The Die Hard Economy Why the doomsayers keep getting it wrong.
By Justin Fox

(FORTUNE Magazine) – If worrying were a sport, Henry Kaufman would be in the hall of fame. In his heyday as chief economist at Salomon Brothers in the 1970s and early 1980s, Kaufman was a thundering prophet of American malaise and decline. He was known in the press as either Dr. Gloom or Dr. Doom, and you can't say the nicknames were unfair. "I am aghast at how much our country has faltered," he said in a characteristically downbeat 1980 speech. "The path to sustainable economic growth seems lost to us."

After Kaufman left Salomon in 1988 to start his own economic advisory firm, he continued to issue dour pronouncements on a regular basis. But he hasn't been in the news much lately, so I stopped by his office at the end of March to find out if he could still do the gloom thing. He gave it his best: Businesses are deep in debt. Managers are too short-term oriented. Financial markets are fraught with more risk than ever. Mergers are eating away at the competition that has been at the heart of American success.

But then I read back to him that passage from his 1980 speech and asked, "Aren't we a bunch better off than we were then?" "Absolutely," Kaufman quickly replied. "This is a wonderful moment."

Being Henry Kaufman, he then couldn't help but launch into a discourse on how we must address all those problems he worries about. The point here, though, is that when even Dr. Doom has good things to say about the U.S. economy, something significant is going on.

What is going on is this: After the longest expansion ever, the economy screeched to a halt last year. Then, after a brief and not very deep recession, it started growing again. It survived a stock market slide and an outright crash in the tech and telecom sectors. It survived a near-vertical drop in corporate profits. It survived the bankruptcies of Enron, Kmart, and Global Crossing. It survived the destruction of the World Trade Center.

As always, dangers may be lurking just ahead (for more on that, see "Ten Things to Keep You Up at Night"). But the current debate over whether growth will be 2% or 4% this year, whether housing sales will hold up, whether business investment will rebound anytime soon, misses an essential point: The American economy of 2002 is a remarkable sight to behold. At 5.7% in March, unemployment is certainly up from the 3.9% of October 2000. That stuff happens when you have a recession. But it's at a level that would have signaled near boom times during the 1970s and 1980s. While growth was slow last year, it wasn't negative--real GDP actually expanded 1.2% in 2001, a recession-year performance surpassed only in 1960. Real after-tax personal income rose 3.6% for the year. Productivity, that flawed but powerful measure of how much economic value Americans generate per hour worked, grew a stunning 5.2% in the fourth quarter. And while it won't keep up that pace, it does appear to have returned to an upward trajectory not seen since the 1960s.

We have arrived at this moment of relative economic bliss despite being told over and over again during the past 20 years that we were headed for the abyss. I'm something of a connoisseur of economic doomsaying. Among the books stacked on my office shelf are The End of Affluence, The Endangered American Dream, The Downsizing of America, and The Internet Depression. My wife and I were even characters in a scaremongering European bestseller a few years ago that was translated into English as The Globalization Trap. The author, an Austrian journalist and family friend, used the cramped dimensions of our old Manhattan apartment as evidence of the failure of American-style free markets.

For a couple of years in the late 1990s we were also confronted by books with titles like Dow 36,000 and The Long Boom and well-paid experts arguing on TV that the economy was going to grow at 5% a year forever and really was worth $160 a share. But for some reason I never bought any of those books, and with the crash of Internet stocks and last year's economic downturn, the pessimists have returned.

The recurrent theme of their worry, ever since the U.S. economy began pulling out of the brutal 1981-82 recession, is that we're living on borrowed time and borrowed money. Some Americans may be doing well, some parts of the U.S. economy may be thriving, but it won't last because sooner or later we'll have to pay back all those loans or the stock market will stop rising or our foreign competitors will start eating our lunch.

It is undeniably true that American consumers won't be able to rack up ever larger credit card bills forever, and that foreign investors won't keep pouring vast sums of money into the U.S. forever, and that the U.S. won't always be (and isn't now) the undisputed leader in every new technology. But after years of reading about these worries and to a certain extent sharing them, I'm finally about ready to say, so what? The unsustainable federal deficit of the 1980s and early 1990s was converted into a surplus without bringing the economy down. The unsustainable stock market run-up of the late 1990s came to an end, and the economy appears to be just fine. Detroit long ago fell from its perch of global dominance, and not just the economy but the U.S. auto industry survived and thrived.

My point is not that everything's perfect and the business cycle is dead and Priceline should again be selling for $160 a share. It is that statistics like the level of consumer debt or the size of the trade deficit don't matter in and of themselves. What matters are the basics: How fast is the economy growing? How many people have jobs? How much money are they making?

Those numbers, as noted above, have been holding up pretty well. Why's that? The erstwhile Dr. Doom, Henry Kaufman, offered me three explanations. One is the return of the U.S. to the role of undisputed military and financial superpower, which helps keep investors' money flowing in from abroad. Another is political cohesion. It may not always seem like it when you listen to the debates on Capitol Hill, but for two decades now U.S. economic policy has been following a reasonably consistent and consistently reasonable course--a mix of moderate Keynesianism in fiscal policy (economic stimulus when times are bad but no attempt to manage the economy the rest of the time), moderate monetarism (a Fed that's focused on keeping inflation at bay but isn't fanatical about it), and moderate free-marketeering (taxes and regulation are modest by European standards but far from nonexistent). Finally, there's what Kaufman calls "a greater responsiveness to economic and financial change."

This last attribute may be most important. We can't bank on global dominance forever. We can't assume politicians will always do the right thing. But if the U.S. economy is better than the rest of the world's at rolling with the punches, and better at taking advantage of the opportunities that pop up, well, that's what you'd call a sustainable advantage.

