The All-American Consumer Who Made World Safe for Selling

Seven years ago, in his 1981 state-of-the-economy address, President Reagan told the American people, “We’re in the worst economic mess since the Great Depression.” The federal budget, he said, was out of control and America faced runaway deficits.

It was an ironic prediction. The highest federal deficit since World War II had been 4.5% of gross national product in the 1975 recession during the Ford Administration. Reagan surpassed that in his first supply-side budget; so that in last Monday’s State of the Union message he was pleased to point out that during the past year “the deficit itself has moved from 6.3% of the GNP to only 3.4%.” Otherwise, the message was the same in 1988 as in 1981: Government is too big and spends too much money.

Good rhetoric. Bad economics. In 1981 the President lamented that between 1960 and 1980 the national debt had increased from $284 billion to $934 billion; what he failed to say was that during the same period GNP went from $515 billion to $2.732 trillion--the debt had declined from 55% to 34% of the GNP. Despite the inception of such major programs as Medicare, federal spending had increased only from 17.1% to 19.25% of GNP. During the 1970s, while government and private sectors were simultaneously expanding in Germany and Japan, the private sector was growing at twice the rate of government in the United States.

Japan is the only competitive nation where the central government taxes less than the United States (when state and local taxes are factored in, the aggregate is virtually the same), and many European governments impose taxes twice as high, or higher, than the federal government. In 1985, for example, the French government revenues were 42.2% of GNP, the British 37.9%, the German 29.2% and the United States 19.8%.

Furthermore, before 1981 the U.S. government was running lower deficits than the Japanese, Germans and almost every other industrial nation. Economists generally regarded America as fiscally conservative, with the Democrats even more prudent than the Republicans. Harry S. Truman averaged an annual surplus of 1.5% of GNP; Dwight D. Eisenhower’s deficit averaged 0.15%; John F. Kennedy and Lyndon B. Johnson’s 0.34%; Richard M. Nixon-Gerald R. Ford’s 2%, and Jimmy Carter’s 1.6%.

“The worst economic mess” was not so much a mess as a ferment, part of the rapid global evolution for which the United States had been the principal catalyst since 1950.

Except in the early 1900s, when the United States, Great Britain and Germany were on a rough parity, there had always been a world industrial leader. Yet before the 1950s, there was only one nation with a highly sophisticated consumer economy: the United States. Now, however, not only are Japan and Germany hard in competition, but a host of other nations are participants in an increasingly fractured industrial world. The oil shock of 1973 ended the halcyon days of the U.S. economy and steady improvement in the U.S. standard of living. The creation of the Organization of Petroleum Exporting Countries was to a large extent a reflection of the oil-producing nations’ reaction to the erosion of the dollar--the currency of world oil trade--and, consequently, their earnings, as well as the transition from a world economy dominated by American companies to one of multinationals and transnational organizations.

Domestically, it marked the beginning of “stagflation.” Between 1961 and 1973, total disposable income in real (not inflated) terms had increased 71.6%, average weekly earnings (in 1972 dollars) rose from $167 to $198 and annual disposable income per capita for Americans in the labor force (including the unemployed) went from $6,961 to $9,481. This, despite an increase in the combined tax burden (federal, state, local and Social Security) from 14.8% to 18.2% of personal income.

In contrast, from 1973 to 1982--as the tax burden continued rising to 19.9%--total disposable personal income increased only 22.4%, average weekly earnings slipped back to the 1961 level and per capita labor force disposable income declined slightly.

Concurrently, the baby boom enlarged the labor force by 20.7 million (a faster pace than from 1961 to 1973, when it had grown 18.8 million). While the burgeoning labor force depressed wages in lesser-skilled, less-unionized jobs, the demand created by the baby-boomers generated surging land and housing prices, adding to commodity inflation. Consumers compensated by forming more two-earner households, in effect increasing their spending power and placing additional pressure on prices and, particularly, interest rates. Although interest rates reached historic highs, their rise was outpaced by inflation, so that the rates were in reality moderate and in some periods even negative. So with money losing value and everything else gaining, the entire economic orientation was toward buying now and paying later with deflated dollars.

President Reagan’s 1981 assertion, “We know now that inflation results from all that deficit spending,” was a then-popular view that proved all too simplistic in a world of ever-more-complex interacting forces, and one that presumably has since been put to rest. As Nobel laureate James Tobin points out, inflation has a variety of causes.

In international transactions, the ‘70s produced a rough equilibrium; the dollar stabilized as other nations were damaged more than the United States by high commodity prices and inflation, and those countries turned to satisfying more of their own consumer wants. The United States, nevertheless, remained the epitome of consumerism. While other industrial nations might produce more cheaply, none equaled the United States in the efficiency of distribution and discounting. Most other nations, furthermore, imposed a turnover tax to discourage domestic consumption while favoring exports.

Yet the President’s tax-incentive supply-side solution to stagflation had the kind of royal road-to-riches appeal that is difficult to resist: holding down prices by increasing production through reducing taxes, while raising government revenues as a result of greater economic activity. Certainly the tax incentives, combined with the major increase in defense spending, had a stimulative impact on the economy, but the results were mixed. Average weekly earnings--remaining at approximately $170 in 1972 dollars--did not improve. The tax burden declined only marginally, from 19.9% to 19.6% of personal income. But total real disposable income (discounting inflation) rose 22.5% between 1982 and 1987, close to double the rate between 1973 and 1982.

