February 6, 2011
It is an enormous honor to be part of this conference from which I have already learned a great deal. One of the things I have learned is that Carlyle got it wrong when he called economics the dismal science. That term should instead be applied to national security studies.
And this is a remarkable collection of people gathered here. Talking about economics in the presence of my teacher, Stanley Fischer, is daunting. Talking about its relation to national security in the presence of my Obama administration colleague, former National Security Advisor Jim Jones, is daunting. And talking about anything in the past in the presence of my Harvard colleague Niall Ferguson is daunting as well. But I shall persevere.
Questions have been raised that are on everybody’s minds. And indeed there is much to worry about. But there always has been. Fifty years ago, I was six years old. Every two weeks my school had a drill where we all learned to crawl under our desks to protect against a possible bomb attack. At that time, President Kennedy believed that the United States economy would be surpassed by the Soviet Union by the mid 1980s – a belief that was supported by the leading economics textbook of the day.1
Such prophesies of American decline and consequent loss of global power proved wrong in the 1960s, and they have proved wrong again and again. They were wrong in the early 1970s when the collapse of the Bretton Wood system, Vietnam, rising inflation, and Watergate led to loss of confidence in America. They were wrong in the late 1970s when oil price spikes, Iranian hostages, and record interest rates led economists to decry our zero sum society,2 and an American President to declare a crisis of the national spirit.3 They were wrong in the late 1980s and early 1990s when it became a cliché contained in every issue of the 1991 Harvard Business Review that the Cold War was over and that Japan and Germany had won.4
I believe that prophesies of America’s decline today, rather than being self-fulfilling, will again prove self-denying, spurring the renewal that guarantees their falsity. America’s economy and the global economic situation in the years ahead will permit us to lead. America’s interest in prosperity and security will compel us to lead. And perhaps after exhausting some of the alternatives, America will find the will to lead.
The dynamics of renewal are underway in ways that may not be fully visible, but the historians will clearly mark. Consider first the dynamics of economic recovery. Others have spoken, powerfully, to the financial crisis that we have just been through. The stock market declined by more between October of 2008 and March of 2009 than it did in the six months following September of 1929.5 The same can be said for world trade.6 The same can be said for employment in the United States.7
Fortunately, we have learned from the Depression and we have learned from the ample history of financial crisis since that time. There was no reliance in the United States and in the many countries that followed the advice of the United States on the self-stabilizing forces of the market in time of emergency. Instead, all the pools of policy were mobilized on an unprecedented scale. Fiscal measures, monetary expansion, support for financial institutions, and direct provision of credit by government public investment, were mobilized to an unprecedented extent, to be sure.8
Problems that were not made in a day or a month or a year have certainly not been resolved yet. Unemployment in our country, in other parts of the industrialized world, remains far too high. And will for a substantial time to come. But the American economy is now on the mend and approaching escape velocity.
For the first time in five years I am more optimistic than the consensus forecast, and expect growth to exceed 3.5% this year. Unemployment has declined by .8 of a percentage point in the last two months alone.9 Corporate profits have increased by more than 60% in the last two years,10 despite business concerns about the direction of public policy. And those who invested alongside President Obama’s recovery program have earned more than an 80% return on the US Stock Market over the last two years.11 Taxpayers have now received essentially all the emergency funds extended to financial institutions backed, and in many cases have earned a substantial profit.12
What is crucial is that we maintain the momentum of this recovery. There are those who believe that the right focus at such a time shifts immediately to inflation. And with the developments in commodity markets we surely do need to be vigilant with respect to what happens at the price level.
But with unemployment still in excess of 9%,13 with substantial capacity unutilized in American business,14 with declining wage cost,15 and with robust productivity performance,16 this is not the time to alert for a lurch to inflation alarmism. It is a time to maintain a focus on ensuring that there is the demand that is necessary to assure growth and demand for exports, which is why President Obama has a goal. A goal in which we are ahead of track, of doubling US exports over a five-year period.17 Demand for investment, something that is difficult to achieve in standard forms of investment when there is excess capacity, but is readily available when there is technological improvement. After all, we have three computers in our basement, but I just bought an iPad.
