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The Coming End of American Triumphalism

J. Bradford DeLong

April 2000

1453 words

Today the conventional wisdom is that the American economy is by a wide margin the most successful economy of the industrial core. A business cycle expansion of extraordinary length, the lowest unemployment rate of any major industrial economy, no visible problems with inflation, relatively rapid productivity growth, high stock market values, and technological dominance of the most vibrant and rapidly-growing sectors of the economy. Once again the United States is--as Leon Trotsky wrote more than seventy years ago--"the furnace where the future is being forged" that is showing other economies an image of their likely future. Governing bureaucrats, politicians, business executives, and intellectuals are pondering how they can at lowest costs adopt and adapt the key economic institutions that underpin the past decade's triumph of the American economy.

But little more than a decade ago things were very different. About fifteen years ago there was a joke making the rounds, about three executives--American, European, and Japanese--about to be executed by terrorists and their last requests. The last request of the Japanese executive was to give a lecture on Japanese management techniques. The punchline of the joke was the last request of the American executive: to be executed immediately so as not to have to listen to another lecture about Japanese management techniques.

Fifteen years ago the "triumphalism" was Japanese economic triumphalism. Observers (including me) looked at Japan's extraordinary rate of investment, the high rates of return on investment in Japan to that date, the extraordinary competences of Japan's export manufacturing sector, and projected those trends forward. They--we--saw the extraordinary productivity of export manufacturing diffusing through the rest of the Japanese economy, and saw the leading edge of the Japanese economy gaining the same productivity edge in processors design, software, networks, and other highest-tech industries that they had earlier gained in industries like consumer electronics, metallurgy, and automobiles. Social solidarity, long-term loyalty, patient capital, a successful developmental state--these seemed to be powerful virtues worth imitating by all.

Today, however, the arms of the Japanese developmental state--MITI and MOF--are seen as having been unequal to their tasks, and unable to grasp the sitation of Japan in the 1990s. Long-term loyalty is seen as a lack of entrepreneurship. Patient capital is seen as a failure to respond to market signals. Social solidarity is seen as blocking the economic reforms that would bring the non-export manufacturing sectors of the Japanese economy up to a first-world standard of productivity.

The pendulum has swung remarkably far away from Japan in the past decade. But before this most recent swing, businesses and governments learned from Japan's economic miracle. The lessons about quality control and productive efficiency taught by Japanese manufacturing firms were painful ones, but the Fords and the Siemenses and the Hewlett-Packards learned.

And the pendulum will swing back, away from the United States economy.

The most likely way that the pendulum will swing back is through a decline--either rapid and short or slow and prolonged--in American stock market valuations and in the value of the dollar. Claims that current American stock market values are sustainable rest on a belief that attitudes toward risk have changed and that the marginal investor in the stock market now expects a Treasury bond-style rate of return from equities. But no one holding Cisco or Yahoo today does so because they anticipate that they will receive a Treasury bond-style rate of return from their investment. Substantial portfolio losses on American equities will make decision-makers all over the world allergic to praise of the American economy. An end to the net inflow of capital to America and a consequent substantial fall in the value of the dollar would substantially reduce the international purchasing power of American investors and companies, and lower their relative weight in the world economy.

Such a decline in the dollar value of American equities and in the international value of the dollar would not have to greatly disturb the fundamentals of American production and employment. The Federal Reserve could use its interest-rate tools to shift investment demand from sectors valuable in times of stock-market exuberance to sectors like construction where investment is profitable when interest rates are low, and a decline in the value of the dollar would eventually generate an export boom. Only if the Federal Reserve badly misses the mark--or if a substantial decline in the dollar is accompanied by the revelation that America's financial institutions have extraordinarily large and unhedged euro, yen, and sterling liabilities--will the American economy face problems of the same magnitude that the Japanese economy faced and has so far failed to surmount as a result of the end of its bubble economy a decade ago.

But even though an end to the period of irrational stock market exuberance and a high currency value supported by large-scale capital inflows will not--or need not--greatly disturb the fundamentals of American production and employment, it will bring an end to the willingness and eagerness of politicans and executives in other countries to learn from America. Cultural patterns and socio-economic institutions are stubborn things that change only under substantial pressure. And there is is a sense in which it would be too bad if the period of American economic triumphalism came to an end soon. For the lessons that the rest of the world economy's industrial core should learn from America's relative economic success in the 1990s have not yet been thoroughly learned, have not sunk in.

What are these lessons--analogous to the lessons about quality control, productive efficiency, and manufacturing organization learned from Japan more than a decade ago--that the rest of the industrial core should learn? I see four:

First, that governments seeking full employment can ease their task by providing large subsidies to businesses that hire relatively unskilled, low-wage workers. The expansion of the Earned Income Tax Credit--a program that directly boosts the wages of the working poor by having the government pay a substantial share--in the United States in the 1990s appears to have been a significant policy success, paying dividends not just in a lowered unemployment rate but a less unequal after-tax distribution of income.

Second, that there is more room for expansionary monetary policy to lower unemployment without raising inflation than anyone had believed. Economists will squabble for decades over whether the large reduction in America's natural rate of unemployment in the 1990s was the result of the end of inflationary psychology, the coming-of-age of the information technology sector, the growing experience of the labor force, or all three. But it is clear that the pattern of inflationary response to even minor monetary easing that has been feared by central banks since the 1970s is greatly weakened, or gone altogether.

Third, that in large part because of changing technology there has been an important shift in the efficient location of new technological development. The extraordinary economic success of the venture-startup system of Silicon Valley is not just a side effect of a stock market bubble, but is the result of a technology-driven decline in the relative competence of very large firms at tasks of developing (but not marketing) new technologies and new products.

Fourth, that it is possible to capture most of the benefits of large-scale integration and also most of the benefits of fierce economic competition if businesses are forced--either by the market or by regulatory authorities--to make their products conform to standards so that other firms' products work with theirs. If there is a lesson from the success of America's telecommunications industries over the past generation, it is that government regulation by the Federal Communications Commission that required firms to build products that other firms' products could connect with was extraordinarily successful. If there is a lesson from the success of America's personal computer industry, it is that the market's forcing nearly all hardware and software manufacturers to make their products first IBM and then Microsoft-compatible--so that nearly any program would run on nearly any microcomputer--created extraordinary value. And if there is a lesson from the internet boom, it is that the common http:// and .html standard open-sourced by Tim Berners-Lee was overwhelmingly more powerful than the closed-source proprietary online system architectures of Compuserve, of Prodigy, of Minitel, or of the original AOL.

Will the rest of the world economy learn these four lessons before the pendulum swings away, and people elsewhere cease for a time to look at America for models to imitate? I hope so.

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Professor of Economics J. Bradford DeLong, 601 Evans Hall, #3880
University of California at Berkeley
Berkeley, CA 94720-3880
(510) 643-4027 phone (510) 642-6615 fax

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