Breaking the Postwar Bargain

The global economy is leaving millions of disaffected workers in its train. Inequality, unemployment, and endemic poverty have become its handmaidens. Rapid technological change and heightening international competition are fraying the job markets of the major industrialized countries. At the same time systemic pressures are curtailing every government’s ability to respond with new spending. Just when working people most need the nation-state as a buffer from the world economy, it is abandoning them.

This is not how things were supposed to work. The failure of today’s advanced global capitalism to keep spreading the wealth poses a challenge not just to policymakers but to modern economic "science" as well. For generations, students were taught that increasing trade and investment, coupled with technological change, would drive national productivity and create wealth. Yet over the past decade, despite a continuing boom in international trade and finance, productivity has faltered, and inequality in the United States and unemployment in Europe have worsened.

President Bill Clinton may have been right to proclaim that "the era of big government is over," and perhaps the American people will ultimately decide that those who need assistance should look elsewhere for help. But if the post-World War II social contract with workers—of full employment and comprehensive social welfare—is to be broken, political support for the burgeoning global economy could easily collapse. For international economic integration is not some uncontrollable fact of life, but has deepened because of a series of policy decisions taken by the major industrial powers over the last 45 years. It is time to recognize that those decisions, while benefiting the world economy as a whole, have begun to have widespread negative consequences. The forces acting on today’s workers inhere in the structure of today’s global economy, with its open and increasingly fierce competition on the one hand and fiscally conservative units—states—on the other. Countermeasures, therefore, must also be deep, sustained, and widespread. Easing pressures on the "losers" of the new open economy must now be the focus of economic policy if the process of globalization is to be sustained.

It is hardly sensationalist to claim that in the absence of broad-based policies and programs designed to help working people, the political debate in the United States and many other countries will soon turn sour. Populists and demagogues of various stripes will find "solutions" to contemporary economic problems in protectionism and xenophobia. Indeed, in every industrialized nation, such figures are on the campaign trail. Growing income inequality, job insecurity, and unemployment are widely seen as the flip side of globalization. That perception must be changed if Western leaders wish to maintain the international system their predecessors created. After all, the fate of the global economy ultimately rests on domestic politics in its constituent states.

The spread of the dogma of restrictive fiscal policy is undermining the bargain struck with workers in every industrial country. States are basically telling their workers that they can no longer afford the postwar deal and must minimize their obligations. The current obsession with balanced budgets in the United States and the Maastricht criteria in Europe must be replaced by an equally vigilant focus on growth and equity. National responses to this global problem are likely to fail, as any state that deviates from "responsible" economic policies will be punished by currency markets and bondholders. States must now reorient their economic policies toward growth, but it should be done as part of a coordinated international effort. Calling for such economic policy coordination might seem utopian in the current political environment, but it has been done before.

The world may be moving inexorably toward one of those tragic moments that will lead future historians to ask, why was nothing done in time? Were the economic and policy elites unaware of the profound disruption that economic and technological change were causing working men and women? What prevented them from taking the steps necessary to prevent a global social crisis?


The current predicament is hardly unprecedented. Writing in Progress and Poverty in 1879, the reformer Henry George observed that "at the beginning of this marvelous era it was natural to expect, and it was expected, that laborsaving inventions would lighten the toil and improve the condition of the laborer; that the enormous increase in the power of producing wealth would make real poverty a thing of the past." George chronicled the many technologies, such as the steam engine and telegraph, that had been introduced in his lifetime, and the great explosion in commerce and trade that followed.

But far from heralding an era of prosperity, "disappointment has followed disappointment. From all parts of the civilized world come complaints of industrial depression . . . of want and suffering and anxiety among the working classes." George observed that the massive investment in technology had only resulted in increasing returns to capital and falling wages for working people. Thus "the mere laborer has no more interest in the general advance of productive power than the Cuban slave has . . . in the price of sugar."

During the nineteenth century, the world enjoyed a secular increase in trade and investment under the aegis of a liberal Great Britain, while the adoption of the international gold standard created the illusion of domestic financial stability. But profound social dislocation accompanied this process of globalization and would eventually contribute to its undoing.

Britain’s decision in 1846 to lift the Corn Laws, which had long protected domestic agriculture, is the classic example of a policy consciously designed to globalize the economy in favor of specific interests. With industrialization, the Manchester factory owners needed more labor. The simple solution was to get farm hands off the land and pay them low wages. The most efficient way to achieve this goal was to introduce foreign competition in agricultural products, forcing down prices and ensuring that farmers and tenants could no longer earn their livelihood. Labor flooded into the cities, and these workers were paid relatively low wages because the price of food—their major expenditure—was falling.

