HOW AMERICA CAN TRIUMPH America can grow much wealthier and provide world leadership for the coming century. It has to do a couple of things right -- both tough, neither impossible.
(FORTUNE Magazine) – AMERICA ENTERS the 1990s bristling with opportunity. The spread of pluralistic, democratic capitalism -- a victory for American ideals and policy -- promises a world bound more tightly together, largely at peace, and freer to concentrate on improving the well-being of its inhabitants. The country is shrugging off the malaise and shrunken visions of the 1970s, partly because the 1980s turned out so much better than the voices of doom predicted. A world of increasingly shared power still needs leadership, and America remains the logical candidate to provide it. That role will almost certainly pass to others if the U.S. fails to strengthen its economy. A decade of federal budget deficits will soon lift the national debt above $3 trillion. Productivity growth, though better lately, is disappointing in comparison with postwar trends -- and more so against the performance of such trading partners as Japan. The nation saves and invests too little. It continues to run trade and current account deficits, sucking in foreign capital at a rate of $10 billion a month. Its debt to foreigners will likely crack the $1 trillion barrier by 1992. On its current course America will lose ground to cutthroat competitors, megabit by megabit. ! This article examines and prescribes the best policies for America to follow over the decade ahead. They boil down to two undertakings, both large and difficult but neither impossible. First, the U.S. must speed the growth of productivity, the engine of wealth and higher living standards. Second, it must eliminate the federal budget deficit. Americans are used to being lectured about the need to achieve these goals, but they don't hear much about what they might gain from doing so. To find out, FORTUNE asked the Laurence H. Meyer & Associates (LHM&A) economic forecasting firm of St. Louis to draw up three long-range simulations of the U.S. economy. The highlights are shown in the accompanying charts. Like any long-run forecaster, LHM&A assumes the economy will suffer recessions along the way but doesn't pinpoint them, and makes no allowance for shocks such as an oil price explosion. In LHM&A's baseline, the U.S. muddles through, largely by following today's policies. Productivity advances at the current 1.2% annual rate. The federal deficit, driven by demands for higher spending, sticks where it is, at 3% of GNP. In both alternative scenarios, government spending falls to balance the budget by 1996, and productivity rises gradually to 1.8% by the turn of the century. In one alternative, which we label Borrow & Invest, we count on a continuing supply of foreign capital. In the Repent & Repay option, we look at what would happen if the U.S. had to eliminate its trade and financial deficit with the rest of the world -- because foreigners, losing faith in the prospects of the economy, are unwilling to keep investing. The two scenarios delineate the outer bounds of reasonable policy choices and business behavior. Each would produce a stronger economy than muddling through. But the rewards of pursuing the high-investment choice are clearly superior: -- GNP in constant 1982 dollars would reach $7.3 trillion by 2008, the end of the forecast period -- over $1 trillion more than the U.S. would get by muddling through. -- NATIONAL DEBT would fall as a percentage of GNP from 42% to 12.9% -- a far more manageable load for taxpayers to handle. Federal interest payments in 1982 dollars would drop from $170 billion a year to about $105 billion. Were America to continue to muddle through with deficits at 3% of GNP, the Treasury's interest bill would reach a staggering $625 billion. -- REAL INTEREST RATES would decline dramatically. Eliminating the federal deficit and boosting productivity would permit the real rate on 30-year Treasuries to fall to just 1%, two points below America's historical level. -- INVESTMENT would rebound. Low interest rates and higher savings should put the cost of capital for U.S. businesses on a par with that of their Japanese competitors. Gross private investment would rise from just 15% of GNP today to nearly 20% -- within hailing distance of the 23% Japanese companies are currently investing. -- LIVING STANDARDS would climb. Real annual per capita disposable income would grow to $17,000 -- 11% higher than in the baseline simulation -- and incomes would go up more than half a percentage point a year faster. With more money, consumers would spend better than $500 billion a year more by 2008 than in the baseline scenario. Yet even with the malls packed, personal consumption as a percentage of GNP would fall from 64.6% today to 60.4%. -- CORPORATE PROFITS would soar 70% above the level of the baseline economy, to a total of $518 billion in 1982 dollars. What about those huge trade deficits and the foreign debt the U.S. piled up during the 1980s? In the high-investment economy, America would remain a net importer of goods and capital well into the next century. LHM&A's model projects that the current account deficit would increase from $141 billion in 1989 to some $215 billion in 2008. Foreign indebtedness measured as a percent of GNP would grow from 11.5% this year to a scary-sounding 28.7%. Net foreign investment in U.S. assets would rise from an estimated $130 billion a year in 1990 to more than $457 billion. MANY ECONOMISTS doubt that foreigners would want to keep investing at that level -- or that Americans would stand for becoming still more beholden to creditors abroad. So in the Repent & Repay scenario, a weaker dollar and much higher exports bring the current account into balance by the mid-1990s. Foreign debt, measured as a percentage of GNP, would fall by nearly five percentage points to 6.7% by 2008.