The economy is recovering. And with that recovery is coming what is the cheapest form of stimulus in any economy, an increase in confidence. And with that recovery will come important changes in psychology.
Now to be sure, only part of the concern about America’s future turns on this financial crisis and the questions it raised about capitalism. The concern is also present that the United States has lost its capacity to lead, that the United States is a declining share of the global economy and will therefore have inevitably diminishing influence.
What I found striking in the GDP chart presented was actually the robustness of the American position. US GDP was very close to 50% of global GDP at the end of the Second World War.18 Over the subsequent 45 years, it fell rather dramatically from 50% to, according to the chart presented, 23%. Yet that is an event that we celebrate. We celebrate the Marshall Plan. We celebrate the reintegration of the defeated powers of Europe, of Japan, into the global economy. And what is striking is that having fallen from 50% to 23% between World War II and 1990, the division is strikingly small from 23% to 20% in the 20 years between 1990 and 2010.19
It was taken as a given 20 years ago that the other industrialized countries would catch up and would ultimately surpass the United States. And yet the reality is that the United States pulled away from the other industrial countries. Why? There are many parts of it, but I suspect it is the capacity that the United States had had, a capacity that I might say that I believe your country shares, to adapt to the knowledge and information economy. To an extent that I think is not fully appreciated, just as the world went through a transformation from an agricultural economy to an industrial economy, it is now going through a transformation from an industrial economy to a knowledge economy.
Less than 5% of the workers in the United States now work as production workers in US manufacturing firms.20 That is roughly comparable to where agriculture was 40 years ago.21 Instead, the major driver of value is increasingly knowledge.
I remember going to Russia at President Clinton’s request to speak about economic policy with the then Russian National Security Advisor. And I droned on about market forces and incentives and it was clear that he found nothing that I was saying to be of any interest to his situation. And then I said, and this did get his attention – I said, you know something, in the United States the Microsoft Corporation is worth more than the sum of all the automobile companies, all the steel companies, and all the aerospace companies multiplied by a factor of 1.5. And he said that couldn’t be right, and I showed him the appropriate table. And he didn’t know quite what to make of it, but he decided there really was something going on with respect to information technology.
Being one of the two countries in the world, Israel being the other, where you can raise your first $100 million before you buy your first suit, gives a nation a powerful competitive advantage in a knowledge economy. And we have benefited from that. Benefited from that in pure economic terms.
General Motors now employs less than a 150 thousand people.22 There are 800 thousand people engaged as their job in transacting on eBay.23 And we have benefited in a much broader way.
Six years ago Mark Zuckerberg was a Harvard Junior who did not go to class. Today Facebook has 600 million users around the world,24 fifty percent of whom were on Facebook yesterday25 for an average of a half an hour. And Facebook is worried about rising competitors who might displace it from its position of strength. As one thinks about the future of nations and their economies, think about that.
Another challenge has been raised with respect to the American economic position. And that is the level of American debt. The first thing to say is that if you as a nation have the opportunity to make investments in companies like Facebook, if you have the opportunity to make investments like the renovation of the American infrastructure, that is not where it should be, and somebody is prepared to lend you money for 30 years in your own currency at 3.5%, there are less rational things to do than to take advantage of that opportunity to borrow. I, for one, would rather live in a country that capital is trying to get into, than a country that capital was trying to get out of.
Now for sure, the US is doing the right thing by assuring that there is public investment, that there is public borrowing to support spending, in the current cyclical moment when borrowing by our households has collapsed, and when borrowing by your businesses has sharply declined.
But our fiscal position is not sustainable without further adjustment. There are differing estimates as to just how large that adjustment is. But a consensus estimate would be that adjustments are needed of between 2% and 3% of GDP if the US debt to GDP ratio is to be returned to a declining path.26
How much is that? It’s about a quarter of the investment necessary in the European countries that are in serious trouble. It is about a third of the magnitude of the fiscal adjustment accomplished by the United States during the Clinton years.27 And speaking under the authority of two former leaders of the IMF, I can say that it is a relatively limited adjustment by historical standards.