Throughout the Industrial Revolution various regulations that had long governed economic life—many dating back to the Middle Ages—were dismantled, and rural laborers found their traditional ways of life torn asunder. Workers became commodities like grain and coal, with demand for and supply of their services a function of market requirements. Such a laissez-faire approach to labor markets was inherently unstable, as the philosopher Karl Polanyi later explained in The Great Transformation. He described the process by which landless working people throughout Europe entered a world of urban poverty, creating a political cauldron. During periods of prolonged depression these laborers became easy prey for extremist political forces. Polanyi argued that it was the complete unraveling of economic and labor market regulations and traditions in the nineteenth century that caused such tremendous social and political upheaval in the early twentieth, culminating in the collapse of the world economy and the outbreak of the First and Second World Wars.

The Great Transformation was published in 1944, the year that the Bretton Woods conference to restructure the international economy was held. And it was Polanyi’s version of history that the postwar policymakers brought with them. As Treasury Secretary Henry Morgenthau said, "All of us have seen the great economic tragedy of our time. We saw the worldwide depression of the 1930s. We saw currency disorders develop and spread from land to land, destroying the basis for international trade and international investment and even international faith. In their wake, we saw unemployment and wretchedness. . . . We saw their victims fall prey . . . to demagogues and dictators. We saw bewilderment and bitterness become the breeders of fascism, and finally, of war." The post-World War II global economy resulted from a series of conscious policy decisions, reached in the belief that increased economic exchange could be a force for world peace and prosperity.

The postwar leaders were committed to rebuilding the world economy, but this time with a significant difference. In globalization’s previous incarnation, governments had done little to protect working people from its malign effects, and their mistake exacted a price in revolutions and war. Having learned from that experience, statesmen now designed a liberal world economy that maintained an active domestic role for the state in order to ensure that equity and growth went hand in hand.

Thus the new global economy would include both domestic and international components. Of greatest significance, the state would supervise most aspects of economic life. In the United States, for example, the Truman administration passed the Employment Act, which set as its objective full employment, and the G.I. Bill, which provided veterans with education and housing benefits. Across Europe, ambitious social welfare policies were enacted. In every industrial country, labor was not to be treated as a commodity, subject to the free market’s destructive whims, and the organization of workers into labor unions was actively encouraged. The implicit agreement struck between states and their societies—what John G. Ruggie has termed the bargain of "embedded liberalism"—ensured that the gains from economic globalization would be used to compensate the losers in the interests of political stability.[1]

Western leaders constructed international regimes for money and trade that by charter were to be responsive to domestic political and economic concerns. When they launched the General Agreement on Tariffs and Trade (GATT) to liberalize and expand commerce among the member states, they also established safeguards to protect workers from unfair trade practices and to assist those who were displaced. When they created an international monetary system to avoid ceaseless rounds of competitive currency devaluation, they also established the International Monetary Fund (IMF) as a lender of last resort for balance-of-payments emergencies. When they formed a European Common Market to promote regional trade and investment, they also permitted states to retain considerable autonomy in social policy.

But the Bretton Woods order would prove unsustainable. It was very generous to workers and capitalists, but it required high levels of economic growth. The oil crises of 1973-74 and 1978-79 hammered the industrial countries, prompting stagflation, that insidious mixture of stagnation and inflation. Furthermore, increasing foreign trade meant greater competition for national firms, while financial deregulation permitted capital to become more footloose. These developments, in turn, led to widespread corporate restructuring and a glut of unskilled labor, which translated into higher unemployment, less tax revenue, and greater pressure on state resources. The crisis of the welfare state had begun.

Faced with the exploding costs of cradle-to-grave support for increasingly idle populations, Western states in the 1980s began to adopt stringent monetary and fiscal policies. Workers, of course, have had little say in this process. Indeed, what governments are really trying to do is break their postwar deal with workers while maintaining their commitment to an open economy. They cannot have it both ways, and instead the policy focus should be on negotiating a package that helps workers adjust to ongoing economic changes.


