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Point of View: What
is the American model really about?
Soft
Budgets and the Keynesian Devolution
By
James K. Galbraith, The Levy Economics Institute, Public Policy Brief
No.72A
The
American model fascinates Europeans. To many on the right, the American
version of the free market—as they imagine it—represents an ideal
type. It is the highest form of capitalism. It is to be celebrated for its
efficiency and technological dynamism, and even its capacity to deliver
full employment—all free from the dead hand of governmental regulation
and control. These charms are largely
lost on the European public, especially the European left. Their view
emphasizes the rapacity of the American multinational corporation, the
absence of universal social services in the
United States
, and the poverty and inequality delivered by
American labor markets. An emerging group of European progressives is
attracted to American solutions to the problems of the American model.
They emphasize the importance of investments in education, of job
training, and of new institutions for “lifelong learning.” Such
measures are particularly intended to help workers adjust to the
inevitable disruptiveness of life under unfettered capitalism. For all
three groups—the European right, the left-leaning public, and the Third
Way liberals—the American model has become a stylized battleground, a
terrain for struggle between those who would destroy European social
democracy, those who would defend it, and those who would adapt it as best
they can.
What
the three groups share is a stabilized understanding of what the
principles of the American model are. These supposedly include
deregulation, privatization, and the free setting of prices, and
especially wages, in competitive markets, without interference from
unions or concern for the shape of the resulting distribution. The
principles favor free international trade. They favor reduction
to the minimum of public subsidies, public transfer payments including
pensions, and public enterprise. And they favor the application of
“sound” fiscal and monetary policies, with the former dedicated to
budget balance and the latter exclusively to price stability. The image of
the United States
upon which these nostrums are based has
little foundation in the American reality. It is useless as a guide to
American economic performance. It is rooted in neither the historical nor
the modern facts of American life. By accepting the free market image,
European progressives find
themselves acknowledging the existence of an economy led to full
employment, at least for a time, through the application of free market
principles, including radical deregulation and the destruction of unions.
Progressives thus find themselves in the position of defending the dismal
economic
performance of modern
Europe
—specifically, high unemployment—on the
ground that the alternative has unacceptable social costs. The case for
social democracy is fatally weakened by the concession that it requires 10
percent of the population to remain idle, or to work off the
books
in the gray economy. Ordinary Europeans do not find this attractive. It is
equally ineffective for the European left to defend
Europe
by decrying the social evils of the American
model.
Real
wages in the United States
are high; some 70 percent of American
households own their own home; and more than a quarter of the adult
population has a college degree, with nearly half having some college
education. Even health care, on which Europeans pride themselves, is
abundantly available in the United States
to those who are insured. Poverty among the
elderly is low in America, and most seniors live independently. By
reacting to the United States
through Reaganite perceptions, Europeans deny
themselves a correct understanding of the keys to the American boom.
Because of their misunderstanding, they cannot draw on the actual sources
of recent American success.
The
Real American Model:
Soft
Budgets in the Social Sectors
So
what are the foundations of the actual American model? It is useful to
approach this question by applying the concept of the “soft budget
constraint,” widely attributed to the Hungarian economist Janos Kornai
(1986). This concept described the condition of state-owned heavy industry
under
the
communist regimes, as unable to make a profit or compete in international
markets, yet so central to the social fabric of the system in which it was
embedded, including the provision of social services, that it could not be
allowed to fail. Uncompetitive firms provided millions with the rudiments
of a comfortable and secure life, which have not always been restored
under the ensuing postsocialist orders. A brief examination of some
important American institutions will establish that the concept of the
soft budget constraint goes very far toward explaining the structure and
conduct of our economy in the past 40 years, particularly in the
prosperous period of the late 1990s. The keys to the American model lie in
those sectors providing social amenities to the middle class: health care,
education, housing, and pensions. In the
United States, health care consumes some 14 percent of
gross domestic product (GDP) (Levit et al. 2003).2 A typical share in
Europe
is 8 to 10 percent of GDP; in the
United Kingdom
the outlay is 7.3 percent (OECD 2003a). What
few Europeans understand is that health expenditures within the direct
U.S.
government budget consume 5.8 percent of GDP
(OECD 2003a). This amount covers only the elderly, the disabled, poor
families, and veterans. For the rest of the covered population, medical
care is paid out of
private
insurance, which offers tax advantages. Over all, the tax-financed share
is just under 60 percent of total health expenditure, or nearly 8 percent
of GDP (Woolhandler and Himmelstein 2002).
Higher education in the
United States
consumes about 2.3 percent of GDP. That total
is split nearly evenly between public spending and the private share,
which involves institutions whose multibillion-dollar endowments are
bolstered by the tax system. A more typical European figure
would
be the 1.4 percent of GDP spent on postsecondary education in
Germany
(OECD 2003b). Public and private institutions
alike benefit from federal research grants, contracts, and student loans.