But those gains would come at a price. In the LHM&A model, the dollar would have to fall nearly 22% by the mid-1990s to close the current account deficit. That sharp drop in the dollar's value drives the real interest rate up to an investment-garroting 7.7%. By the end of our forecast period, the U.S. would have been sacrificing over a half-trillion dollars annually in real GNP -- some 7% less than it would have gained in the high-investment model. & FORTUNE argues for investment and growth. In the metaphor that dominates America's thinking about the subject, foreign money is a dangerously addictive drug -- financial crack. But if Congress and the Administration can break the budget gridlock, and if the Federal Reserve Board can keep inflation leashed, foreign capital will look more like vitamins. Stimulated by it, the U.S. economy would grow faster than the inflow of capital, making the obligations easier to carry. The current account deficit would shrink from 3.5% of GNP today to 3% by 2008. And because of lower interest rates, net interest payments to foreigners would be less than they would on the smaller debt load of the Repent & Repay option. Balancing the federal budget and raising productivity fall squarely within the scope of what American policymakers and businesses can accomplish. But our numbers reveal only the possible, not the inevitable. Here's what's needed to make the high-performance economy a reality. -- WHY ''NO NEW TAXES'' MAKES SENSE. Economists making inflated claims on behalf of the Reagan tax cuts in the 1980s gave supply-side a bad name. The lower taxes failed to light a fire under private savings and investment and produced gaping budget deficits instead. The old-fashioned supply-side principles could be vindicated -- no kidding -- in the 1990s and beyond if the budget is brought into balance through spending curbs instead of tax increases. Joel L. Prakken, LHM&A's director of model development, compared how much additional growth in GNP the U.S. could expect were the federal government to close the budget deficit in the mid-1990s by reining in spending, or by raising income taxes, or by phasing in a consumption tax. He discovered a remarkable counter-Calvinist principle: The economy gains the most when taxpayers suffer the least pain. Once the budget is brought into balance, the Treasury's revenues begin to exceed federal spending -- even at current tax rates. After 1996, the government would start piling up large surpluses. By taking advantage of this ''fiscal dividend,'' America could lower income taxes by some 20% to maintain a balanced budget. Thus, Prakken estimates, a combination of spending restraints followed by tax cuts that would stimulate the economy could add more than $1.5 trillion to cumulative GNP by 2008. That represents nearly six times more output than the economy would realize by raising income taxes to balance the budget, and almost three times as much additional growth as a consumption tax would yield. Because lower taxes would fatten take-home pay and increase individuals' incentives to work, the tax cuts could add 3.6 million workers to the baseline growth of the labor force by 2008. The additional labor alone could lift GNP some $170 billion, or 2.4% a year. In their scenarios, LHM&A balanced the federal budget through across-the- board spending freezes. Policymakers can do better than that -- and some of the right choices will help enhance America's world leadership role. CONGRESS and the Administration will get help from the peace dividend that's likely as the Cold War winds down. Defense Secretary Richard Cheney is already pressing the armed services to seek cumulative cuts of up to $180 billion from the defense budget over the next six years. Reducing -- but not eliminating -- America's huge army in Europe will ease the anxieties of European voters who think it's too much of a good thing. The U.S. should also map cuts in its unconscionable agricultural subsidies, using the offer to entice trading partners, notably Japan, to sharply reduce their own extravagant payments to farmers. Policymakers need to reestablish more discretion in the budget process. They must reexamine entitlement spending, which now has the budget tied in knots, with an eye toward making the billions spent on these programs more cost- effective. Too much Medicare spending, for example, goes to unneeded testing and operations that are at best marginal -- and helps fuel medical cost inflation. Washington must begin asking hard questions about who gets how much. For example, some 85% of the more than half-trillion dollars the federal government spends on entitlement programs is not means tested. Should more be? Nearly 80% of all social benefits programs are fully indexed, compared with just 6% in the 1960s. By making cost-of-living adjustments trail two percentage points behind annual increases in the consumer price index, the government could save $93 billion over the next five years. As the government regains control over defense and entitlement spending, it can strengthen such contributions to general welfare as environmental protection and proven programs like Head Start. -- FAN THE FLAMES OF PRODUCTIVITY. In a country's long-run pursuit of well- being, the single most important objective, the one that should guide all other economic policies, is higher productivity growth. Do you want more goods, more