regulations such as tariffs, quotas, and domestic-content rules. Clay’s American System used tariffs to protect American infant industries, but Hamilton preferred bounties, or subsidies, on the grounds that their cost was spread over the tax-paying population as a whole, instead of falling solely on consumers. Either method may be appropriate in particular cases and either method may be abused by special interests. Abuse, though, is not an argument against a manufacturing policy, any more than it is against any other government policy, including defense, which depends on the national manufacturing base.
From the foundation of the republic, American industry has been supported by government at every stage, from federally funded invention to early adoption with the help of military procurement and protection from foreign competition during development. The federal government subsidized early American aviation and performed aeronautic research to support it, while atomic energy, jet propulsion, computers, rockets, and satellites were invented and developed in government laboratories. Early steamships and radio networks benefited from initial government-granted monopolies, while automobiles benefited from tax-funded roads and highways. The government has built and turned over telegraph lines and factories built during wartime to private owners and has set standards of best practice for private enterprise, as the nineteenth-century federal arsenals did when they taught American businesses to use the arsenal system of interchangeable parts. The American states, and the colonies before them, have been even more involved than the federal government in American enterprise, in some cases wholly or partly owning their own banks, canals, and railroads.15
Government in America has never been limited to enforcing property rights, educating workers, and acting as an impartial umpire in competitive markets. Industrial policy is not alien to the American tradition. It is the American tradition.
THE NEXT AMERICAN SYSTEM: INFRASTRUCTURE
In the decades ahead, the United States needs to spend more money on infrastructure, merely to maintain the roads, railroads, airports, power lines, and water systems that have already been built. Unlike in earlier generations, when it was clear that a particular kind of infrastructure needed to be built out—canals, railroads, interstate highways, and rural electric grids—today there is no national consensus about the next American infrastructure.
In recent years many urban intellectuals and politicians in the dwindling downtowns of America have favored mass transit, high-speed rail, and renewable energy, out of a mixture of self-interest and idealism. But fewer than 4 percent of Americans commute using mass transit each day. It is wishful thinking to hope that the automobile-centered society that took shape in the twentieth century will somehow give way to pedestrian villages connected by mass transit in the twenty-first. High-speed rail might be justified in a few dense regions like the East Coast, but in most of the country it is not a plausible alternative to intercity travel by airplane or bus. The unexpected abundance of natural gas made possible by fracking means that natural gas pipelines are more likely to be in demand that high-voltage lines carrying energy from solar panels that carpet the southwestern desert or vast arrays of windmills.
A more likely scenario is the automation of otherwise conventional automobiles and airplanes. The Defense Advanced Research Projects Agency (DARPA), which in previous generations contributed to the development of the computer and the Internet, has done pioneering research in “robocars,” which has been built on by Google and companies and universities around the world. The chief barriers to the automation of transportation will be legal and psychological, not technological. Another possibility is telecommuting, which may finally live up to its long-prophesied potential.
Both a transition to automated vehicles and a partial shift from commuting to telecommuting would require infrastructure investment on a grand scale. Like other capital projects, infrastructure should be paid for by borrowing—for example, by means of a federal infrastructure bank. The present federal system of funding infrastructure chiefly through the highway trust fund, which has become a slush fund allowing members of Congress to “earmark” pet projects, needs to be rethought and replaced.
THE NEXT AMERICAN SYSTEM: FINANCE
The fourth element of a new American System, financial policy, should support the previous three. One component should be an expanded system of public purpose banks, like an R&D bank and an infrastructure bank, which can tap large amounts of private capital for public investment to increase the productivity of the American economy.16
Successful public purpose banks have a long and successful history in the United States. They include not only the Reconstruction Finance Corporation, which was abolished after World War II, but also the Farm Credit System and the Home Loan Bank System. The worst failures were Fannie Mae and Freddie Mae. But those two government-sponsored enterprises (GSEs) failed not because they were public but because they were compelled to act like profit-maximizing corporations instead of public utilities. Free-market ideology was responsible for the privatization of Fannie Mae and the creation of Freddie Mac as a would-be competitor. Ginnie Mae, which remained a government corporation, did not engage in similar profit-driven risk taking. Nor did the Federal Home Loan Bank system, which, like the Farm Credit System, is a nonprofit cooperative, owned by risk-averse member banks. The lesson of the Fannie/Freddie debacle during the housing bubble and subsequent crash is not that public financial institutions are a bad idea, but rather that they work only when they are organized as nonprofit government corporations or public-private cooperatives.