We have the room to make that adjustment. The most important determinant by far of the US fiscal position is what’s happening on healthcare costs. And with US healthcare costs running at 17% of GDP, 50% more than they are in any other major country in the world,28 we have the capacity to realize economies in healthcare.
Frankly, it was inconceivable that that capacity would be realized as long as 50 million people were without health insurance, because any move to cost cutting and economy would be certain to fall on those unfortunates. We now have a framework in place, to be sure not a self-executing framework, but a framework in place, that offers the prospect for reductions in healthcare spending, and its trend growth.
We have, for the first time, bipartisan recognition of the reality that our retirement programs will need to be adjusted for the fact that people are living longer.29 And we have, in a little remarked, but fundamentally important development, a bipartisan recognition that so-called tax expenditures, subsidies contained in the tax code,30 are a kind of expenditure, rather than a kind of tax. And therefore, the alleviation, the removal of those subsidies is not properly thought of as a tax increase, but as an expenditure reduction.
All of these building blocks, I believe, suggest that as the economy recovers, as the government’s borrowing is no longer a supplement to lagging private borrowing, but a competitor for private borrowing, the political consensus for fiscal action will, I am confident, emerge. And as that development emerges, this too, will be a further contributor to US confidence.
More and more of the economy is becoming more and more anchored in knowledge and information technology in which the fastest rates of growth are recorded. This suggests the likelihood not of the exhaustion of growth opportunities, but the real and plausible prospect for the acceleration of growth opportunities.
Now a third important concern was raised, and it is a crucial question in looking at the global economy. Which is the rise of emerging markets. Now to be sure, those nations that had been seen as likely to surpass the United States, the Soviet Union in the ‘60s, the other industrial countries in the late 1980s and the early ‘90s, no longer seem the economic threats that they once did. And no one can fail to recognize the significance of what is happening in emerging markets in general, and in China where a fifth of humanity lives in particular.
Here’s one way to think about it. On the most generous rating of the statistic, standards of living in cutting edge societies doubled between the time of Pericles in Ancient Greece and London in 1800, 2300 years.31 Standards of living and the period of the most rapid US economic growth doubled in a single human life span,32 then about 45 years around the beginning of the 20th century.33 And growth is preceded in China for the last decade at a rate where standards of living double in a single decade.34
China has emerged as a major force in the global economy, and it will be a central task for all nations to assure that that is an opportunity and not a burden. But again, I ask you, is the United States poorer because Germany and Japan recovered?
I live in the city of Boston in the United States. The south of the United States has recovered on a substantial scale over the last 40 years, driven by the spread of technology, driven above all else by the presence of pervasive air conditioning35 that has made it a far more attractive place to locate and produce. Has that made Boston poorer, or has that made Boston richer? I think it has made Boston richer.
There is no reason why the success of emerging markets need threaten the prosperity of those who are in industrial countries. At the same time I think it is easy to reach judgments that look rather foolish in retrospect with respect to countries that have grown rapidly recently.
One of the largest differences between what economists know and what most observers of economies believe, is that extrapolative forecasting doesn’t work. You can array all the countries in the world, and you can look at their growth rate in one decade, and you can look at their growth rate in the next decade, and you will find that everybody thinks that the countries that grew very fast in the last decade are sure to grow very fast in the next decade. And then you can look decade after decade, the 60s, the 70s, the 80s, the 90s, the first decade of the 21st century, what that correlation is. And it is very close to zero. And so we need not to assume that past is necessary prologue36– that a society beset by environmental problems, rising expectations, problems of governance and corruption, and financial bubbles will, with certainty grow in the future as it has in the past.
And if you remember only one thing from what I say, remember this. Look in on those most recent IMF statistics or the CIA’s World Fact Book, or any of the people who access these matters. Look at Chinese standards of living. And then go back and calculate at what moment America had the same standard of living. There are different ways of doing the calculation, and you can do it at purchasing power parity, or you can do it using the exchange rate.