services, more leisure? Do you want to share more with the poor? Higher productivity gives you the resources to make the choices. A steady rise in private nonfarm productivity growth from its 1.2% average of recent years to 1.8% by the end of the 1990s -- a large jump, but well within the bounds of what is technically possible -- would add over $700 billion to GNP by 2008. How can the U.S. get this speedup? Through thousands of large and small improvements in technology and techniques -- the photos on these pages illustrate how diverse and sometimes surprising they are. The basic ingredients are ''human capital,'' meaning a smarter work force; smarter management; and money. Public policy has a major role to play in upgrading the work force. Measured by standardized tests given to students around the world, American primary and secondary education lags behind not only that of other major industrial nations but such countries as Hungary and South Korea. The U.S. won't get the productivity growth it needs if the education reform movement now under way falters or falls short. If the schools can do a better job of teaching, there will be plenty of incentive for students to learn. That's the clear message of recent research by Dale W. Jorgenson, a Harvard economist and a specialist in measuring advances in the quality of human capital. Because employers' demand for managers and skilled workers with post-secondary training is racing ahead of supply, the economic incentives for the current crop of high school students to get their diplomas and go on to college have never been better. The returns to those who invest in education beyond high school are the highest of the postwar period. Over a lifetime of employment, a worker with post-secondary education today can expect to earn nearly $550,000 more than a high school grad. Jorgenson expects the earnings gap to stay open for a decade or more. By the time supply catches up, he estimates, the better-educated work force could add up to a half-percentage point to annual GNP growth. Says he: ''Through the higher wages employers are paying for more skills, the market is sending a powerful message to young people that is only beginning to sink in -- you will be rewarded handsomely for staying in school.'' America will get some help from demography. The work force is beginning to tilt toward a larger proportion of seasoned older workers, among them the first generation of women making career-long commitments to the workplace. Early in the 21st century, some three-quarters of the labor force will be in its most productive career years, 25 to 54, vs. about two-thirds in the 1980s. There should be no mystery to managing smarter. A European commission that examined U.S. productivity in the early 1950s marveled at how the Yanks did it -- and their observations sound a lot like what Americans say today about the Japanese. ''American operatives do not work harder than their opposite numbers in Britain, nor are their machines in general better tooled or superior,'' said a British team. ''Their high productive efficiency is due largely to more accurate planning by management and more constant analysis of methods.'' Added the French: ''((In the U.S.)) productivity is a state of mind. It is the continuous effort to supply new techniques and new methods. It is faith in human progress.'' Today's management has just started to get back on that track. Since the early 1980s, more and more companies have begun to see payoffs from new ways of organizing the production process: giving employees more responsibility, training production workers in the methods of statistical quality control, forging cooperative new relationships with suppliers and customers. Employers should find the 1990s an even more propitious decade for productivity-boosting innovation. Because older workers change jobs less frequently, companies should capture more of the benefits of what their employees have learned. The art of delegating responsibility to workers continues to evolve. Edward E. Lawler, director of the Center for Effective Organizations at the University of Southern California business school, thinks two techniques now beginning to spread will take hold in the decade ahead. Self-managing work teams give groups of employees engaged in a common task the autonomy to devise the most effective methods to reach output targets and push authority deep into the organizational ranks. Gain-sharing compensation plans allow employees to divvy up part of the savings realized by hitting predetermined productivity targets. Well-run employee-involvement programs incorporating these new approaches, Lawler's center has found, can reduce costs 30% to 40%. -- INVEST MORE, INVEST SMARTER. The earnest restructurings of the 1980s were merely an appetizer. The main course will come in the 1990s and beyond, and America's leading foreign competitors are already digging in. Says Joseph Bower, director of doctoral programs at Harvard business school: ''The successful firm of the future will be an innovation machine characterized by speed and flexibility.'' Though America can get a lot of mileage from ''soft'' managerial techniques for raising productivity, hard cash is also vital -- to pay for the research and development that yields productive new machinery and processes, and to build the machines and plants. Capital spending by American companies has risen