The United States is becoming a Third World Country, and only aggressive industrial policy, reformed education and new uses of taxation can save it. In capsule, that provocative view is put forth by Edward Luttwak in The Endangered American Dream. Best known as an international security expert, Luttwak exhibits his usual high-octane candor in examining domestic issues. When it comes to remedies, however, he is often short on specificity and appropriateness.
Luttwak's list of American shortcomings is all-inclusive and accurate-trade and budget deficits, inadequate schools, huge income disparities and stagnating incomes. He attributes the relentless U.S. slide toward Third World status to the continued decline in per capita GNP, the deliberate undervaluation of the dollar since the 1985 Plaza Agreement and the misallocation of capital. He blames, in particular, the absence of "patient capital"-interests that don't seek short-term profits-and foreign takeovers of U.S. companies in the 1980s.
Luttwak points to what he describes as "self-inflicted wounds," such as huge budget deficits, financial deregulation, a collapsing public education system, too many lawyers and failing social programs. In harsh, populist terms he attributes the increase in crime and the decline in public education to the increasing concentration of wealth in fewer hands.
It is unfortunate that Luttwak paints these social and economic issues with such a broad brush. It is hard to find the causes of the ills he describes and to reconcile them with his suggested remedies. For instance, he claims that most of our economic ills are self-inflicted, yet he clearly attributes many of them to unfair foreign competition. He advocates higher pay and higher benefits, following the example of German economic success, yet recognizes that German factories are being transplanted to the United States because of these policies. He blames short-term speculation for many takeovers and LBOS without recognizing that some of the most egregious cases (such as RJR Nabisco) hinged on huge loan commitments from the very source of "patient capital," namely Japanese banks.
REMEDIES-REALISTIC AND OTHERWISE
Luttwak focuses his remedies on public education, taxation and industrial policy. He decries the bloated and corrupt bureaucracies of thousands of independent school boards, correctly identifies violence as one of the most corrosive influences on both teachers and students, and criticizes racial politics and multicultural education as profoundly destructive of educational standards.
He recommends shifting control from school districts to individual school boards in order to increase parental influence. To promote excellence, he proposes federal pay incentives for teachers who pass qualification exams set to demanding national standards. He favors much more emphasis on vocational training, possibly making it the "predominant form of secondary education for older teenagers." These are constructive proposals. Federal pay incentives for outstanding teachers and more emphasis on vocational training would be beneficial.
But the desperate condition of our public school system calls for greater boldness. Should federally financed infrastructure investments include computer hardware, software and teacher training in exchange for local reforms? Why not seize the opportunities of interactive technologies? (Computer-assisted instruction and educational television start in the lowest grades of European and Japanese education.)
If revolutionary change, as Luttwak correctly argues, is needed in the schools, the issue of school choice must be discussed. I support public-school choice, having witnessed the New York city public school system disintegrate over 20 years, despite large expenditures that currently total $7 billion annually, or $7,000 per student. Without some competition to reward excellence and penalize failure, turning over control to local school boards will not make things better.
It is also necessary to have schools address two of our greatest social tragedies: teenage births and aids. Sex education and the distribution of condoms are a minimum, but the departure of Chancellor Joseph Fernandez of the New York City School Board attests to the perils of such initiatives. The problems of the public schools cannot be separated from the problems of the big cities: drugs, guns, crime, broken families and crumbling housing. We cannot fix the schools without fixing the cities.
TAXES, INDUSTRIAL POLICY AND JOBS
Luttwak attributes the deterioration of America's public infrastructure, as well as the private sector's failure to offer sufficient amounts of well-paid employment, to a scarcity of domestic savings and capital. He recommends a phased replacement of the corporate income tax and the Social Security payroll tax with a federal sales tax or a European-style value added tax (vat), collected at each level of production. As part of such reform, all tax deductions and credits would be eliminated.
Luttwak's laudable tax and investment policies are implausible in today's political environment. The system will move in the direction he advocates only in smaller, discrete steps. For instance, in lieu of a broad-based vat (which incidentally would require readjusting all local sales taxes nationwide), a phased-in increase of gasoline taxes, tied to infrastructure investment, should be pursued. Instead of eliminating the corporate income tax, a good initial step would be the elimination of the double taxation on dividends, which would reduce the tax law's bias toward debt as opposed to equity securities. The negative economic impact of state and local taxes should also be addressed. Some assumption of local burdens by the federal government, conditioned on reductions in local sales and property taxes, is worthy of examination.
Contemplating what he calls a "geo-economic arms race," Luttwak favors an aggressive, government-directed industrial policy. But he provides no details on how it would work and how it would relate to the rest of the world. Industrial policy is a misnomer. Better to think in terms of coordinated government and private sector actions in the national interest. Combining gas taxes with infrastructure investment is a form of industrial policy if it reduces our consumption of imported oil and assists in defense conversion. U.S. government assistance to the former Soviet Union to rebuild nuclear power plants is also industrial policy if it is conditioned on U.S. companies getting a fair share of the contracts.