Nobody disputes that the past two decades have been cruel to unskilled workers in the industrial countries. Growing income inequality has given rise to millions of working poor in the United States, and this sorry condition is now becoming apparent in Western Europe. Between 1973 and 1993 the real hourly wage of Americans without a high school diploma fell from $11.85 an hour to $8.64 an hour. In the early 1970s households in the top 5 percent of the income bracket earned 10 times more than those in the bottom 5 percent; today they make almost 15 times more. Similar trends are evident in Britain and even that most egalitarian country, Sweden.

Workers have been further squeezed by the decline in manufacturing employment. Manufacturing employment in the United States fell by 1.4 million between 1978 and 1990. Those who lost their jobs were, in general, the unskilled, and when they found new work it was usually at lower pay. The experience has now become familiar to middle managers as well, as evidenced by the recent spate of major corporate layoffs. The failure of the industrial sector to generate new jobs has been a major cause of labor’s economic problems, and perhaps some of America’s social problems more generally. Fully two percent of all working-age American men are behind bars.

In Western Europe, the unemployment figures are frightening. In France, average unemployment between 1969 and 1973 was 2.6 percent; today it is over 11 percent. In Germany the rate was below 1 percent; today it is approaching 10 percent. In Belgium, the unemployment rate has quadrupled over the past 20 years. The Europeans have created a lost generation of workers and are now suffering for it in terms of increased crime, drug abuse, violence against immigrants, and the increasing popularity of extremist political groups. In this context, it is sobering to realize that Germany’s current level of four million unemployed is the highest it has been since the early 1930s.

At the same time, there has been a dramatic decline in unionized labor in both the United States and Europe. The unionized portion of the U.S. labor force has dropped by more than one-third—from 25 to 16 percent—since the 1970s, and organized labor is also declining in Austria, France, Germany, Italy, the Netherlands, Switzerland, and the United Kingdom.[2] Labor is losing its political voice, and the consequences of its demise—lower wages and benefits for unskilled workers, greater job insecurity, and less political interest in the economic losers—should not be dismissed.

Further, it should be recalled that organized labor in the north has been a prime mover behind unionization and the promotion of human rights in the developing countries of the south. International activism by unions has been a help to workers in Latin America and other countries struggling to win the right to collective bargaining, as well as better health and safety standards. Now that all industrial workers—unionized or not—could benefit from this type of activism in such countries as China and India, and other non- or anti-union regions of the world, organized labor is no longer vigorous enough to play this role. To be sure, unions are hardly perfect; they too form entrenched interests that hinder labor market flexibility and job creation. But their historical role in economic development and social equity has been forgotten.


Solutions to these bleak trends need not await some consensus among economists about their causes. Policymakers debating these issues are like firefighters idly wondering what started the blaze while the house burns to the ground. The two traditional culprits that have once again emerged from the economics literature are trade and technology. A third, cited by few economists but by some journalists and politicians, is immigration.

Economists who focus on the effects of trade, such as Adrian Wood, have argued that the contemporary problems of unskilled workers in the north are linked to a strong increase in trade between north and south and a change in its composition.[3] Historically, the developing countries provided the industrial world with agricultural goods and raw materials in exchange for manufactured goods. The gains from such trade have been analyzed and extolled by economists since David Ricardo, sustaining the free trade movement.

Such trade is rightly celebrated, since it makes nations wealthier than they would otherwise be. More recently, however, the south has moved into the business of manufacturing, from clothing to consumer electronics. Today such goods account for over 50 percent of the south’s exports and surpass its commodity exports in value. As is well known, workers in these developing countries are generally paid peanuts for their labor—less than a dollar an hour in such countries as China, India, and Pakistan—and in many countries, including China, they are prevented by law from forming unions or otherwise bargaining collectively.

According to a theory proposed by Paul A. Samuelson and Wolfgang Stolper in 1941, two countries that practice free trade and have the same technology should eventually see their wages equalize. In effect, wages in the First World are forced down by competition from developing countries in similar industries. Ironically, even though falling wages would seem to confirm Stolper-Samuelson, some economists are now claiming that its assumptions are wrong.[4]

In Western Europe wages are less skewed than in the United States, but the continent has paid for relative equality with higher unemployment. Economic theory also helps to explain why this is so. If Germany begins importing Polish goods produced with unskilled labor, and regulations and other rigidities prevent wages from falling to Polish levels, unemployment among unskilled German workers will rise in the absence of new job creation.

