One of the great mysteries of our time seems to be why the U.S. economy is so good. An article on the front page of the Wall Street Journal not too long ago summed it up nicely: "Pinch me," the reporter wrote. "A lot of good things are inexplicably happening. The economy tops the list. Economists remain mystified why."
What factors brought about this relatively blissful economic state--this decade-and-a-half-long expansion that began during Ronald Reagan's first term? And will those factors continue to operate in the future?
John Maynard Keynes and Adam Smith
A little more than sixty years ago, in his influential book The General Theory of Employment, Interest, and Money, John Maynard Keynes addressed the question of the necessary conditions for economic prosperity. Although much of what passes for Keynesian economics today is of dubious worth, Keynes was a perceptive thinker, and a number of his earlier insights have been forgotten. For anyone familiar with the jargon in today's academic economic journals, perhaps the most striking thing about The General Theory is how much of it is written in clear, eloquent English, with virtually no use of mathematics.
Keynes argued that a large part of our economic activities "depend on spontaneous optimism rather than on a mathematical expectation, whether moral or hedonistic or economic." He went on to write that "most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits--of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities." Further, he argued, "if the animal spirits are dimmed and the spontaneous optimism falters enterprise will fade and die." He concluded with this: "Economic prosperity is excessively dependent on a political and social atmosphere which is congenial to the average business man." Another, even more famous economist, Adam Smith, expressed much the same view some 180 years earlier, in 1755, when he wrote that "little else is required to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice; all the rest being brought about by the natural course of things."
Ten Factors That Cause Economic Prosperity
For some time now I have been compiling a list of what I think are the fundamental factors that can have a powerful effect--either positive or negative--on our economic prosperity. So far I have ten factors on the list. The first three on the list, and perhaps the most important, are the requisites for prosperity that Adam Smith observed in 1755, namely, peace, justice, and easy taxes.
Number One The most important fundamental factor driving the new prosperity of the past fifteen years is the disappearance of the threat of an all-out nuclear war between the Soviet Union and the United States. The absence of the threat of nuclear war stretches out people's time horizons. If they believe that they will live longer, their personal discount rates decline, which will be reflected in a downward trend in long-term interest rates.
Some intriguing, though little noticed, studies have been done on the relationship between personal savings rates and the fear of nuclear war. In the September 1993 issue of the American Economic Review, two professors, Joel Slemrod of the University of Michigan and Bruce Russett of Yale University, found that a decreased fear of nuclear war is likely to increase personal savings, which is likely to decrease long-term interest rates. And low long-term interest rates are good for economic prosperity.
Number Two The next item on the list is the mushrooming growth of capitalism throughout the world. In terms of justice, capitalism is the most just system for business ever devised. Private property and the rule of law create an environment that simply does not exist in any statist society.
Number Three The third item on the list is easy taxes. The recent tax increases by Clinton and Bush have tended to make us forget just how high tax rates used to be. When President Reagan took office in 1981 the top marginal personal income tax rate was 70 percent. We have retreated a bit from the low tax rates of the mid-1980s, but, compared with where we were before we began the fifteen-year prosperity ride we are now on, tax rates are still relatively low.
Number Four Fourth on the list is the computer/communication revolution. Powered by spectacular technological progress in communications and computers, the entire world of business and finance has been compressed and speeded up. It is as if someone had a big can of WD-40 (the all-purpose lubricant) and was spraying it on the machinery of free enterprise, making all of it hum and whir with increasing efficacy. The personal computer, cellular phones and pagers, faxes and copying machines, and now the Internet--all of them are great for prosperity.
Number Five Next on the list is the control of government spending. During the past fifteen years this has been the most intractable and disappointing part of our economic policy, but even this now seems to be coming under better control. Primarily due to defense cuts that flowed from winning the Cold War, the federal deficit has been reduced this year to 1.4 percent of our gross domestic product, the lowest level in more than twenty years.