In addition to creating new public-investment banks, Americans need to create a replacement for the dysfunctional American financial system, in which “too big to fail” financial institutions reap huge profits from highly leveraged gambling when they succeed, while their losses are socialized by the taxpayers when they lose their bets.
Because the system of financial regulation created by the New Deal created several decades of financial stability before it was dismantled in the late twentieth century, many seek to turn back the clock to the mid-twentieth century. But that would be a mistake. The purpose of New Deal financial reform was not simply to stabilize the financial system, but also to preserve small local banks from interstate and even intrastate branch banking. In other nations during the same decades, like Canada and Australia, major financial crises were also rare or absent, even though their banking systems were organized as national oligopolies with a handful of big banks.
What matters is not the size of the banks but the absence of a toxic mixture of competition for market share with explicit or implicit government insurance. Problems arose in the United States when deregulation gave banks, savings and loans, and other financial institutions opportunities to compete for market share and high profits, while pressure from shareholders compelled them to do so. In other words, banking is an industry, like railroads, airlines, and telecommunications, in which “ruinous competition” can be the problem and in which restraints on competition can be the cure.
In the first few years of the Great Recession, however, the most popular proposed reforms were inspired by ideas that assumed that the solution involved more competition, not less. On the right, libertarians failed to recognize the utility-like nature of massive, interconnected financial institutions such as megabanks by arguing that they should be allowed simply to go bankrupt periodically, as though they were corner umbrella stands. On the left, many progressives naively called for breaking up big banks into little banks, without understanding that the small-bank system of the New Deal era worked only because of the anticompetitive limits on branch banking. If big banks were broken up but mergers and branch banking were still allowed, then a few megabanks would soon grow by devouring their rivals, defeating the intent of the reform. And if megabanks were allowed to engage in risky behavior, as long as the government did not bail them out when they failed, then their periodic collapses could bring the economy down with them.
A better approach would be to focus on functions, walling off casino banking from utility banking and redefining investment banking. Proposals to revive the Glass-Steagall separation of commercial and investment banking make sense, even if other elements of the New Deal system are anachronistic. In addition, a modest financial transaction tax, or Tobin tax, which would hardly be noticed by most individuals and businesses, could raise large amounts of revenue, while discouraging the diversion of capital to unproductive, high-frequency speculation.
As in the past, merchant banks or investment banks could specialize in connecting capital with promising investment opportunities. The utility functions of banks, such as small savings accounts, deposits, and payments, might be assigned to banks that are designed as boring, low-profit utilities, whether they are publicly owned or privately owned, but highly regulated. Utility banks would resemble other utilities, like water and electricity, and other than tradition there is no reason why they should not be regional or national monopolies, with fees set by utility-regulatory commissions in the interest of the public. In other countries, public postal savings banks provide basic financial services, and the United States had its own postal savings system from 1910 to 1967. The American postal savings bank could be revived, as a low-cost national public bank for small savers and ordinary transactions.17
In the words of Alexander Hamilton: “Public utility is more truly the object of public banks than private profit.”18
HOW MALDISTRIBUTION OF INCOME AND WEALTH THREATENS THE ECONOMY
A new American system, if it is successful, can increase the productivity of the US economy in the generations ahead. But productivity-driven economic growth by itself is not enough. The gains from growth must be widely shared among the citizens of the American republic.