smartly over the past two years, and streamlining production methods has made the spending more efficient. For example, just-in-time inventory systems free up space on the factory floor, adding capacity without requiring new bricks and mortar. But America's competitors are investing more of their GNP, and spending the money more shrewdly. If U.S. industry isn't to enter the new century competitively emaciated, capital investment will have to rise and, more important, managers will have to rethink what they are spending for. Manufacturing is in the throes of a technological revolution. At the forefront is so-called programmable automation, best exemplified in the flexible manufacturing systems (FMS) that can turn out a wide range of products on the same line, shifting instantly from one model to the next. Robert Hayes, a management professor at Harvard business school, estimates that companies that successfully adopt FMS technology can double or triple the efficiency of both capital and labor, and cut defects and the time it takes to introduce new products by an astonishing 90%. FMS is spreading too slowly, especially among the smaller manufacturers that can gain the most competitive leverage from it. In Japan, says Hayes, small companies buy half of all flexible manufacturing systems. In the U.S., by contrast, giants such as 3M, McDonnell Douglas, and Deere are doing most of the buying. American companies also fail to exploit FMS's fullest potential. A comparison of U.S. and Japanese manufacturers that use the technology by Harvard business school professor Ramchandran Jaikumar showed that U.S. companies turn out just 25 different products on each piece of equipment, vs. 240 products for their Japanese competitors. American industry also benefits too little from the huge sums it shells out for research and development. The $67.5 billion the U.S. spent for civilian R& D in 1987, the last year for which figures are available, nearly equaled the combined R&D spending of Japan, West Germany, and France. But dollar for dollar, America's trading rivals get a bigger bang. The whole economy gets a lift when one company's innovation spreads through an industry and on to its customers. Martin Neil Baily, an economist at the University of Maryland, calls this process ''creative imitation,'' and the U.S. could do with much more of it. Edwin Mansfield, director of the Center for Economics and Technology at the University of Pennsylvania, estimated that the return on R&D investments to companies inventing a totally new product averaged a healthy-sounding 25%. But as imitators re-engineer and refine the pioneer's breakthrough, they and the industry's customers reap returns averaging 56%. There's an important lesson here for American business. U.S. companies spend two-thirds of their R&D budgets on new products and processes. Their Japanese counterparts spend two-thirds of their R&D on the scores of small refinements that can improve manufacturing quality and efficiency. The resulting well- honed skills also help them get new products to market faster and with few glitches. Mansfield estimates that innovation by Japanese companies is 15% faster and costs up to 20% less than that of U.S. firms -- an unbeatable combination for winning market share and profits. Can America do the same thing? It used to. U.S. industry rose to world leadership by shamelessly borrowing and refining the breakthrough innovations of British and German scientists. The creative Yankee tinkerer, embodied in a Henry Ford or a George Westinghouse, figured out how to turn other people's brilliant ideas into products. The breed is still alive in such tinkerer- inventors as Steve Jobs, co-founder of Apple Computer and more recently founder of Next Inc., and boy billionaire Bill Gates, the college dropout who co-founded computer software giant Microsoft. But the Japanese are much better at institutionalizing the process. A few American companies are beginning to fashion themselves into tinkerer organizations. Hewlett-Packard, for example, is tying its research engineers more closely to the engineers who supervise the production lines and exploiting scores of small breakthroughs. H-P last year introduced its market- beating DeskJet printer, which it developed in just 22 months -- less than half the time it used to take to get a complex new product to customers. More companies need to follow suit. -- THE LIMITS ON SAVINGS. Though private savings have risen recently, Americans salted away just 4.7% of disposable income on average since 1983 -- well below the post-World War II high of 9.4% reached in 1973. Optimists bank on a lift in the national savings rate -- some of the giddier estimates run as high as 10% to 12% of GNP -- as more Americans enter their gray-haired, wide-girth years with most of their aggressive consumption needs satisfied. If the forecast for the high-performance economy pans out, the optimists are apt to be disappointed. Eliminating the drag of the federal budget deficit -- what in economic terms amounts to government dissaving -- would lift the national savings rate. But the steep decline in real interest rates would lower returns to individuals, depressing the private savings rate. Buying a CD player would still look more appealing than buying a bank CD. Our scenario projects that private savings will not rise beyond 5% of GNP by early in the next century.