Many American economists, such as Paul Krugman and Robert Z. Lawrence, contest these explanations. They point out that foreign trade remains too small a share of economic activity in most industrial nations to be responsible for such large and pervasive phenomena as unemployment and income inequality, and they assert that technology must be responsible for these changes. According to this school of thought, the introduction of new technology—say, computers—creates a surplus of unskilled labor. At the same time, the new technology increases the demand for the skilled workers who know how to run it, raising their wages. As a result, income inequality widens because of the good old-fashioned law of supply and demand. The evidence for this line of reasoning is the heavy investment in new technology by manufacturing during the 1980s, when growing wage inequality became apparent in the United States.

But economists are wrong to treat trade and technology as competing explanations. A significant share of new technology, for example, has been induced by foreign competition. Indeed, when one looks at those industries that have suffered great job losses on the one hand and enjoyed significant investment in new technology on the other, they are concentrated in sectors, like steel and automobiles, that have faced tremendous pressure from imports. Still, the widespread introduction of technology across many sectors suggests that domestic competition spurred much of this investment.

As a general explanation, technology is unsatisfactory. It is never clearly distinguished from other kinds of capital, and there is no reason that its introduction must in principle reduce the wages of the unskilled. Technology is for economists the residual that accounts for everything their theories cannot.

Yet a final explanation for labor’s lament is immigration. During the 1980s the United States had the largest immigration boom in its postwar history. Between 1980 and 1989 more than six million legal immigrants alone came to its shores. In 1994 more than three million arrived illegally. The net effect of legal migration has been positive. The new arrivals bring needed skills, create businesses and jobs, and raise output. At the same time, the pool of unskilled labor has also increased, forcing down their wages. As with other facets of globalization, increased migration benefits countries overall, but it hurts some groups. The failure to address their dislocation will allow nativists to seize the debate, creating a more permissive environment not only for protectionism but for hate crimes, as is already evident in Western Europe.


Whichever explanation is most important, the fact remains that technological change, free trade, migration, and other forces such as defense cuts create losers as well as winners. The rationale for open economies is that, in principle, the gains will outweigh the losses for the country as a whole; thus, the winners can afford to compensate the losers. Under GATT and Bretton Woods, this compensation took the form of such short-term measures as trade adjustment programs, which provide unemployment insurance, retraining, and even support for moving to new communities. When a robust economy was creating lots of good jobs, everyone was made better off. But that is no longer the case. Today, a worker who loses his job is likely to find a new one only at lower pay. Indeed, as The New York Times reported earlier this year, 65 percent of workers who ultimately find jobs after a layoff do so only at lower levels of pay, and Morris Kleiner of the University of Minnesota has found that most such workers are still earning much less even five years later.

According to an analysis of dislocated defense workers in New England, defense workers should have an easy time finding new jobs, given their skills and experience with computers, precision tools, and quality control—even if these attributes have not been tested in the context of more highly competitive enterprises. But even among these workers, one in five of those who found new jobs had wage rates that "represented a pay cut of 40 percent or more." Indeed, over 60 percent of all dislocated workers "had noticeably lower hourly earnings."[5] Their experience with retraining should also counsel caution. Some could not afford the costs associated with these programs, while others had difficulty matching training opportunities to projected new job requirements. For still others, the lack of growth prospects in even distantly related industries raised questions about whether retraining was really a good investment. Overall, as the World Bank’s 1995 World Development Report concluded, results are mixed regarding the value of training in helping unemployed workers find new jobs.

But even if training is a good investment, the cost of providing it to all unemployed workers is prohibitive. There are now some 34 million unemployed persons in the member countries of the Organization for Economic Cooperation and Development (OECD). If the average cost of retraining for each worker is $7,000, the total bill would be $238 billion. For the United States, with its 7 million unemployed, the total would be $49 billion. Today, the U.S. government spends about $10 billion on work-related education and training. In the current fiscal environment, it is difficult to imagine that number rising by the required amount.

On the contrary, these programs are being cut back. Since 1992, funds for labor market training and other active measures have fallen in such countries as Canada, Germany, Sweden, and the United States, the last especially ironic since Secretary of Labor Robert Reich is one of training’s greatest devotees (though in fairness, he does have to contend with a Republican Congress). Incredibly, public spending for higher education has also fallen. In the United States, such expenditures were cut 10 percent in the early 1990s, and in Britain only marginally less. At the same time, in countries with federal structures, where the constituent states were expected to assume increased public burdens, local crises and fiscal stringency prevented them from taking up the slack. This is the very problem facing many Russian regions and American states.

