The Global Economy: An American Perspective

Murray Weidenbaum

Murray Weidenbaum holds the Mallinckrodt Distinguished University Professorship at Washington University in St. Louis, where he also serves as honorary chairman of the Weidenbaum Center on the Economy, Government, and Public Policy. This article was an address given to the MasterCard Future of Payment Summit in O’Fallon, MO, November 15, 2002.

It is a great pleasure to have the opportunity to address this distinguished group of journalists and analysts from around the world. I have prepared an analysis which I hope you will find useful as you process all of the information that you are gathering at this unprecedented international meeting.

To break the suspense, I would like to give you my conclusion at the outset. It is in the form of a quotation from my favorite economist and philosopher. I am referring to the late Oklahoma cowboy-humorist Will Rogers, who stated, “Things will get better, despite our efforts to improve them.”

This is a time, however, when negative reports dominate the economic news. That is precisely why I believe that Will Rogers’ cynical but upbeat attitude is a useful approach to follow. Unfortunately, forecasts of doom and gloom always sell well. After all, it was not that long ago that we all believed that Japan would dominate the world economy. Americans were all supposed to be serving hamburgers in a low-tech service society. All of us were also scheduled to suffer global cooling-yes, that was the rage in many intellectual circles in the 1970s.

This phenomenon reminds me of a standard proposition in economics, Gresham’s Law: bad money drives out good money. There seems to be a form of Gresham’s Law that operates in so many economic discussions: bad news and downbeat forecasts drive out good news and upbeat forecasts.

The Global Economy

The news is good as I examine the global economy. Last year, the economies of the world grew at an average of 1.7 percent. This year they are growing a bit more rapidly, 2.5 percent. Next year, the outlook is for world growth of 3 percent or more. That is not a justification for wild optimism, but 3 percent or even 2 percent is not exactly the basis for another doom-and-gloom scenario.

The puppet-parading protesters so visible in Seattle and Genoa are wrong. Globalization is working. When we penetrate the noise, it turns out that those terrible multinational corporations are creating widespread wealth. The poorer countries are growing more rapidly than the more advanced and developed nations-about 50 percent faster this year. More people have moved out of poverty in the last two decades than ever before in world history.

Surely, the task of economic development is far from complete. Many societies are not yet actively participating in the world economy. This is especially true in Africa. The challenge now is to help them get into the global marketplace. The poor nations need to get the opportunity to reap the benefits that have been achieved by other hitherto poor and undeveloped economies such as South Korea.

Let me offer a personal but representative example of the power and effectiveness of the international economy. I can go 10,000 miles to the other end of the globe without any cash in my pocket. I can count on people who never saw me before and probably never will meet me again to provide me with the goods and services that I need. Moreover, they can confidently expect that somebody else that they never have met will pay them.

All I have to do is to wave my magic wand-or rather a credit card such as MasterCard. When I stop to think of it, the degree of trust implicit in these relationships is awesome. Of course, all human institutions are imperfect. However, in over 40 years of international travel, the system has worked well for me and for so many other travelers.

Nevertheless, there is no need to ignore the challenges and difficulties that do arise in the global economy. The development of China as an industrial power and the rise of India as a major service center are fundamental developments. Their growing position in the global marketplace is generating problems as well as opportunities for business firms and their employees around the globe. It will probably take many years or even decades before the full effects are realized. As an economist, of course, I view this new source of international competition as ultimately benefiting the United States and other industrialized nations.

History provides earlier examples of the ramifications of such basic changes. In the early and middle 19th century, the European nations dominated the world economy. Their monopoly of the global marketplace ended with the rise of the United States as a major industrial power. Even though Europe’s relative share of world commerce subsequently declined, the absolute results were very positive. The total amount of world trade and investment rose, as did the living standards in each of those nations.

An analogous situation is developing in Asia. Japan became a recognized major economic power in the 20th century-and the pace of economic development continued, and at times accelerated. In the 21st century, we can expect China and India to have the opportunity to move from being important regional powers to becoming members in good standing of that informal but important club of world economic leaders.

Much will depend on the policies they pursue and the actions they take. I am always reluctant to offer unsolicited advice. Yet, some lessons of the past may be useful. Just examine the nations that prosper in the international marketplace. You will find that, by and large, six factors are key to their global success:

1. An economy open to foreign trade and investment.
2. A government minimizing controls over business, but effectively supervising financial institutions.
3. A judicial system working well with corruption kept low.
4. Economic information that is transparent and readily available.
5. High labor mobility.
6. Relatively easy entry into the marketplace by new businesses.

These six points underscore an even more basic notion: healthy and vigorous domestic competition is the key to long-term international economic success. I contend that, as uneven as it is, the idea of progress is alive and well in the international economy. The most striking evidence is that far more people are anxious to become part of the global marketplace than voluntarily want to drop out.