Public policy could ameliorate the effects a bit, though there's as yet little consensus on what measures would be most effective. James Christian, chief economist of the U.S. League of Savings Institutions, argues persuasively for giving individuals more responsibility to save for retirement. Since 1984, Christian points out, most additions to private savings have been contributions to pension plans with employers -- not employees -- doing most of the saving. Last year individuals withdrew nearly $90 billion more than they added to savings. ''Preparing for retirement is the greatest incentive individuals have to save,'' says Christian. ''Plans funded only by employers neutralize that incentive.'' Employers should keep making those contributions, he says, but employees should also be required to kick in part of their pretax wages. Such plans are currently offered by just a third of all employers. More widely adopted, says Christian, they could add one or two percentage points to the savings rate in the 1990s. -- THE CASE FOR FOREIGN CAPITAL. The most controversial policy FORTUNE advocates is to continue relying on heavy infusions of foreign capital. Being a big borrower -- or having foreigners build more Toyota plants and buy more Rockefeller Centers -- doesn't sit well with a country accustomed to being king of the world. The higher the level of foreign lending and ownership, the likelier a xenophobic backlash that could restrict capital movements or even ban foreign ownership. Counting on that flow to continue is risky for other reasons. The surprising recent strength of the dollar suggests that for now, America is still the world's favorite place to invest. Says Jerry Jordan, chief economist at First Interstate Bancorp in Los Angeles: ''That strength is telling us that foreigners' eagerness to add to their portfolios of U.S. assets exceeds America's demand for their goods. If the Japanese and Europeans who are making these investments spoke Spanish, we'd be calling their rush to load up on U.S. assets 'flight capital.' '' But could foreigners find more lucrative investment opportunities elsewhere in the years to come? Recent changes in the Eastern bloc have come with surprising speed, and market-oriented economic reforms there could also come more rapidly than anyone anticipated a few months ago. If they developed, they could attract a lot of capital that now heads for America. Those prospects look dubious now, but 20 years is a long time. And if foreigners made their decision to shift investments elsewhere abruptly, the sudden devaluation of the dollar could shock the U.S. economy and most others. IN THE REAL WORLD outside of economic models, the U.S. will probably find a course between those outlined by LHM&A, getting somewhat less in the way of foreign investment and somewhat more in the way of taxes than the ultimate high-performance scenario calls for. Such a course would still yield most of the benefits -- and produce America's next triumph. But a zealous effort to abolish the trade deficit holds greater risks than relying on foreign capital, and American leaders need to explain this to their own people. Even if it didn't impel the U.S. to protectionism, ''managed trade,'' and other neo-mercantilist acts, the perceived independence it aims for belongs to the dead era of American hegemony -- the old idea of the country beholden to no one. That's precisely the wrong way to head. More than any other nation, America stands for the free flow of goods, services, capital, people, and ideas around the world. It has to show the way to an open global economy by example as well as by rhetoric. Japan's former Prime Minister Yasuhiro Nakasone summed up the case for American leadership in an interview early this year in the Harvard Business Review. Said he: ''People from all over the world go to the United States to live, and they have become an important element in building it. The frontier spirit is still very prominent. As a result, intellectual stimulus is prominent, too. Unless these elements disappear, the United States will remain at the top.'' He might have added: as long as it rises to its economic challenge.
CHART: NOT AVAILABLE CREDIT: DATA SOURCE FOR CHARTS: LAURENCE H. MEYER & ASSOCIATES CAPTION: What the U.S. Can Achieve Real GNP
CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: Balancing the Budget Will Boost Saving and Spur Investment Higher productivity and a balanced budget strengthen the economy whether the U.S. borrows from abroad (''Borrow & Invest'') or not (''Repent & Repay''). But foreign investment will produce stronger growth. FEDERAL DEFICIT SURPLUS REAL INTEREST RATE SAVINGS RATE INVESTMENT
CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: Higher Output Will Make America Richer CORPORATE PROFITS DISPOSABLE PERSONAL INCOME CONSUMER SPENDING
CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: REAL GNP SPURS TO PRODUCTIVITY New developments, from scientific breakthroughs to social trends, constantly raise productivity and real GNP, the red line.
CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: Used Productively, Foreign Capital Will Be a Bargain NET INVESTMENT BY FOREIGNERS FOREIGN DEBT NET INTEREST PAID TO FOREIGNERS