Two decades ago, Washington questioned who the real economic winners of World War II were and whether our pursuit of prosperity required us to emulate the policies that were working so well for Germany and Japan.
If Americans could become serious savers like the Japanese and the money could be directed into the economic winners of the future, selected by a government agency such as Japan’s Ministry of International Trade and Industry, which set priorities and coerced corporations to pursue them, we could grow as fast as they did. If Americans were guaranteed lifelong employment, then they would work enthusiastically and loyally, and productivity would improve.
If that view was too extreme, we could go partway by copying the German economic miracle, where long-term relationships between banks and their corporate customers would create a healthy, patient capitalism in which investors stayed for the long pull, rather than demanding immediate gratification. And the presence of well-trained workers, represented on corporate boards, would inspire a labor peace that emphasized cooperation rather than competition.
That was then.
Things look very different now. Luckily, we didn’t follow the leaders, although whether that reflects wisdom or lack of discipline remains an open question.
Today Germany is the sick man of Europe, and Japan seems intent on setting a new record for economic anemia. What happened? Where did we go right?
Oddly but typically unnoted at the time was the fact that there were two seemingly contradictory explanations for why America seemed weak while the former Axis partners seemed strong. One provocative hypothesis came from a University of Maryland professor named Mancur Olson, who wrote “The Rise and Decline of Nations–Economic Growth, Stagflation and Social Rigidities.”
Olson argued that these competitors had been spared the gridlock that was hobbling the United States because they had had the good luck to have their political and economic infrastructures destroyed by World War II, thereby creating an unusual receptivity to new ways of doing things. There were no interest groups with the power to block new initiatives. Of course, the fact that they were growing from a very modest base and had great needs probably had an influence as well.
A similar theme was subsequently developed by a Washington journalist named Jonathan Rauch, who came up with a name for this phenomenon, demosclerosis. Broader democracy was not without its price, Rauch argued. He did not say that the old days of centralized power were better, but he noted that it sometimes now seemed like every group had the power to block any change–and no one was happy with the outcome.
The few groups that once had power to halt legislation did not like sharing it. And the groups that had recently gained ability were frustrated because their enhanced power to stop bad things from happening could not easily be expanded into achieving positive goals.
Theory: Too much self-interest
Meanwhile, there was a second competing theory. It argued that Japan and Germany had much more domestic economic discipline than the United States did. Everyone worked together, and all were willing to sacrifice to achieve long-term goals. In the United States, by contrast, things seemed messy and divisive. There was too much self-interest, which some saw as simple selfishness, and not enough public interest. Not only was our savings rate lamentably low, but the money that was banked somehow ended up financing office buildings that had trouble finding tenants.
The condition of America’s savings and loan associations, the “S&L mess,” came to symbolize how badly we had gone astray. It all started with financial deregulation when banks were allowed to compete for depositors by offering higher rates.
Of course, if they paid more for their money, they would have to make riskier loans so they would make more money. Couple that with the incentives built into the tax code and that led to investments in speculative office buildings. Mix in avarice, cupidity and a new breed of arrogant bankers who thought they had invented everything but compound interest and you have the makings of a potential financial mess. Change the tax incentives, which the 1986 tax law did, and the mess becomes reality.
The result was a lot of rhetoric about how government regulators had been asleep at the switch, incarceration for a few of the most flamboyant highfliers and a government expenditure of tens of billions, casting a financial cloud that wouldn’t clear for years. A terrifyingly large federal deficit became even larger, but there was no other way out.
Washington responds to emergencies when it must.
A few years later, when the threat was a seemingly endless series of federal deficits, the first President Bush and Congress rose to the challenge again and agreed on a budget-balancing plan that included higher taxes, notwithstanding earlier uncompromising presidential rhetoric on this topic.
The S&L bailout responding to the punctured real estate bubble and the march toward a balanced budget created an environment that made the prosperity–and the high-tech bubble–of the 1990s possible.
Deficit problems
Japan, meanwhile, was experiencing a property bubble of its own. It was said that the imperial palace in Tokyo occupied land equal to the value of the entire state of California, which covered quite a bit more territory. But it seemed that the Olson argument had been turned upside down. The Japanese lacked the will to admit just how bad things were, close the banks that had made bad bets on rising property values and move ahead.
And those once-innovative Japanese firms seemed to be ossifying, unable to cut employment (recall that one pillar of the Japanese economic miracle was the promise of lifetime employment) quickly enough to respond to changing market conditions.
The Japanese kept spending money on public projects (proving to public transit advocates that you can have fast, clean trains if you’re willing to subsidize them with large gobs of public funds) even if that meant pushing government spending into the red. As the American deficits were disappearing, Japan was moving in the opposite direction.
The deficit disease spread to Germany, where it was particularly embarrassing. It was Germany that had demanded its neighbors bring their budgets near balance as a condition of European unification. Now Germany was the economic outlier.
Again, the old arguments echoed. The close long-term ties between banks and manufacturers came to be seen as a weakness rather than a strength that short-circuited the type of investor pressures that had pushed American firms into becoming more productive. Commercial restrictions that discouraged large-scale discount stores (also an issue in Japan) were now viewed as an expensive impediment rather than helpful social policy that created cohesive communities.
Despite alleged American gridlock, the flexibility of deregulation went further faster here despite some growing pains along the way.
This recent chapter is not without relevance to the upcoming elections.
Soon we’ll be treated to political campaigns in which challengers will predictably complain about yet another “do-nothing Congress.” But no one will ask the obvious question–who here is responsible for this remarkable reversal of fortune?