The U.S. Economy

I now would like to turn to an examination of the American economy and for a very basic reason. It is not a matter of national chauvinism or even the large size of the U.S. economy. Rather, it is clear that my knowledge of domestic developments far exceeds my understanding of events in other countries. As I am fond of telling my students, Adam Smith taught us the benefits of the specialization of labor.

The United States is coming out of one of the mildest recessions in modern times. There is both a good news component to this as well as bad news. The favorable report is that unemployment has risen less than in most recent recessions. Also, the other key economic indicators have declined much less-industrial production, personal income, and wholesale and retail trade.

The unfavorable news is that there is now little basis for a strong recovery. Economic history tells us that sharp business declines lead to big snapbacks. But modest declines generate small recoveries. That is so because there are no backlogs of unmet business or consumer demand.

At the moment, the U.S. economy is marking time. Companies and investors are reluctant to make major commitments due to the uncertainty in the most basic area of national policy: war or peace. Will there be a war in Iraq? How quick and successful will it be? Will there be serious repercussions elsewhere? No economist can answer these questions.

However, there are some important factors that we do know. The economic impact of armed conflict today is very different than it was in the classic case of World War II. Back then, the United States started with a very small military establishment and a similarly inadequate defense industrial base. Before this nation could engage in major hostilities, it was necessary to invest in the creation of a new military production industry and then manufacture the armaments needed for the rapidly expanding armed forces. That burst of military demand was sustained until the end of the war. It was a key factor in ending the prolonged depression of the 1930s.

In striking contrast, a modern war is waged with the forces and equipment that are already in existence at the outset of the conflict. Given the speed of events, there is no time for a huge military production buildup. In fact, recessions occurred in this country during the Gulf War and the Afghanistan campaign. The price of oil shot up. Uncertainty pervaded business investment decisions and financial markets.

On the positive side, a successful conclusion to the military effort by the United States and its allies would clear the air. Defeating al-Qaeda and the Taliban in Afghanistan restored confidence in America generally and helped turn around our economy. I believe that eliminating Saddam Hussein from power would generate a huge sigh of relief around the world.

Candor, however, requires me to state that a variety of alternative war scenarios come to mind. The prevailing case calls for a short and successful military campaign. The direct cost is estimated at about $10 billion a month. That is a very manageable amount for a $10 trillion economy. World oil prices initially shoot up beyond the current level of $25 a barrel. However, non-Iraqi suppliers increase their production rates to offset the temporary loss of the Iraqi supply. The price of oil declines to its prewar level.

In this optimistic scenario, after the war Iraq moves toward a more democratic society and its oil revenues are devoted to enhancing the economic development of its people and its civilian industries. However, less optimistic situations also come to mind.

At the pessimistic end of the spectrum of alternatives, we can conjure up circumstances where the military campaign in Iraq is not decisive. The situation becomes complicated when serious terrorist actions occur elsewhere at the same time. Theoretical possibilities are numerous, including dangers in Pakistan, Indonesia, the Philippines, Israel, etc. Under such conditions, the other major oil supplying nations might be reluctant to expand their output to offset the decline in Iraq’s production. In such event, world oil prices could be expected to rise further. The resultant uncertainty in financial markets and in business decision-making could generate a double dip recession in the United States. We would also see a slowdown in the global economy generally. That is the pessimistic alternative.

We should also consider intermediate outcomes between the optimistic and pessimistic extremes. For example, the United States and its allies make progress in ousting Saddam from his leadership position. However, a stable Iraqi nation does not quickly emerge. A large continuing military presence is needed to keep peace among the various contending ethnic and religious factions.

At home, a sluggish recovery is experienced in the economy. Inflation rises as higher oil prices work their way through the production process. Domestic policy focuses increasingly on new government efforts to accelerate the pace of economic activity in order to bring down the unemployment rate.

It is disturbing to think about these disquieting alternatives. However, this leads me to recall one of the many occasions during my White House days when I would look out at the scenery. Invariably, I would see people parading with signs warning of all sorts of imminent dangers. My favorite marcher, however, was more optimistic than the others. He carried a simple banner, “The end of the world has been postponed.”

The Economic Outlook

In that upbeat spirit, I would like to present what is the prevailing view of professional forecasters as we look out to 2003. To put the matter in a nutshell, the outlook for the American economy in the year ahead is for neither boom nor gloom. Our expectation is for a rate of growth of about 2.8 percent. This would be a modest improvement over the 2.5 percent growth rate expected this year.

Inflation, at 2.3 percent, would be a little higher than the current rate, but it would not become a serious issue. Virtually all of the rising prices are occurring in the service sectors of the economy. On average, the prices of internationally tradable goods are anticipated to continue declining. That’s one of the results of global competition.

The unemployment rate is projected at 6 percent, just a bit higher than this year’s 5.8 percent rate. To put the matter succinctly, this outlook does not qualify for the Guinness Book of World Records.