If you work very hard to do it in a way that flatters China, you will conclude that China has the standard of living that United States had in 1930. If you do it in a more straightforward way, you will conclude that China has a standard of living like that in the United States at the beginning of the 20th century.37
Now to be sure there are all kinds of problems of measurements, and China has all kinds of capacities starting with missiles and weaponry that nobody could have dreamed of in the 20th century. But to suggest that this is a transcendent threat to America’s prosperity or America’s capacity to have substantial influence in the world is, I think, quite unlikely.
We saw this in a way in the last three weeks. People were very concerned with what was happening on the street in Egypt. They were very concerned with what was happening within the Egyptian military. And they were very concerned not with what the reaction was in Europe, or in Beijing, or at the United Nations, but what the reaction was in Washington. And Washington saw itself as having an obligation to respond.38
So I would suggest to you that those who believe that the United States does not have the capacity, the economic strength to respond to global events, may be making a very serious mistake. There is still the question, and it is perhaps the most fundamental one of all of whether or not the United States, even if it has the capacity, has the will it has had in the past to lead.
To be sure the last was not an easy decade for our country. It was a decade of hubris abroad followed by humbling through the financial crisis at home. And therefore there is the fear that gridlock at home, and disengagement abroad will be what follows. Those are real risks. Those are the things that people prophecy. Prophecies that I believe will be self-denying.
What about gridlock? You know, you can argue – people surely do and will for a long time, argue about the substance of the policies President Obama has pursued domestically. What you cannot argue with is that the first two years between 2009 and 2010 of his administration were the most productive period for the production of consequential legislation in the last 40 years.
It was expected that following the election, an election in which the President’s party surely did not do as he would have wished, that there would then be gridlock and it would be impossible for anything meaningful to happen in what we always call the Lame Duck session of our Congress. And yet substantial fiscal legislation that was important to the upward revision of the economic forecast that I have described was passed.
The most vexing issue in American politics, one of the most vexing social issues in American politics, the question of gay soldiers in the military was resolved.39 And the most important arms control agreement in well over a decade was passed.40 And this in what was regarded as a Lame Duck session.
Some suggest that that was the last hurrah for American policy and hold out the protest that with divided government, the Republican leadership in one party, nothing important will happen. This is a hypothesis that has been carefully studied by political scientists. And if anything, the evidence suggests that because doing painful things requires more than one hand on the dagger, that periods of divided government are more productive in terms of the ability to make painful adjustments in our national path.41
So, yes, the concern, the fear, the challenge, are appropriate. But gridlock is, I believe, not the right prediction for the years ahead.
What about the suggestion that United States will turn inwards and not take its global responsibilities seriously in the years ahead? Surely this judgment will be something that will depend upon how the economy fairs. If, as I’ve explained, the economy recovers, if the economy expands, America’s self-confidence and its capacity for global action will be enhanced in the years ahead.
There are some things that Americans do understand. Terror has no address, but it does have well understood roots in depravation and frustration – and that policies that address that frustration and give all a chance to participate in the global economy and that support the continuous openness of markets are availing.
If you think back over the last two years, what is remarkable is not that the US-Korea Free Trade agreement has not passed yet.42 What is remarkable is that after six months when world trade declined more rapidly than it ever has, with the worst economic downturn, with the first year of global GDP decline since the Second World War,43 that there has been essentially no systematic move towards protection. The global markets have remained open. What is remarkable is that the openness brought about by improvements in communication and transportation technology that dwarfs what’s achievable through legalistic agreements has actually been allowed fully to continue.
Complexity is necessary for prosperity, but it also produces vulnerability. Nowhere is this truer than in the energy area. A good rule in life in forecasting financial crisis, in forecasting developments in the national security and political sphere, and I would suggest with respect to technology, is that as my late teacher Rudi Dornbusch used to say, things take longer to happen than you think they will. And then they happen faster than you thought they could.