It is odd that training has become the mom and apple pie of economists and public officials across the political spectrum when it could at best provide only a partial answer to the problems of dislocated workers, at least given the knowledge base about what works at current spending levels. Indeed, one learns in economics that policymakers should choose the most direct and efficient means for solving problems. This lesson suggests that if the concern is income inequality, policies should be adopted to close the income gap. If the concern is unemployment, more jobs should be created. Training should not be abandoned, of course, but it is not by itself a solution.


In developing positive solutions, however, it is important to recognize that declining rates of economic growth, caused largely by a drop-off in productivity, are hurting all workers. Curiously, analysts have paid less attention to these indexes than to unemployment and inequality. But had the industrial countries continued to grow in the 1990s at their earlier postwar rates, many current headline issues would hardly attract attention. If growth had remained at the 1960s average of 3.5 percent instead of current levels of just over 2 percent, more jobs of all kinds would have been created, rectifying unemployment in Europe and obviating inequality in the United States.

In truth, this productivity slowdown remains a puzzle. Why is it happening if the industrial countries have invested heavily in technology and opened their economies to foreign competition? These things should have spurred productivity growth. At present there is no good answer, though hypotheses focus on such diverse factors as the widespread shift from manufacturing to services in the north, and the decline in educational attainment, especially in science and math, among workers in many of the industrial countries.

Between 1971 and 1978, according to the OECD, the members of the Group of Seven (G-7) enjoyed an average economic growth rate of 3.5 percent per year, and this during a period of severe oil shocks, with the consequent rise in energy prices and inflation. Since 1989, by contrast, growth has averaged 2.1 percent. For Japan, the drop has been even steeper. Its average growth between 1971 and 1978 was 4.5 percent, a number that has fallen in the 1990s to 2.4 percent. Meanwhile, between 1979 and 1994, unemployment in the OECD rose from 17.7 million and a rate of 5.1 percent to 34 million and a rate of 8 percent.

Unfortunately, this slowdown in the 1990s followed on the heels of a period of inflation, deficit spending, and increasing government debt levels around the industrial world. In the G-7 the interest payments on government debt rose from 1.6 percent of GDP in 1980 to 2.5 percent in 1990. Today the figure stands at 2.8 percent. In order to stabilize their financial affairs, states adopted stringent monetary and, more recently, fiscal policies—in short, policies deemed sustainable or credible by financial markets. These policies privileged financial stability over employment. They were the welfare state’s equivalent of a grapefruit diet. The problem is that, as with all diets, they can become obsessive and cause more harm than good.

Over time, special interest groups have become entrenched around particular sets of policies, creating bureaucratic sclerosis. Restrictive economic policies—reduced deficits, reduced spending, reduced taxes, and the most exalted deity, low inflation—have favored financial interests at the expense of workers and have created an international rentier class. For anyone with money to invest, the last 20 years have been bountiful. Fiscally restrictive policies have become an ideology of this class for all practical purposes, defended in the pages of the leading newspapers and economic journals and most of the Beltway think tanks. Public officials who adopt restrictive measures are labeled "responsible" by editorialists, and the markets reward their behavior, sustaining the ideology.

The politics of financial credibility has played out somewhat differently across the industrial world. In the United States they have centered around the balanced budget debate between President Clinton and Congress. Indeed, they led to Clinton’s Hoover-like statement about big government in his recent State of the Union address. Policies have targeted inflation and fiscal expansion in recent years, but the benefits of this approach have yet to be widely shared. At the same time, polling data and other evidence, such as the results of the Republican presidential primaries, suggest that the American people are becoming increasingly worried about their economic security and want the government to do something about it. And this concern is not solely a local phenomenon. What in America was once called the battle between Wall Street and Main Street has now become global.

The budget debate is a case of ideology overriding economics. In fact, there is no reason a balanced budget must always be favored over Keynesian deficit spending. As economist Robert Eisner wrote in How Real Is the Federal Deficit? in 1986, "Deficits can be too small as well as too large." He reminds us that when "there is slack in the economy, deficit-induced demand stimulates output and employment." It may well be the case that Clinton has gone too far in agreeing with congressional Republicans about the need to balance the budget over the next seven years.