The economic and socializing role of the American university system,
especially its effects on the demand side, receives too little attention
among foreign observers. Nearly 26 percent of the adult population has at
least a four-year college degree, thanks in part to the postwar GI Bill
and the
late-1950s
McGovern Act (NCES 2003). This population is essentially qualified to
participate in the economic life of an advanced credit economy. Having
received education loans, the population is eligible for mortgages and the
entire spectrum of access to private credit. It is presumed competent
to
navigate the tax and subsidy system in order to take advantage of credits,
deductions, and guarantees. Second, higher education has a direct effect
on employment and labor force participation. It employs a great many
people, including, of course, large numbers of the intelligentsia, who are
thus kept contented and busy. Even more important, it provides a place for
many who would otherwise spend their young adulthood unemployed.
The
United States
maintains two additional public systems that
keep otherwise difficult-to-employ young people out of the ranks of the
jobless. One is the armed forces, which consume 4 percent of GDP (BEA
2003). The second is the prison system, whose expansion in recent years is
deplorable, but whose effect on the unemployment rate among young adults
is similar to that of the military. Consumption of housing services
accounts for about 9 percent of U.S. GDP, while residential construction
accounts for another 4 percent (BEA 2003). The housing sector exists on
its present scale thanks to a vast network of supporting financial
institutions, all subject to federal deposit insurance, the secondary
mortgage markets provided by quasi-public corporations (Fannie Mae, Ginnie
Mae, Freddie Mac), and the tax deductibility of mortgage interest. In
recent years such measures as the Community Reinvestment Act have brought
pressure on private financial institutions to reduce their practice of
redlining and thus extend credit to poorer communities where their
presence had previously been
largely
predatory.
Finally, Social Security payments to the elderly and other
income-security programs finance about 8 percent of U.S. GDP, based on the
reasonable assumption that these transfers are substantially spent rather
than saved by their recipients. Social Security is the major source of
disposable income for 60 percent of the American elderly (SSA 2003).
Poverty in this group has fallen dramatically since the early 1970s and is
now lower than among the general population, largely as a result of
expanded Social Security pensions. The aforementioned elements together
account for nearly 40 percent of the total consumption of goods and
services in the
United States
. This does not include the direct
contribution of nonmilitary public expenditures at the federal, state, and
local levels, in such areas as primary and secondary education,
transportation, and the administration of justice.
Thus, some of the most
important sectors of the economy are funded by a bewildering variety of
financial schemes involving public support in myriad direct and indirect
ways,
including direct appropriations, loans, guarantees, and tax favors. A
broad political constituency supports all of these government measures,
affording them political staying power, while control over the scale of
these activities has slipped away from those who ostensibly oversee the
public budget. This is the genius, if one may call it that, of the
American model. The situation is different in
Europe
, where health care and higher education
remain substantially public sector activities, as do housing and pensions
(outside the post-Thatcher
U.K.). This accounts for the difficulties
Europe
experiences in absorbing its employable
population. Public sectors are subject
to hard budget constraints, in part because the public sector cannot lobby
nearly as effectively as the private sector for public support. And where
the public sector has a near-monopoly in the provision of a service (such
as health care), the private sector is forced to operate in other
areas—protected private retail shops and small farms, for
instance—that may not enjoy comparable rates of growth as incomes rise.
The American system of dual mechanisms of finance is far less efficient,
but it absorbs many more individuals into gainful employment. Moreover, as
European national budgets come into conformity with criteria established
by the Stability and Growth Pact, the expansion of human services becomes
more difficult, rather than less so.
Public
Policy Brief Highlights 4
The
Myth and the Reality of the New Economy
In
the rise of the United States
toward full employment, followed by the
subsidence of the past two years, what has been the role of the vaunted
flexibility of American labor markets? Increasing labor market flexibility
is not the cause of falling American unemployment. When American labor
markets
became more unequal in the 1980s, unemployment was stubbornly high.
American labor markets did not become more flexible as the economy
approached full employment in the late 1990s, and they certainly did not
become less flexible in the recent recession. Indeed, measurements
of
pay inequality in the United States show, unambiguously, that structures
of pay became substantially more equal as the 1990s progressed and
unemployment declined.3
In earlier work I have argued that the
much-repeated comparison of an inegalitarian, full-employment United
States
with
an underemployed, egalitarian
Europe
was and is based, in part, on a misperception
of the appropriate boundaries. It is true that
U.S.
incomes are substantially more unequal than
the societies of northern European countries, and roughly as unequal, by
most measures, as those of southern European countries. But these regional
comparisons ignore the component of inequality contributed
by
differences in average pay among European countries. These differences
remain far more substantial than comparable differences among American
states. (For this argument, see Galbraith, Conceicao, and Ferreira1999.)