And I suspect that that may happen in the energy area. We have been vowing progress on reduced dependence on oil and in particular Middle Eastern oil for the better part of half a century now. The combination of most important fossil fuel development in 40 years, pervasive discoveries including in the United States of natural gas, substantial technical changes on the energy use side,44 particularly with respect to the use of electricity and natural gas in vehicles, and progress in a variety of new technologies on the production side leads me to expect that 15 years from now people who look at the oil dependent statistics are going to be quite surprised by the progress that has been made.
And finally there is an awareness, and an awareness that my former colleagues in the administration have very deeply – and I think it is an important awareness but one that sometimes complicates the interpretation from the outside of what is being done – that power is like capital. Invested prudently it grows. And invested unwisely it is lost.
The most important difference between negotiation and the achievement of objectives in the private and in the public realm is this – in a private negotiation no aspiration is unacceptable. The more ambitious the aspiration the better the starting point for the negotiation.
It is very different when you negotiate in the public realm. An excessively ambitious aspiration can sacrifice legitimacy. The quality of outcomes is judged not just by the outcome, but the difference between the outcome and the stated aspiration. And that is why the management is so very difficult. And it is why those who wish to enhance their power choose which of the many objectives that they desire it should be devoted towards. I believe that is the approach the United States has taken and will continue to take in the future.
Now to be sure, I have sketched the optimistic view of the future. Perhaps in some places I have substituted prescription for description. And no one can know with confidence what the future will bring. And there can be no certainties.
But I would suggest this aspect of the United States stands out and it is another respect in which we are bound to our country – we are a fractious democracy. Fractious democracies are not always satisfying to watch. They sometimes move too slowly. But they have a very important virtue. A virtue that is increasingly important in an ever more complex and an ever more changing world. And that virtue is resilience. And it is the resilience of American society that is the reason that all those fears that people had when I was six years old huddled under a desk were wrong. And it is the reason why I believe most of the prophecies of American decline will prove to be self-denying once again.
Thank you very much.
1 Steve Forbes, “Copernican Revolution Coming to Economics,” Forbes Magazine, January 17, 2011.
2 Rich Karlgaard, “Zero-Sum Fallacies,” Forbes.com, July 23, 2007 12:00 AM.
3 Jimmy Carter, Speech: Crisis of Confidence, July 15, 1979.
4 Harvard Business Review, January-December 1991, available at http://hbr.org/archive-toc/3911.
5 Dow Jones Industrial Average (1900 – Present Monthly), available at http://stockcharts.com/charts/historical/djia1900.html.
6 World Trade Organization; United Nations, Historical Data 1900-1960 on international merchandise trade statistics, April 28, 2009.
7 Bureau of Labor Statistics, Unemployment rate 1948-2011; Pedro Schwartz, The long-term legacy of the 1929 crisis, European Ideas Network Seminar, January 27, 2009.
8 Supeed Reddy, “The New Old Big Thing in Economics: J.M. Keynes,” Wall Street Journal, January 8, 2009.
9 Bureau of Labor Statistics, “The Employment Situation- January 2011,” February 4, 2011.
10 Bureau of Economic Analysis, “Table 6.16D: Corporate Profits by Industry,” January 28, 2011.
11 Dow Jones Industrial Average 2009-2011, available at http://finance.yahoo.com/echarts?s=%5eDJI+Interactive#symbol=^DJI;range=2y.
12 David Cho, “U.S. take if it sells its Citi stake to settle cost of bailout: $8 billion,” Washington Post, March 27, 2010.
13 Bureau of Labor Statistics, supra note 9.
14 Federal Reserve, Statistical Release: Industrial Production and Capacity Utilization, G.17, February 16, 2011.
15 Bureau of Labor Statistics, Employment Cost Index 2001-2010, available at http://data.bls.gov/pdq/SurveyOutputServlet?data_tool=latest_numbers&series_id=CIU1010000000000A
16 Bureau of Labor Statistics, Economic News Release: Productivity and Costs, Forth Quarter and Annual Averages 2010, Preliminary, available at http://www.bls.gov/news.release/prod2.nr0.htm.