But there is no direct correlation between deficit spending and inflation, as Japan demonstrates. During most of the postwar era Japan has had far higher deficits than the United States as a percentage of GNP, but lower inflation. The reason is Japan’s credibility when it comes to maintaining monetary stability. Given Japan’s high savings rate, the markets have confidence in its ability to finance long-term debt obligations. Today Japan is the only industrial country that is taking a Keynesian approach to its economic problems, and its latest growth figures suggest that fiscal expansion has been beneficial. There is, in short, no reason that moderate fiscal relaxation must generate high inflation. Moreover, to the extent that Japanese levels of inflation become somewhat higher than those in the United States, they would contribute to easing tensions over the yen-dollar exchange rate.

In contrast, leaders in Europe, where deficits are also higher than in the United States, have demanded a rapid reduction in government spending in order to meet the criteria of the Maastricht treaty on monetary union. With Germany setting the economic rules of the game according to its domestic preferences, European states that wish to participate in the planned union must reduce their budget deficits to 3 percent of GDP by 1999. In France, where deficits are now running at 5 percent of GDP, the rules mean applying the ax to the state budget. These policies reflect an obsessive fear of Europe’s traditional bouts of inflation, but the major central banks have done a credible job of maintaining monetary stability. What has been the point of adopting these anti-inflationary policies if they do not permit governments some fiscal room to maneuver?

Even in Russia one can see restrictive fiscal policies dismantling earlier contracts between the state and society. Thus, under stringent IMF discipline, Russia too must reduce its budget deficit. Those hardest hit have been pensioners, the unemployed, and the poor—again, the people most in need of state services. The collapse of the social safety net in Russia explains why the Communist Party received the largest share of the vote in the December 1995 Duma elections and why its leader, Gennadi Zyuganov, may be elected the country’s president in June 1996.


To meet the growing problems of working people, governments must develop a coherent package of economic policies and programs supported by international policy coordination that generates renewed growth. Such a strategy, which will require some fiscal relaxation, has some costs, but the consequences of doing nothing will be worse, since disastrous measures like protectionism and nativism are again being mentioned, even in economically literate circles.

The starting point for any policy effort of this kind is the normative assertion that the appropriate goal of economic policy is to improve the lives of the citizenry. Monetary and fiscal policies should be structured in such a way as to ensure the fundamental promise that working people can earn a living wage. This means that in every industrial country policies must be directed toward helping people cope with the consequences of economic change. Of course, the appropriate policy mix will vary. In the United States, job insecurity, income inequality, and the plight of the working poor are now chief concerns. In Europe, job creation is key. Thus the policy for Europe would permit greater fiscal relaxation and that for the United States more income redistribution.

The argument that present-day fiscal restrictions must be maintained in order to balance budgets and stabilize national economies is without merit. The critical issue on the fiscal side is how governments spend the money. Just as with corporate investment, there is a difference between investments that are likely to yield long-term benefits and those that throw money down rat holes. To take an extreme case, no American during World War II said that the investment in armaments was a bad one, and it was gladly financed through bond issues and payroll taxes. Contemporary critics who would say that spending money on labor policies is unfair to the nation’s children forget that the best thing that can be bequeathed to the next generation is social peace.

An expansionary strategy must include both microeconomic and macroeconomic elements, coupled with international policy coordination. Microeconomic policies, like the expansion of education and training, are needed to provide workers with the skills that will enable them to rejoin the labor market or find better career prospects. But these policies and programs are of little value if the economy is not producing good jobs. Macroeconomic policies, like fiscal relaxation and changes in taxation, are therefore required to provide a stimulus to spur economic growth. Taken together, these micro- and macroeconomic policies should translate into a better-educated and more productive work force. Finally, international policy coordination is necessary so that countries can develop expansionary policies within a collective framework, avoiding competitive currency depreciations that in the long run hurt everyone.

Governments that wish to assist unskilled workers have four choices: protectionism, education and training, public works programs and employment subsidies, and tax policy and income transfers. All of them entail costs, which must be paid for in one way or another.

Protectionism has received both renewed attention and scrutiny since candidate Patrick Buchanan’s victory in the New Hampshire presidential primary. Buchanan, an avowed ‘economic nationalist,’ would place prohibitive tariffs on a range of imports in order to protect American jobs and wages. Unfortunately, whatever the alleged benefits of protectionism, the costs would outweigh them for most workers, and national income would certainly fall. Protectionism would lead to higher prices for all products, both foreign and domestic, resulting in lower consumption and an economic slowdown. Furthermore, America’s trading partners could not be expected to sit passively while they were victimized; they too would erect higher trade barriers in response, eliminating markets for U.S. exports and the high-wage jobs that go with them. Since exports are the fastest-growing segment of the economy, policies that lead to their restriction deserve condemnation. In short, protectionism is a remedy that is worse than the disease.