This boost to American consumerism unbalanced the tenuous equilibrium between consumption in the United States and the rest of the world, which lacked similar stimulus. And with imports of consumer goods running more than twice exports (42% to 18% of external trade in 1987), consumerism itself may have more to do with our foreign-trade problems than the value of the dollar.

What has happened in the automobile market, by far the most important economic sector, is instructive. The greatest increase in the prices paid by Americans for foreign cars occurred before, not after, the dollar’s fall. In 1981, Americans spent an average of $8,619 on a new domestic car and $8,471 on an import. By 1985, at the peak of the dollar’s value, they were paying $12,719 for an import and $11,870 for a domestic. In 1987, after the dollar’s fall, the differential was only $191 more: $14,387 for the average import, $13,074 for a domestic. And though higher prices were responsible for a 200,000 drop in Japanese sales in 1987, these were more than made up by a 300,000 increase in Hyundais from South Korea.

As Nobel laureate Milton Friedman suggests, there are other factors than the value of the dollar at work--primarily the import quota worked out by the Reagan Administration with the Japanese. “We essentially pressured them to establish a government cartel that would keep down the number of cars,” said Friedman, “as a result of which they were able to get a higher price. They liked it enough so that when in 1985 the United States said we didn’t mind if they eliminated the voluntary quotas, they said, ‘Oh no! we’re going to continue.’ ” Both foreign and domestic producers took the opportunity to increase the average sales price by some $5,000 at a time of sharply declining inflation, earning record profits for the U.S. automobile industry and huge bonuses for management. What is clear is that future U.S. economic performance will depend on the real value of its products far more than on monetary manipulation or artificial devices such as tariffs, quotas and subsidies. What is noteworthy about Japan is that the government has consistently emphasized long-term development and gain over short-term profits, in marked contrast to American industry, where managers must continuously justify themselves on quarterly statements.

We cannot expect to make other nations over in our image, and while American culture has made a special impact on the world since World War II, societies remain structurally diverse. A large part of U.S. trade difficulties would disappear if all agricultural barriers and subsidies were to be removed. Yet every nation has an emotional commitment to its farmers--in Japan, rice has had mystic significance and was once a measure of value equivalent to gold--and none, given the vagaries of international diplomacy and power politics, will put itself at the mercy of another for a major part of its food supply. Nor can we redraw the world; other industrial nations have less land area and are more urbanized than we, with people living in smaller units on congested streets. The two- or three-car family is no more practical in Tokyo or London than in Manhattan, and makes no sense when there is efficient public transportation. So even if American cars and other goods were suddenly to become cheaper in Japan than Japanese wares, there are limits to the kind of rampant consumerism prevalent in the United States.

What we must do is examine ourselves, our inefficiencies and self-indulgences. Despite current U.S. economic difficulties, no nation in the world has better or brighter prospects. We are the only one that comes near self-sufficiency, with all the independence of action and power that implies.

The Japanese and other major Asian economies must import most of their commodities and can only prosper through the value added in production and re-export; they are naturally more cautious to take measures to stimulate their own consumption. The Germans are at the point of a declining population and work force; they see no self-interest in stimulative measures that would put pressure on labor availability, risking inflation and an unfavorable balance of trade.

In the fast-changing climate of global economics, it was the Germans, less than six years ago, who were running deficits, raising alarms as clamorous as those in the United States today.

Meanwhile, trying to deal with the other part of the twin deficit, President Reagan has once again called for “a constitutional amendment that mandates a balanced budget.” Yet as economist Robert Eisner has pointed out, a balanced federal budget would be a prescription for recession. The problem is that starting in the 1970s, state and local governments began piling up substantial surpluses. Whenever these exceed the federal deficit, as in 1973-74 and in 1978-79, they have a depressing effect; whenever government takes more money out of the economy than it puts in, it tends to reduce consumer purchasing power.

The downfall of the Carter Administration and the election of Reagan came about in part not because government was spending too much, but too little or--depending on how you look at it--because it was taxing too much. Indeed, the approximately $1.03 trillion deficits of the first six Reagan budgets (1982-87 fiscal years) have been offset more than 30% by the $313 billion state and local surpluses. Given the current fiscal situation in the United States, it is questionable whether it would be prudent to reduce the federal deficit below about $70 billion or $80 billion annually; Gramm-Rudman may be nearer a desirable target than is generally recognized.

Overall, the economists interviewed for this series of articles are concerned about the near-term but upbeat about America’s long-range future. Allen Sinai, chief economist for the Boston Co. Economic Advisers Inc., said last year, “In 1989 we’re expecting a much weaker economy. We can’t sell our debt and keep interest rates low at the same time. So if the Federal Reserve fights the market by running a low-interest rate policy, eventually it will actually be worse. We’ll have higher inflation and higher interest rates, which will wind up ending our expansion.”

MIT economics professor Rudiger Dornbusch summed up, “If you look at the Reagan Administration, you would have thought the vengeance would come much earlier; and now we aren’t really sure there’ll be a vengeance. We have a very narrow margin now to have a nice soft landing. But with any luck and further dollar depreciation, the U.S. economy will do extremely well, and much, much better than Europe.”