Given the very low level of interest rates, we cannot expect much more stimulus from the Federal Reserve. It is likely that President Bush and his advisers will rely primarily on fiscal policy in order to achieve a stronger economy. The Treasury Department has been engaged in an ambitious effort to develop a comprehensive tax reform proposal, such as a flat tax or a value-added tax. Surely, a simplified revenue structure that shifts some of the tax burden from saving to consumption would be helpful. That change would help generate more investment and a faster rate of economic growth. The result invariably is reduced unemployment and rising living standards.

As a veteran tax reformer, however, I must report that getting a major tax reform bill enacted into law is a very extended process in the United States. At its best, the process takes several years. The development of an attractive proposal is just a start. Then, it is necessary to generate sufficient public support. Following successful congressional hearings, the actual drafting and negotiation of legislative language gets underway. It is not easy to balance the pressures from contending groups who would either benefit or be hurt by any significant change in public policy.

Under the circumstances and simultaneous with the Treasury’s work, a more modest and private effort is underway in Washington, DC. The purpose is to convince the Congress to move on less ambitious tax changes that would be consistent with the broader subsequent tax reform program. Informally, this approach is called “five easy pieces” (named after the movie with the same title but a rather different theme).

Here are the five tax pieces:

1. Lower marginal tax rates. For example, the tax rate reductions now scheduled for 2004 and 2006 could be brought forward. This action would bolster the key sector of the U.S. economy, consumer spending.
2. Provide more generous business depreciation allowances. The temporary liberalization of depreciation schedules that expires in September 2004 could be extended. The idea is to provide an additional incentive for new business investment.
3. Eliminate the double taxation of dividends. Individual taxpayers would be allowed to exclude dividends from their taxable income. The justification is that corporations have already paid taxes on such income. This action would encourage people to invest in the now depressed stock market.
4. Reduce the tax burden on saving. Expand the existing but limited tax deductions for saving (the IRAs and the Roth IRAs) to cover all personal saving. This approach is designed to generate more funds to finance investment rather than current consumption.
5. Exclude income from exports from domestic taxation. U.S. actions to do this via special tax treatments have been turned down repeatedly by the World Trade Organization as an unfair trade practice. Most industrialized nations accomplish this objective by adopting a value added tax. The existing corporate income tax could be converted into a VAT (which would be WTO compatible).

Personally, I do not believe that it would be an easy task to get Congress to quickly enact all five of these proposals. But they are an attractive menu from which legislative leaders could usefully make a selection. Early enactment of any one or two of these “pieces” would contribute to a brighter outlook for the American economy. Such action would also re-enforce the role of the United States as the major engine of growth in the world today.

A Longer-Term Look at the World Economy

You have been very polite. My own students rarely let me talk this long without arguing or at least asking questions. I do look forward to a vigorous question and answer period. So I will end with just a few remarks about the longer-term future. Most important decisions-in the public sector as well as in the private sector-are made on the basis of far more than a twelve-month period. In that vein, let us look across the current valley in the economy to the middle of this decade.

The U.S. economy will not look the same as the high economic mountains of the late 1990s that are behind us. That was an extraordinary period when the gross domestic product grew at over 4 percent year after year. To some degree, economic policymakers today are the cleanup crew the morning after the big party.

U.S. economic performance in the coming decade is likely to be more modest than the feverish pace of the last decade but the outlook is positive. I think of hills ahead of us rather than spectacular mountains of economic activity. Western Europe may grow a bit more slowly than the United States and East Asia more rapidly. On balance, the new situation will also be more sustainable and perhaps more typical of the future experience.

A key reason why my longer-term outlook is upbeat rather than downbeat is the positive role that technology will continue to play. Especially in the United States, a silent but strategic crossover has occurred in recent years. For many decades-from 1940 to 1980-most of the research and development was sponsored and financed by the Department of Defense. Thus, during that long period, the needs of the armed forces determined the direction of most of the R&D in this country. The lion’s share of the advances in science and technology were aimed at generating new weapon systems.

Since 1981, a fundamental shift has occurred. A majority of all R&D in the United States-a growing majority-is now sponsored, financed, and performed by private enterprise. Currently, the private share is up to 70 percent of the national total.

Nobody can forecast the precise results of this massive investment-in the fruits of science and technology. That investment in R&D amounts to tens of billions of dollars a year. The current 4 percent growth in productivity is direct evidence of the powerful force at work. We can expect, in the years ahead, an accelerated flow of new and better products and methods of production.

We have a very good example of this positive development here in Missouri. The work at MasterCard’s new Global Technology Operations Campus is bound to enhance the productivity of the many users of the payment processing system.

I have had the good fortune of encountering some truly great thinkers and world leaders in my long career. Yet none of them made the lasting impression on me that Will Rogers did. Yes, things will get better. That has always been a very good long-term guide and forecast.

Thank you and good luck!