The maldistribution of income and wealth that has occurred in the United States since the 1980s should not have come as a surprise. What else could one expect to happen, once unions were crushed, the minimum wage was reduced by inflation, labor markets were flooded with low-wage immigrants, taxes on the rich were dramatically lowered, and salaries and stock options for corporate executives were raised to obscene levels?
Apart from their tendency to fray the social fabric of a democratic republic by diminishing the middle class, extreme concentrations of income and wealth are undesirable for purely economic reasons. Modern technology-based industries benefit from increasing returns to scale, which in turn are made possible by mass markets of middle-income consumers. Even the most profligate rich people tend to spend less of their incomes on consumption than the thriftiest poor do out of necessity. As Keynes observed, the poor have a greater “marginal propensity to consume.”
When too much of the wealth of a nation or the world is channeled to too few people, industries are starved of the mass demand they need to keep running or to expand. At the same time, the economy can be destabilized, when the rich try to become even richer by speculating with the money they do not consume or save. The series of asset bubbles the world economy has experienced in recent years—in housing, in stocks, and in commodities such as gold and energy—is a telltale sign that too much money is going to the rich, who use it to gamble on assets, rather than the middle class and the poor, who would have spent the money on goods and services generated in the productive economy.
The maldistribution of income is a global problem, not just an American one. While debt-led growth replaced wage-led growth in the United States in the 1990s and 2000s, on the other side of the Pacific investment-led growth replaced wage-led growth in China and other East Asian mercantilist nations. If every country tries to minimize wage costs, then global aggregate demand will be artificially suppressed, to the detriment of most of the world’s people.
THE NEXT AMERICAN MIDDLE CLASS
In a Fourth Republic of the United States that emerges from the wreckage of the Great Recession and its aftermath, a new American System should be complemented by a strategy for building the next American middle class.
The middle class in America, outside of the South, has always been in part a creation of economic engineering by means of laws and public policies. The first American middle class consisted of white yeoman farmers, who benefited from land reforms like fee-simple land sales and the abolition of primogeniture and entail, the banning of slavery from the northern states and territories, the Homestead Act that allowed farm families to purchase farms with their labor, and infrastructure projects sponsored by local, state, and federal governments that connected farmers with national and global markets.
The second American middle class was based on white male factory workers. Among the measures that sought to ensure married men would earn a breadwinner’s wage so they could support a homemaker wife and children were wages-and-hours regulations, government support for labor unions, and policies to create tighter labor markets by limiting immigration and removing convicts, children, and women from the labor force.
The third middle class was based in the service sector after World War II. Its members were office workers, a group that increasingly included women. Access to this new, suburban, service-sector middle class was enlarged first by compulsory public high schools and then by expansion of public colleges and universities and financial aid for higher education, including the G.I. Bill, student loans, and Pell Grants.
The fact that middle classes are made in part by enlightened public policy is illustrated by the contrast between the South and the rest of the nation. While independent yeoman farmers formed a majority in the North in the first half of the nineteenth century, in the South poor white farmers were squeezed between a tiny oligarchy of rich planters and the slaves they exploited. In northern factories, despite employer resistance, unions made gains, particularly during the New Deal and World War II. But the one-party South used law and intimidation to prevent unions from taking root in a region whose elites viewed themselves as employers or brokers of poor black, white, and Latino workers deprived of bargaining power. As a result, in the twenty-first century, many southern states have levels of inequality, poverty, and illiteracy similar to those of developing countries.
SERVICE-SECTOR FORDISM
The combination of automation and offshoring has destroyed many routine clerical and lower-level managerial jobs. With the disappearance of middle-skill jobs, the American job market has become polarized between highly paid managerial and professional jobs and poorly paid jobs in the service sector. Most of the job growth in the early 2000s has occurred in three areas: health, education, and government. According to the Bureau of Labor Statistics, health care accounts for seven out of the twenty fastest-growing occupations, more than any other category. Home health aides and personal and home-care aides are found both among the fastest-growing job categories and among the occupations with the largest overall job openings in the years ahead.
