Strong Where It Counts Most

NEW YORK —  First a market crash, now a war: The economy has had a brutal 18 months since the Nasdaq composite passed 5000 in March 2000. The Internet turned into tulipmania; high-tech turned into high risk; now fanatics have desolated parts of lower Manhattan, stopped the U.S. airline industry in its tracks, caused hundreds of conventions to be canceled, emptied thousands of hotels and dimmed the lights on Broadway.

Confident market gurus who cheered the market up during the long bull market are clearly out of their depth; “Dow 36,000” isn’t where we are headed. The bullish argument about the American future looks shaky. High corporate profits seem a thing of the past, and academics are increasingly challenging the productivity data that underpinned Fed Chairman Alan Greenspan’s optimism about the economy’s growth potential. Mass layoffs and the highest number of new claims for unemployment insurance in nine years are undermining the incomes and confidence of hundreds of thousands of households.

The shock and horror of the terrorist attacks in New York and Washington deepen the gloom. Consumer confidence is sinking by the day; rattled investors are seeking signs of direction and asking if they can believe in anything.

The impact of the U.S. downturn on Asia and Latin America will be political as well as economic, and with Japan still hovering on the brink of a full-fledged depression, it is hard to overstate existing risks. Even so, the long-term outlook, both for the United States and the world, remains very strong. It’s a time for sober, thoughtful confidence.

That doesn’t mean the problems aren’t serious. In some ways, the global economic outlook is significantly worse than it was during the 1997-98 financial crisis. For the first time in a generation, Asia, the U.S. and the European Union face simultaneous downturns. With the United States temporarily unable to function as the locomotive of world growth, it is not clear how or when the economic outlook will improve.

For emerging economies, the outlook is particularly worrying. Asian economies remain dependent on exports, especially electronic and high-tech exports, to the United States and Japan. Argentina, Brazil and even Mexico look increasingly unstable. Despite its recent bailout by the International Monetary Fund, Turkey has been badly shaken by slow economic growth in Europe and turmoil in the Middle East.

The U.S. economy looks strong, for a number of reasons. First, despite the recent downward revisions to productivity growth estimates, the productivity of U.S. workers is increasing--and increasing fast enough to keep the economy as a whole growing at something close to our long-term historic rate of 3.7% a year. That means investors can have reasonable confidence that, on average, stocks will, over the long haul, perform at historic levels, meaning an average annual return of about 10%.

It also means that living standards--and the ability of consumers to buy new products and keep the economy moving--will continue to rise. As people become more productive, the value of their work increases, and they are able to command higher wages. The long period of stagnation in U.S. living standards that started in the early 1970s was linked to a slowdown in productivity growth. As productivity rebounded in the mid-1990s, standards of living also began once again to move higher. A recession may temporarily slow both productivity and wage growth; however, when the economy recovers its footing and starts to grow again, productivity and wage growth should kick back in.

Second, even taking Social Security into account, the finances of the federal government are strong. Currently, the national debt stands at 56% of gross domestic product. The United States can comfortably carry a much larger load. In 1945, the debt stood at 117% of GDP; in the 1990s, it rose as high as 67%. In neither case did the federal debt stop growth in its tracks.

This means that if we need to spend more money--to win a war against terrorism or simply to stimulate economic growth through tax cuts or new spending--we can. Even with the new and lower projections by the Congressional Budget Office, we can expect a budget surplus of $121 billion for the year. If we had to, we could run a deficit of up to 3% of GDP ($306 billion) for several years without any long-term adverse effects; in a real national economic or defense emergency, we could spend much, much more.

Third, while some gloomsters look at America’s dependence on foreign capital as a source of economic weakness, there are few signs that foreigners can or will take their money home, whatever short-term problems we may have. Our economy and market are too large for foreigners to stay out, and our capital markets and companies are too dynamic not to attract international investment. Europe, in any case, is at least as vulnerable to terrorism as we are, and Asia and Latin America are so dependent on U.S. markets for growth that few investors think their money will be safer outside the United States than in it.

Finally, and perhaps most important of all, the human capital of the United States represents a resource that has no peer in the world. Eighty-one percent of the U.S. population 25 years and older have a high-school diploma or higher; 25% of U.S. adults have a bachelor’s degree or better. Both these indices are at their highest levels in U.S. history, and they are still rising. Women and minorities continue to make educational gains, and hundreds of thousands of the brightest, most ambitious and hardest-working people in the world continue to flock into the United States each year.

Long term, there is no economy in the world whose prospects are as bright as those of the United States. Short term, the U.S. economy is entering a period of high government spending, low interest rates and falling energy prices. That combination is the best known way to get an economy moving again. At this point, the outlook for 2002 is about as good as it gets.