17 Helene Cooper, “Obama Sets Ambitious Export Goal,” New York Times, January 28, 2010.
18 Deanne Julius, “US Economic Power: Waxing or Waning?”, Harvard International Review, August 23, 2006.
19 World Economic Outlook, “US GDP based on PPP share of world total,” EconStats, available at http://www.econstats.com/weo/V012.htm.
20 Bureau of Labor Statistics, “Occupational Employment and Wages,” May 14, 2010.
21 United States Department of Agriculture, “The 20th Century Transformation of U.S. Agriculture and Farm Policy,” June 2005, available at http://www.ers.usda.gov/publications/eib3/eib3.htm.
22 Bill Vlasic & Nick Bunkley, “The Last Holdouts Cast Their Lot With G.M.,” New York Times, May 20, 2009.
23 John Kador, “10 Tips for Bootstrapping Your Technology,” Inc., June, 3, 2010, available at http://www.inc.com/guides/2010/06/tips-for-bootstrapping-your-technology.html.
24 Jessica Guynn, “Facebook hits 600 million users, executive says,” Los Angeles Times, January 24, 2011.
25 Facebook.com, Pressroom: Statistics, available at http://www.facebook.com/press/info.php?statistics.
26 Ben S. Bernanke, Speech: The Economic Outlook and Macroeconomic Policy, February 3, 2011.
27 Per Gunnar Burgland & Matias Vernengo, “A Debate on the Deficit,” Challenge, November/December 2004.
28 Toni Johnson, Healthcare Costs and U.S. Competitiveness, Counsel on Foreign Relations, March 23, 2010.
29 Jonathan Weisman and Damian Paletta, “Majority of Panel Backs Deficit Plan,” Wall Street Journal, December 4, 2010.
30 Mark Feldstein, “The ‘Tax Expenditure’ Solution for Our National Debt,” Wall Street Journal, July 20, 2010.
31 John Maynard Keynes, Essays in Persuasion, New York: W.W.Norton & Co., (1963)
32 Richard H. Steckel, “A History of the Standard of Living in the United States,” available at http://eh.net/encyclopedia/article/steckel.standard.living.us.
33 Laura B. Shreshta, Life Expectancy in the United States , CRS RL32792, August 16, 2006.
34 Nin-Hai Tseng, “China is richer, but most Chinese are still poor,” CNNMoney.com, February 17, 2011; Central Intelligence Agency, The World Factbook, available at https://www.cia.gov/library/publications/the-world-factbook/geos/ch.html.
35 Larry J. Griffin and Don Harrison Doyle, The South as an American Problem, University of Georgia Press (1995)
36 Lant Prichett, “Understanding Patterns of Economic Growth: Searching for Hills among Plateaus, Mountains, and Plains”, The World Bank Econ Rev (2000) 14(2): 221-50.
37 Steckel, surpa note 32; Tseng, supra note 34; Central Intelligence Agency, supra note 34.
38 Hans Nichols and Mike Dorning, “Obama’s Words Put to Test in U.S. Response to Egypt Anti-Mubarak Uprising,” Bloomberg, January 31, 2011.
39 Nathan Hodge, “Senate Passes Bill to Lift Military Gay Ban,” Wall Street Journal, December 18, 2010.
40 Julian E. Barnes and Naftali Bendavid, “Senate Ratifies Nuclear-Arms Pact,” Wall Street Journal, December 23, 2010.
41 David R. Mayhew, Divided We Govern, Yale University Press (1991).
42 Elizabeth Williamson, “U.S.-Korea Pact Hinges on Autos,” Wall Street Journal, December 3, 2010.
43 Central Intelligence Agency, The World Factbook, available at https://www.cia.gov/library/publications/the-world-factbook/geos/xx.html.
44 Angel Gonzalez, “Exxon Sees Burgeoning Demand for Natural Gas,” Wall Street Journal, January 27, 2011.