What is driving this growth? The US health-care industry is plagued by inefficiency and rent seeking by private insurers, pharmaceutical companies, hospitals, physicians, and lawyers. But even when costs are brought into line with those of other countries, the US health-care system is likely to increase its share of the economy. One reason is the aging of the population. Another is the fact that societies, like individuals, choose to purchase more health care as they grow more affluent. Health is a good that makes possible the enjoyment of all other goods.
Far from being a problem, then, the steady and sustainable growth of employment in the health-care sector, along with jobs providing care for the elderly and children, education, and the provision of public goods, may be the next stage in the evolution of advanced economies. As technology made possible greater production with fewer workers, first agriculture and then manufacturing shed labor to other sectors. Today, information technology, by eliminating much routine office work, is shifting labor into “proximity” services such as health care that cannot be offshored and cannot be automated. A high-tech economy leads to more “high-touch” jobs that only human beings can perform.
Will the health aide be the typical worker of the twenty-first century, the successor to the farmer, the factory worker, and the office worker? The German poet Johann Wolfgang von Goethe would not have been surprised. In 1787, he sardonically commented: “Speaking for myself, I too believe that humanity will win in the long run; I am only afraid that at the same time the world will have turned into one huge hospital where everyone is everybody else’s humane nurse.”19
The high-wage, high-consumption economy established in the United States and similar nations during the Glorious Thirty Years after World War II was easier to create than its equivalent would be today. In the mid-twentieth century, factory workers were a large enough proportion of the workforce that simply raising their wages stimulated the whole economy when they left the factory and spent money on rent, groceries, clothes, and haircuts. But gains in productivity in the highly robotic domestic manufacturing of the 2030s or 2050s may not translate into gains for the rest of society, even if the few remaining workers are very well paid. Higher pay for robot supervisors will not necessarily translate into higher incomes for home health aides.
It is not enough to say that everyone in society benefits from the cheaper goods and services made possible by productivity. This is true, to be sure. But if an ever-greater share of the gains from national economic growth goes to a small oligarchy of capitalists and well-paid managers, then the distance between them and the rest of society will continue to increase. In the United States, the growing share of the rich of national income and wealth has already translated into much greater political dominance than existed in the days of strong unions and local political machines. If America’s rich continue to get relatively richer than the rest, they will be even more socially dominant and even more politically powerful.
As Henry Ford recognized, workers are also consumers, who need to be paid well if they are to be able to afford the products that they make. What is required is nothing less than “service-sector Fordism”—the equivalent, in the service sector, of the Fordist system in the mid-twentieth-century industrial sector. Industrial Fordism meant that factory workers made enough money to be able to buy the products they made. Service-sector Fordism means that service-sector workers should be able to obtain the kind of services they provide. Whether from the private market or public services, health-care aides should be able to afford health care, nannies should be able to afford child care, and restaurant workers should be able to afford restaurant meals. The alternative—a return to a society in which most Americans, directly or indirectly, are “in service” to the affluent few, like the butlers, valets, and maids lined up in the driveway of an Edwardian British country house—would mark the abandonment of the American Dream.
If the United States is to avoid turning into a high-tech version of stratified societies like Brazil and Mexico, with which it shares the Western Hemisphere, mechanisms must be found to allow most of American citizens to share in the gains from productivity growth, in addition to falling prices for particular services and goods. Higher taxes on the rich could finance greater redistribution of income—for example, by means of an earned-income tax credit (EITC) that goes to middle-class as well as poor Americans. Yet another possibility could be greatly expanded direct or indirect public employment, paid for out of taxes on the rents that go to the rich. One beneficial side effect of greater public employment could be tight labor markets that raise the pretax incomes of private-sector workers.