Increased spending on education and training appears to be the only policy intervention that meets with universal approval across the political spectrum. Over a generation, unskilled workers will respond to the economic signals and opt for more education and training. Historical evidence suggests that this process occurs in most industrial countries undergoing significant economic change.[6] But the benefits of training for dislocated workers are uncertain, and the costs of universal training would be prohibitive. Clearly, the expansion of educational opportunities should play a central role in any democratic society and should be financed—it makes for good politics and good economics. It cannot, however, provide anything resembling a near-term solution to the structural problems of unemployment and inequality.

The third approach is to increase the number of jobs through public works programs or, perhaps more effectively, employment subsidies to the private sector. Few Western countries have pursued this tack as an explicit policy since the Great Depression, but it should be remembered that the New Deal was successful in creating jobs and reducing misery. Public job creation is relatively efficient and socially productive—since it provides younger workers with needed job experience—and it can be done fairly quickly. If the government subsidizes jobs, it will get more of them. Such policies, however, must be designed carefully to avoid an unproductive substitution of subsidized for unsubsidized workers.

This approach becomes all the more compelling in light of the sharp defense drawdowns among the member states of NATO. In the United States, for example, the size of the military force has shrunk by nearly one million since 1986, closing a once-promising route to education, training, experience, and responsibility for thousands of young adults. France will soon end military conscription. Alternative paths must be forged to help this population enter the workforce. Moreover, public works spending would counteract the fiscal drag of these defense cuts.

Finally, it is clear that tax policy and income transfers must play a key role in any serious effort to help working people and to finance new programs. One possible approach, combining in a sense the best of candidate Steve Forbes’ flat tax and Senator Jeff Bingaman’s (D-N.M.) proposal to tax financial transactions, would be to lower overall federal income tax rates—perhaps eliminating income taxes altogether for a large number of the working poor—while making them sharply more progressive up the income ladder. In the United States, the fiscal gap that resulted could then be covered by introducing a national value-added tax, at least on luxury goods. Most industrial countries already have a vat. In principle, workers would still pay less in overall taxes, since their vat payments would be lower than their income taxes under the current system, while the rich, who now enjoy a variety of tax loopholes, could not escape paying their fair share of the vat. Most important, more job-related services could be provided than is now the case.

In Europe, unemployment rather than income distribution is the key problem. Additional reforms are needed there if the goal is to increase labor market flexibility, the hiring of new workers, and small business creation. Again, the policies are not a mystery, and inaction reflects a lack of political will rather than of economic knowledge. Among these reforms, reductions in employer social charges such as health care costs and greater flexibility in hiring, firing, and setting work hours are absolute necessities. Small and medium-sized enterprises in particular, which are important generators of new jobs, are being stymied by these onerous charges. Furthermore, unemployment and other benefits in most European countries are simply out of proportion, and they give the jobless little incentive to seek work. Here, the Europeans probably could learn something from the United States. Savings in these areas could provide funds for programs that create employment. Unfortunately, Europe’s technocratic leaders have done a poor job of explaining the economic situation to voters and have lacked imagination in promoting new ideas.

A recent Brookings Institution study of the policies needed to restore growth in the U.S. economy, including funds for education and training and adding spending for research and development, estimates annual expenditures on the order of $80 billion, a large but not Himalayan sum. In Europe with its far higher levels of unemployment, the costs would likely be greater. To pay for this program, the authors call for higher taxes on upper income groups, coupled with spending cuts in other areas, presumably defense. While one can disagree with the specifics, the cost estimate suggests the magnitude of the task that confronts decision-makers.

One of the main arguments against an expansionary strategy, of course, is that it is inflationary. In the current climate, inflation can be avoided if monetary discipline is maintained. But in the event, some inflation overseas, as in the Japanese case, might well suit American interests. For Europe, it may be time to reassess the costs associated with the doctrinaire German approach to monetary policy. While inflation is a scourge, so is double-digit unemployment, with its dangers to the global economy.