Number Six Then there is the government regulation of business. Overall, the onset of new government regulations slowed considerably over the past fifteen years. There was even a significant amount of deregulation. Remember when the controls on gasoline and oil were lifted in 1981--and the gas lines miraculously disappeared? Except for a brief flirtation with turning our health care system over to federal control in 1993, the days of big new government regulations appear to be over.
|The most important factor driving the new prosperity is the disappearance of the threat of an all-out nuclear war|
Number Seven Monetary policy is next on the list. During the past fifteen years our country has been blessed with two of the best leaders the Federal Reserve System has seen: Paul Volcker and Alan Greenspan. Overall, monetary policy has been stable and predictable and inflation has been low.
Number Eight On my list of things that lift the "animal spirits" is something that, if done properly, is barely noticed. That is policy consistency.
The past fifteen years or so have not seen a totally consistent economic policy, but, compared with what we saw in earlier decades, it has--overall--been very, very good. The control of government spending has improved, tax rates have stayed close to the low levels set in the early 1980s, regulatory pressure has eased, and monetary policy has been superb and steady.
Number Nine The next item on my list is our stock of capital. Any nation's level of prosperity depends on the base from which it began. During the past fifteen years an enormous amount of wealth has been added to America's economic base. Our stock of factories and homes, of schools and roads and every other kind of tangible asset you can think of has increased tremendously. Our intellectual capital has increased perhaps even more, especially in such critical areas as computer technology and software. The base of our industrial machine dwarfs that of any other nation on earth.
Number Ten The last point is superiority. In this new global economy the United States economy may not be perfect, but, taking all relevant factors into consideration, it is simply the best.
If anyone doubts the superiority of the U.S. economy, try this exercise. If you wanted to invest or start a business in any other society in the world, where would you go? Canada? Russia? Japan? Cuba? Germany? China?
Being the best means we draw investment from all over the world from those concerned with an optimum blend of opportunity and safety. And, in a free enterprise world, being the best is great for economic prosperity.
How Long Can It Last?
So if you look back at the course of the past fifteen years and examine the major changes in politics and technology that have occurred, some of the mystery of why the stock market has gone so high disappears. The investors may not have had an econometric model to guide them, but, on balance, they seemed to know what they were doing.
An even more interesting question is to what degree this economic prosperity will continue in the future. There is no crystal ball; it is a matter of personal judgment that only an individual can make.
But if we run down the list of the ten factors that raised the sea level of economic activity during the past fifteen years or so, we probably can make an informed judgment as to whether or not those factors will continue to be in play in the months and years ahead. And from that maybe we can deduce our own personal forecasts.
Here's the list again:
- The vanished threat of nuclear war should hold for a long time to come. There will be an increasing threat of an accidental attack or one from a small, rogue state, but the construction of a small missile defense system could greatly reduce even that threat.
- The spread of capitalism shows no signs of abating. No new statist theories are on the intellectual horizons.
- Easy taxes. At least for the next four years the chances of any major tax increase in the United States are close to zero, especially if the Republicans continue to control Congress. Both parties are now committed to some form of a tax decrease. We may even get a major reduction in the capital gains tax rate.
- The computer revolution shows no sign of abating. If anything, it may be speeding up.
- Control of government spending. This is the most difficult to predict, but at least for the next few months things look pretty good. In fact, the prospects for correcting the consumer price index are increasing, which could mean savings of hundreds of billions of dollars.
- Deregulation. There is not even a whiff of any major new government regulatory programs. Pressure is still strong to reform and reduce regulation.
- Stable monetary policy. Alan Greenspan is good for another four years. After that it depends a good deal on who succeeds him.
- Steady economic policy. There seems to be a developing unanimity on the key policies necessary for economic growth. The five pillars are (a) spending control, (b) low taxes, (c) reasonable regulation, (d) sound monetary policy, and (e) consistency.
- The U.S. capital base. Every year it just gets bigger and more powerful. No sign of any decline, either in real or intellectual terms.
- The superiority of the U.S. economy. Our economy is now more than twice the size of its closest competitors. Even with prodigious advances by other nations it would be decades before even a Japan or a Germany could begin to draw close.
The more you examine the powerful political and technological factors affecting the U.S. economy, the less mystery there is about its robust condition. The U.S. economy is good for good reasons. We should not be surprised to see the Dow Jones average hit 10,000 or higher before the end of the century.
As President Reagan once said, "You ain't seen nothing yet."