Other methods would rely less on taxation and redistribution and more on structural changes in the labor and capital markets. Tighter labor markets, produced by the combination of the restriction of unskilled immigration and the growing ratio of retirees to workers, could raise market wages at the bottom, forcing affluent Americans to pay higher wages for service workers. Another alternative to redistributive taxation would be increasing the number of Americans who own shares in highly automated industries—either directly, through some form of universal shareholding, or indirectly, through the nationalization of some industries and the public provision of goods or the use of profits from government sales to reduce tax burdens on the majority. These and other methods to enlarge the middle class are radical but may be worth considering, if the goal is to prevent the good of productivity growth from generating the evil of plutocracy.
THE NEXT SOCIAL CONTRACT
In addition to devising new forms of stakeholder capitalism and utility finance, Americans need to construct a new social contract that is suited to the workforce and economy of the twenty-first century.
The social contract that crystallized after World War II combined four different, rival approaches. The social-insurance programs, such as Social Security, Medicare, and Medicaid, were administered by government and paid for chiefly by payroll taxes. Coexisting with this system of social insurance was another system of tax-favored employer-based benefits, of which the most important were employer-provided health care and employer-provided pensions. To complicate matters further, beginning in the 1970s, two other approaches were added: tax-favored private accounts—for retirement savings and other purposes, including health care—and tax credits for welfare purposes—of which the most important were the EITC, a subsidy to low-wage workers, and the child tax credit.
Changes in the economy and society have undermined all the elements of the American social contract other than simple, straightforward social-insurance programs. The employer-based health-care system is crumbling, because the rising costs of health-care provision in the United States have caused fewer and fewer employers to offer health care. Employer-based pensions are even further along the road to extinction, having been replaced either by nothing at all or by tax-favored individual retirement accounts like 40l(k)s or IRAs. Tax credits are popular among politicians, because they allow transfers to be hidden in the tax system rather than visible among direct appropriations, but a tax code riddled with tax credits must raise revenue with higher nominal rates, which generate political opposition.
If the system of employer-based benefits collapses entirely, the alternatives, if the safety net is not simply to be reduced, are an expansion of social insurance or an expansion of tax-favored private accounts or tax credits. Most conservatives and libertarians favor replacing Social Security with private savings accounts invested in the stock market and replacing Medicare and Medicaid either with vouchers in the form of tax credits or tax-favored health savings accounts.
These are bad ideas. After two stock market crashes in the first decade of the twenty-first century and the prolonged bear market of the Great Recession, it makes no sense to argue that Americans should be more rather than less dependent on the state of the stock market at the time of their retirement. Even worse, retirement-fund managers routinely and quite legally rob American investors in private plans by charging hidden fees, while the administrative costs of Social Security are much lower. Social Security provides a more stable source of retirement income in bad times as well as good. Its long-term solvency could be assured without significant cuts either by lifting the cap on payroll taxes paid by the affluent or by adding new revenue from other sources, such as general revenues or a new dedicated tax such as a value-added tax (VAT).
The idea of using competition based on individual health-care vouchers to reduce medical costs is a naive fantasy of right-wing ideologues; no modern society does that, because no modern medical sector functions as a free market. Indeed, the combination of vouchers with uncompetitive markets is a recipe for disaster. Unlike Social Security, Medicare can be thought of as a voucher system for health care, and student loans can be thought of as vouchers for higher education. As the cancerous growth of health-care prices and tuition prices in the United States demonstrates, vouchers without price controls encourage unchecked price-gouging by the providers of subsidized goods and services, such as American health-care providers and American universities. For practical and political reasons, it is impossible to turn health care and higher education into truly competitive markets with vast numbers of small providers. Like other natural monopolies or oligopolies, health care and higher education need to be turned into publicly regulated utilities, in order to prevent their providers from extracting excessive rents from a victimized public.