No single formula would produce an optimal set of policy reforms. Each industrial country must find its own mix, given its particular political and economic circumstances. But these efforts will be more effective if pursued as part of an international effort. Without such policy coordination countries will either be penalized by financial markets for adopting growth-oriented policies or they will aggressively pursue beggar-thy-neighbor currency devaluations.

Effective coordination in the G-7 is not impossible; the global economy could not have been built without it. Nor is there a risk that such growth-oriented coordination would be undermined by massive capital flight to East Asia or other regions, since the United States and other Western countries still dominate the global financial marketplace. According to the OECD, in 1994 member countries were home to 90 percent of world stock market capitalization and bond issues.

A precedent for cooperation during hard times is the Bonn Summit of 1978. As the world economy was recovering from the oil crisis of 1973-74, the OECD called on governments to stimulate their economies to ensure that the growth prospects became a reality—remarkable in light of today’s deflationary bias. The member countries agreed to a package of national measures that would collectively spur global growth. These included a reduction in U.S. oil imports, which led to a fall in world oil prices, and the implementation of expansionary policies in Germany and Japan. Unfortunately, the second oil crisis, caused by the Iranian Revolution, undercut most of these initiatives.

Why have Western countries eschewed this type of coordination in recent years? If they truly believe in globalization, they must accept that the economic performance of trading partners is converging. They should see such variables as growth rates, interest rates, and workers’ wages approaching some common values. But instead, there are profound divergences in national economic performance, even in Western Europe, suggesting the continuing importance of domestic politics. This internecine competitiveness makes policy coordination difficult to achieve in the best of circumstances, but all the more so when growth is sluggish.

During the postwar decades, American leadership has time and again played a crucial role in leading the industrial countries out of the doldrums. The United States has assumed this burden not because it is magnanimous, but out of enlightened self-interest. Prosperous allies are needed for both economic and security reasons, and the OECD countries still generate by far the largest share of world trade. Today that leadership is absent. The president, perhaps pushed by Congress, seems to believe that domestic economic problems can be solved through domestic economic policies. The administration’s singular focus on the international front has been export promotion. But American exports can increase only if the world economy continues to liberalize and grow.

This is an age of widespread economic insecurity, brought about by profound changes in trade, finance, and technology. For globalization to proceed, public officials in every country must give the lie to those who assert that it is anathema to workers’ interests. The best way to make this case is by restoring growth and opportunity. Restrictive economic policies may have been necessary when first conceived in the 1980s to bring stability to financial markets, but they have failed too many people too long.

While the world stands at a critical time in postwar history, it has a group of leaders who appear unwilling, like their predecessors in the 1930s, to provide the international leadership to meet economic dislocations. Worse, many of them and their economic advisers do not seem to recognize the profound troubles affecting their societies. Like the German elite in Weimar, they dismiss mounting worker dissatisfaction, fringe political movements, and the plight of the unemployed and working poor as marginal concerns compared with the unquestioned importance of a sound currency and balanced budget. Leaders need to recognize the policy failures of the last 20 years and respond accordingly. If they do not, there are others waiting in the wings who will, perhaps on less pleasant terms.

[1] John G. Ruggie, "International Regimes, Transactions, and Change: Embedded Liberalism in the Postwar Economic Order," International Organization, Spring 1982, pp. 195-231.

[2] Melvin Reder and Lloyd Ulman, "Unionism and Unification," in Labor and an Integrated Europe, ed. Lloyd Ulman, Barry Eichengreen, and William T. Dickens, Washington: The Brookings Institution, 1993, p. 24.

[3] Adrian Wood, North-South Trade, Employment and Inequality: Changing Futures in a Skill-driven World, New York: Oxford University Press, 1994.

[4] See, for instance, Jagdish Bhagwati and Vivek H. Dehejia, "Freer Trade and Wages of the Unskilled—Is Marx Striking Again?" in Trade and Wages: Leveling Wages Down? ed. Jagdish Bhagwati and Marvin H. Kosters, Washington: AEI Press, 1994, pp. 36-75.

[5] Yolanda K. Kodrzycki, "The Costs of Defense-Related Layoffs in New England," New England Economic Review, March/April 1995, p. 16.

[6] Jeffrey G. Williamson, Inequality, Poverty, and History, Cambridge: Blackwell, 1991.

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  • ETHAN B. KAPSTEIN is Director of Studies at the Council on Foreign Relations. His most recent book is Governing the Global Economy: International Finance and the State.
  • More By Ethan B. Kapstein