In certain high-technology areas, the national interest requires government-backed action. Luttwak is right in pointing out that an example of successful industrial policy is the subsidized development of the Airbus commercial airliner in Europe. The Super Concorde should be our answer to Airbus. Industrial policy cannot consist purely of domestic actions to protect failing industries; it must be part of a global strategy of helping key U.S. industries become more competitive.
THE WORLD AS IT IS
The revolutionary forces rocking the world are driven by real-time access to information anywhere, anytime, by worldwide technology transfers made possible by new communications systems, and by global capital markets driving more than $1 trillion daily through the New York Clearinghouse System. Those technology transfers enable McDonnell Douglas Corporation to manufacture DC-9s in China, and Bangalore, India to become the software capital of the world.
Global capital markets enable foreign exchange speculators to cause the collapse of the pound sterling despite concerted counterefforts by central banks. However, they also testify against the thesis that the United States has a capital shortage. In addition to access to huge domestic savings pools ($3 trillion in U.S. pension funds alone), the United States has access to worldwide savings pools. That access requires a return to sound fiscal policies (which Clinton has begun), free trade and investment, and the maintenance of a strong dollar. It does not require a balanced budget, but suggests lowering the deficit to, say, between 2 and 2.5 percent of GNP. It also suggests that the amount and structure of the total public and private debt is more important than the amount of the federal government debt. In that connection, the current policy of the U.S. Treasury to shorten the average maturities of the national debt for limited short-term budget savings is short-sighted and risky. When long-term interest rates are at their lowest level in 20 years and we are faced with steep borrowing requirements well into the future, the Treasury should be selling 50-year bonds (or 100-year bonds like those of the Walt Disney Company) instead of three- and five-year notes that are likely to create a roll-over problem in five to seven years.
The need for a strong dollar, coupled with an aggressive domestic and foreign investment policy, goes counter to attempts by several administrations to depreciate the dollar versus the yen to reduce the U.S. trade deficit. This has never worked before and is unlikely to do so now. A strong dollar, in the long run, is more important; it encourages American companies to invest overseas. Eventually, that will do more for trade than the temporary help of a weak dollar.
Japan is indeed a special case. The semiconductor quota agreement argues for additional sectoral targets for a few major trade categories (i.e., automotive parts) coupled with greater efforts to open up opportunities for direct investment in Japan. It is in our best interest to encourage open markets and freedom of investment and to push Japan hard in that direction. We should surround Japan with free trade zones, which she shall ultimately be compelled to join.
It is likely, however, that the dislocation created by these trends will continue to put pressure on American private sector employment. Lower-cost foreign competition, coupled with increasing local skills and availability of advanced technology, will continue to drive the restructuring and downsizing of American businesses. It might, however, be useful to be somewhat more radical in examining some possible areas to create employment. These might include some forms of earlier retirement or shorter work weeks as well as tax incentives for early retirees to create small businesses. These are hard to reconcile with the need for productivity improvements, but it is equally necessary to protect the standard of living and the personal security concerns of average Americans.
Education and training alone will not create employment. The trends created by technology and foreign competition must be considered; they all go in the other direction. The need for new jobs can be met in part with a major long-term infrastructure program. This should be financed by borrowings secured by a version of Luttwak's consumption taxes, most easily, gasoline taxes. A $250 billion ten-year program should generate one million new jobs annually, rebuild badly needed public facilities and assist conversion of defense industries. Increases in gasoline taxes could be made politically palatable if tied to construction and jobs. Rapid rail transit, new airports and other large-scale engineering projects are needed to maintain the skilled technical base of the defense sector and improve our infrastructure. A modest annual increase in gasoline taxes would be adequate to finance such a program over 30 to 40 years. Its financing should take place off-budget and would be self-liquidating. Moreover, it would sustain job growth better than building unnecessary weapons such as the Seawolf submarine.
Luttwak has raised some perfectly valid approaches-industrial policy, public education and taxation-to deal with some of our most serious problems. But even couched as part of a "geo-economic arms race," his recommendations appear disconnected to surrounding realities. In education, for example, the crisis of the schools cannot be separated from the crisis of the cities. As for the economy, we cannot separate the United States from the rest of the world. There is no shortage of capital for the U.S. economy, despite Luttwak's arguments; there may, however, be a global shortage of capital, which could affect the ability of countries like China, Russia and India to develop their economies. The development of those economies, along with Mexico and Latin America, will be necessary to drive economic growth in the United States and Europe. Without that growth, the Western democracies may find their ability to deal with social problems such as education, health care, old-age security, etc. will be seriously impaired.
At a time when we seem totally focused on the domestic economy, it might be more appropriate, for example, to consider a greater role for the State Department in developing strategy on global economic issues, instead of thinking of an American MITI. The domestic economy may have brought President Clinton to power; the international economy may be needed to keep him there.
Luttwak raises the right questions; his answers are more problematic.
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