Of the mechanisms that other countries use to contain health-cost increases, the most important is “all-payer regulation”—in effect, price controls, set by the government in consultation with health-care providers and renegotiated every few years. This kind of regulation of rates is taken for granted in the United States in the case of electric utilities and local water systems. Americans need to treat the health-care sector as a public utility, with publicly regulated rates. If health costs are brought under control, then the aging of the US population by itself is predicted to add only a few percent of GDP in increased spending on Medicare and Medicaid in the next half century, something that can easily be managed.20
Notwithstanding the enthusiasm for pseudomarket solutions that have dominated Democratic as well as Republican thinking for decades, the conclusion must be that the best way to rebuild the American social contract would be to reduce or eliminate the rickety Rube Goldberg schemes of employer-provided benefits, private savings accounts, and tax credits, and replace most or all of them with a simple, streamlined system of universal social insurance paid for out of current taxation (not necessarily payroll taxation alone). Inasmuch as employer-based benefits, private accounts, and tax credits are all government programs, replacing them with social insurance would not replace “the market” with “big government”; it would simply replace inefficient, overcomplicated, and frequently unfair government programs with government programs that are more efficient, simpler, and difficult for special interests to manipulate.
AMERICAN IMMIGRATION: FROM NEPOTISM TO SKILLS
With the exception of the American Indians and descendants of American slaves, all Americans are the descendants of voluntary immigrants. In the past two centuries, the American population has been expanded and transformed by immigration, which will continue to reshape the nation in the generations ahead.
The major trend in the United States, as in other developed countries, has been a long-term trend toward falling birth rates, which are below replacement level for native-born white and black Americans. Only the above-replacement fertility of immigrants and their children keeps the US population growing.
During the bubble economy of the late twentieth and early twenty-first centuries, straight-line projections based on the high immigration and high immigrant fertility of the last generation led to estimates of anywhere between 400 million and a billion Americans by 2100. All such projections should be treated with caution, because even minor changes in immigration or fertility can produce major long-run differences.
Nevertheless, it is safe to predict that the United States will continue to choose to admit significant numbers of immigrants, as an alternative to allowing the population to shrink because of low native fertility. What criteria are used to select foreign nationals to work in the United States and become citizens has always been a matter of contention.
The goal of US immigration reform during the civil rights era in the 1960s was to replace a low-immigration, racist national quota regime that minimized non-European immigration with another low-immigration regime based on nonracist national quotas. It did not work out that way. Immigration based on family ties, which was expected to be minor, now accounts for the majority of legal immigration to the United States. By a sort of compound-interest effect, this has resulted in an ever-growing Latin American share of US legal immigrant flows, as the largest groups already in the United States can bring in ever-growing numbers of their relatives, in what is called “chain migration.” Because of the proximity of Mexico and Central America, illegal immigrants are also overwhelmingly Latin American in origin.
Nativists to the contrary, the assimilation and intermarriage rates of Latinos in the United States are comparable to those of European immigrants in earlier generations. The problem is that most of them, through no fault of their own, are poor and poorly educated. So were many of the European immigrants of the past. But they came to a country in need of farm labor or unskilled factory labor. Today’s unskilled immigrants enter a labor market that, even before the Great Recession, was producing mostly poorly paid jobs in the menial service and construction sectors.
In addition to lowering wages for native and naturalized competitors, unskilled immigration tends to retard productivity growth in an advanced industrial nation like the United States. By enlarging the pool and reducing the costs of unskilled labor, a high level of unskilled immigration warps the incentives of American employers, making it more rational for them to add unskilled workers rather than invest in innovative labor-saving equipment or innovative labor-saving techniques. As a result of Japan’s restrictive immigration policies, Japan is far more advanced in robotics than the United States, while Australian agribusiness relies far more on machinery than American agribusiness, with its never-ending supply of serflike labor from south of the border.
Meanwhile, the United States is competing with other low-fertility societies for talented immigrant scientists, engineers, scholars, and entrepreneurs. From Alexander Graham Bell to Albert Einstein, skilled immigrants have always benefited the US economy. While skilled immigrants may displace Americans or reduce their wages, the economy gains as a whole from the intelligence and enterprise of the best minds from other countries. The United States can always benefit from foreign-born talent.