Over all, unemployment and inequality are not substitutes,
but
complements, when measured at the appropriate level of geographic
aggregation. The rise to full employment in the
United States
in the late 1990s occurred, in part, because
of a very steady expansion of the quasi-public sectors, while the federal
government sector did not grow at all. State and local governments did
expand as the boom gathered force; so did tax-subsidized expenditures on
housing and health care. (To note this, of course, is not to minimize the
contribution to private business investment of the technology sectors,
abetted by private capital inflow from abroad.)
This
trend spurred growth in the 1990s. It worked for the conventional
Keynesian reason: a high level of effective demand. The peculiarity of
effective demand in the United States during this period—a nuance that
seems to have eluded European observers—was that much of it was
generated or encouraged by acts of public policy, but most of it did not
register on the public balance sheet. Thus the
United States
achieved full employment with record
surpluses. One might call this the Keynesian Devolution.
A
Crisis in the American Model?
The
problem of the Keynesian Devolution lay not in its efficacy as a mechanism
for growth and prosperity, but in its implications for the balance sheets
of the household sector. As the Levy Institute has emphasized in a series
of papers (Godley and Izurieta 2001a, 2001b, 2002; Papadimitriou et al.
2002), the American household sector’s spending has exceeded its income
since 1997. The net negative acquisition of financial assets peaked at
around 3 percent of GDP in 2001 and has since been falling sharply, in a
process known as reversion. When households cut back on spending in order
to bring their outlays into line with their (declining) incomes, a
prolonged period of stagnation, if not recession, is unavoidable.
Furthermore, the new fiscal era dawned badly for the state and local
government sector, which continues to operate under quasi-hard budget
constraints imposed by constitutional balanced-budget requirements. If
states and localities cannot avoid cutting their spending or raising
taxes, they could deplete as much as 1 percent from the overall spending
stream in the year ahead.
Thus the American model is entering a moment,
perhaps
even
a prolonged phase, of crisis. This crisis is mainly due to the behavior of
sectors in which budget constraints continue to bite—or are starting to
bite again after many years. To the extent that the state fiscal crisis
affects education and health care and the household sector avoids new
mortgage borrowing, soft budget constraints may give way to hard
constraints. Unless reversed, such a trend could derail the continued
success of the American model.
Public
Policy Brief Highlights 5
What,
Then, for
Europe
?
A
comprehensive approach to European unemployment must produce a
consistently higher rate of economic growth through the absorption of 30
to 35 million people into gainful employment, particularly those in
lower-income regions where unemployment and underemployment are pandemic.
How is this to be achieved? The objective of full employment must not be
simply part of the European Charter, but a core objective of all
policy-making institutions. It must be more important in practice than
either price stability or fiscal balance, and the authorities must
recognize that fiscal balance is a consequence, not a cause, of full
employment. Expanded credit access, through loan guarantees, homebuyer
subsidies, and secondary mortgage markets, can help
distribute
the burden of increasing effective demand over the private sector.
However, it is better to raise incomes than to underwrite a massive
increase in debt. Unlike the
United States,
Europe
lacks
retirement systems on the continental as opposed to the national scale;
consequently, the purchasing power of the elderly and other economically
secondary populations (including nonemployed women) in the less wealthy
countries is weak. The remedy is to move toward a Europeanized pension
system that would pay all European elderly on the basis of continent-wide
average productivity. Similarly,
Europe
could implement a system to increase the
income of
the
lowest-paid members of the European Union workforce, analogous to the U.S.
Earned Income Tax Credit.
In
higher education, the creation of even a handful of major EU-funded
institutions, strategically located in Greece, Portugal, southern Italy,
and Spain—as well as in the former East Germany, the Czech Republic,
Hungary, and Poland—could have significant effects on regional
development patterns and, ultimately, on continental integration. New
educational institutions should be funded not only through public grants,
but also through private charitable donations that are strongly supported
by the tax system. Major improvements in European health facilities could
also be funded by the European Union, with special emphasis on
lower-income regions. Perhaps equally important
would
be an expansion in facilities for the care of the infirm elderly, whether
in the form of institutions or by simply employing trained professionals
to assume part of the burden of caring for the elderly in their own homes.
In sum,
Europe
needs public investment, private credit, and
direct transfers to lower-income populations, both working and nonworking.
It needs softer budgets in strategic sectors in order to expand the
mechanisms of the welfare state, which were introduced in the postwar
period, from a national to a continental scale. A good place to start
would be with the basics, such as a continental Social Security system,
like that pioneered in the American New Deal.
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