Britain, Canada, and Australia have created point systems that award immigrants points if they speak English and are highly educated. As a result, most immigrants to those nations are highly skilled, while the majority of immigrants to the United States are unskilled immigrants, most of them family members of Americans. The United States should encourage skilled immigration, by creating a point system for permanent immigrants based on skills. The quota should not be so large that skilled American workers are displaced in great numbers.
At the same time that the quota for skilled permanent immigrants is moderately increased, temporary worker programs, such as the H1-B visa, that tie immigrants to particular employers, in a modern version of indentured servitude, should be scaled back or eliminated. The idea of granting legal permanent resident status to all graduates of US universities—“stapling a green card to every diploma”—should be rejected. That would only encourage the creation of diploma mills with no purpose other than allowing foreign nationals to purchase American residency and citizenship with their tuition fees. And existing programs that provide privileges to prospective immigrants who promise to invest in the United States should be abolished, not expanded. American citizenship should not be for sale.
While it can always be enlarged in the future if necessary to maintain an adequate population, in the near future the numbers of unskilled immigrants legally admitted to the United States each year should be reduced. Family-based immigration should be limited to immediate family members. The illegal immigrant workforce, which is largely unskilled, should be reduced by a combination of strict sanctions on employers with the help of a national ID card, tough border enforcement and, if necessary, a one-time amnesty for some illegal immigrants coupled with symbolic penalties for their violations of law. No immigration policy is possible unless immigration laws are enforced.
From the eighteenth century to the twenty-first, America’s immigration system has always been based on some form of nepotism—racial nepotism (“free white persons”) from the 1790s until the 1920s, then ethnic nepotism (the national quota system) from the 1920s to the 1960s, and finally family nepotism from the 1960s to the present. The American immigration system needs to be reformed, so that the main criterion for immigration is not race, or nationality, or kinship to particular American citizens, but the potential to contribute to America’s economy. Immigrants should be admitted to America on the basis of their talents, not their genes. In the words of President Lyndon Johnson when he signed the 1965 immigration reform act: “This is a simple test, and it is a fair test. Those who can contribute most to this country—to its growth, to its strength, to its spirit—will be the first that are admitted to this land.”21
STILL A LAND OF PROMISE
Every few generations, the familiar American republic falls apart and must be rebuilt in a generation-long struggle. To date, each American republic has provided more freedom and more opportunity than the one that preceded it. The First Republic abolished aristocracy and feudalism on American soil. The Second Republic abolished slavery. The Third Republic eliminated widespread destitution and sought to suppress the exploitation of wage labor. And each republic has used the technological tools of its era to create a more productive economy with gains shared by more Americans.
In the words of the stockbroker’s warning, “Past performance is not a guarantee of future results.” The United States could emerge from the trial of the Great Recession as a more productive nation with more widespread sharing of the gains from growth. Or it could go into relative and even absolute decline, losing its technological and industrial edge to foreign competitors and fissioning at home along the lines of caste and class. The United States could come to resemble the oligarchic countries of Latin America—or some of its own impoverished southern states. The American experiment could end in failure.
National renewal or national decline? The question will be decided by today’s Americans. In meeting the challenge, they can be inspired by those who successfully met even greater challenges in the past.
They can be warned by George Washington, who observed, in his circular letter to the states in 1783, that if the United States were to fail, then it “will be a subject of regret, that so much blood and treasure have been lavished for no purpose, that so many sufferings have been encountered without a compensation, and that so many sacrifices have been made in vain.”22 They can learn from Franklin Roosevelt, in his speech accepting his second nomination as president: “There is a mysterious cycle in human events. To some generations much is given. Of other generations much is expected. This generation of Americans has a rendezvous with destiny.”23
And Americans can find guidance in the words of Abraham Lincoln in 1862: “The dogmas of the quiet past, are inadequate to the stormy present. The occasion is piled high with difficulty, and we must rise—with the occasion. As our case is new, so we must think anew, and act anew. We must disenthrall ourselves, and then we shall save our country.”24