In fact, a lot of other economy watchers, from Alan Greenspan on down, started remarking on this new flexibility in the mid-1990s. At its most extreme, such as when it came to justifying tech stock valuations, this "new economy'' reasoning could get kind of silly. But that doesn't mean the core observation that the U.S. economy has fundamentally changed was wrong.

Finding hard evidence of this change is difficult. But there is that uptick in productivity growth, which could reflect newfound efficiencies generated by new ways of doing business. There's also been a marked decline in economic volatility: Since the 1981-82 recession, economic growth has followed a significantly smoother path than in the decades before (that is, downturns have been shallower and peaks less steep). The favored explanation for this has been a steadier hand at the Federal Reserve. But it may also have to do with changes in how markets--for goods, for services, for financial products--respond to events. One example: Mortgage markets used to be squeezed by regional credit crunches as banks and S&Ls battened down during slumps. Now mortgages are sliced and diced and packaged into securities sold to investors all over the world. Last year those investors kept buying, mortgage rates kept dropping, and the resulting boom in mortgage and home-equity lending may have been the single biggest reason the recession was so mild.

That's the theory, at least. But I wanted some more real-world evidence. So I got on a plane to Flint, Mich., birthplace of General Motors and marvel of the old U.S. economy, to see how that city fit into the new model.

That a person can get on a plane to Flint was a revelation in itself. I connected through Detroit, but there are also nonstops from Cincinnati, Minneapolis, Milwaukee, Atlanta, and Orlando. My flight was packed.

This was a revelation because most non-Michiganders who've heard of Flint have heard of it for one reason: Michael Moore's 1989 documentary Roger and Me, which told the sad tale of Flint's betrayal by GM. The Flint that Moore portrayed was a basket case, devastated by the loss of tens of thousands of high-paying jobs and perhaps even more devastated by the loss of trust in Father GM.

Because of Roger and Me, Flint has become a regular stop for journalists looking to expose the dark side of the post-1980 economy. And there's lots to expose, if that's what you're looking to do. Downtown is a less-than-lively assemblage of offices, empty storefronts, and a couple of lunch spots. Head north and you'll see grass growing where shops used to be, abandoned houses by the thousands, and GM's massive Buick City assembly plant going under the wrecker's ball. Crime is high; schools are struggling. The unemployment rate in Flint proper is 12.3%. The city government can't make ends meet; the longtime mayor was recently recalled by angry voters; the state is about to take over.

But across the street from City Hall, in the Genesee County government offices, these are the best of times. The county has a budget surplus. With fancy new suburban subdivisions going up all over and a bustling commercial center sprawling just west of Flint's city limits, the property tax base keeps rising. In the past five years the county's credit rating has been upgraded five times. In 2000 unemployment in Genesee County, including Flint, fell to 5.4%, its lowest level in more than 30 years. Last year it went back up to 7.1%--but that's still better than any year in the 1980s and all but one (1973) in the 1970s. And it's far less of a jump than had occurred in previous recessions.

A quarter-century ago, GM employed 80,000 people in the county. Today the number is only about 25,000. And yet the unemployment rate is lower. How does that compute? A lot of people simply left: The city's population has slid from 193,000 in 1970 to fewer than 125,000. This is usually painted as a sad and terrible phenomenon, but it's actually one of the great strengths of the U.S. economy: If there are no jobs where you live, you go somewhere else. That's far from the whole explanation, though. Genesee County's population, after dropping in the 1980s, is growing again. Some of the employment slack has been taken up by Flint's three hospitals, which are now regional medical centers, attracting patients from outside the county. Another growth area has been higher education: There are now 25,000 students at Flint's four colleges (one of them a former GM training institute), studying everything from truck driving to biochemistry. There are also new local businesses like the Coffee Beanery, a chain based in the county, and old ones that have discovered new ways of making money, like Schmald Tool & Die--which used to do only GM work but now supplies customers from all sorts of industries from all over the world.

The biggest change, though, is that the people of Greater Flint have taken up commuting. In 1970, 4,000 Genesee County residents traveled to jobs outside the county. Today the number's nearing 30,000. "We're now part of a much more diverse economy," said county treasurer Dan Kildee, who when I talked to him was about to head to New York to say the same thing to Standard & Poor's. "We're the northern edge of the southeastern Michigan economy. We're no longer a self-contained economy."

Just south of Genesee is Oakland County, formerly home to a couple of auto plants and a few fancy Detroit suburbs but now the economic heart of Michigan. Its growth is due partly to auto companies fleeing Detroit, but it's much more than that. Of the seven FORTUNE 500 companies based in the county, three (bankrupt-but-still-big Kmart, Pulte Homes, and Kelly Services) have nothing to do with cars. Unemployment in Oakland County was 3.6% last year, 2.2% the year before.

For Flint and Genesee County, this boom to the south is, of course, dumb luck. If Oakland County were 100 miles away, the story would be different. But it isn't 100 miles away, and there are a lot of Oakland Counties in this country: Sprawling, fast-growing former suburbs--author Joel Garreau coined the term "edge cities" to describe them--that have turned out to be more adept than older cities at accommodating the needs of growing businesses and the people who work at them. Happily for Greater Flint, it has been pulled into the economic realm of one.

It's not that GM no longer matters in Flint. It just matters a lot less--and looks a lot different. One of the first places I visited in town was a new plant where they make six-cylinder engines for the Olds Bravada, the GMC Envoy, and the Chevy TrailBlazer. To people who worked in the old V-8 factory that once stood on the site, the most striking things about it are how clean and quiet it is and how few people it employs (700, compared with 5,000 at the V-8 plant in its heyday). What struck me most was how much it resembled the cellular phone factory I visited two years ago and the printing plant I visited in January. GM's word for the plant's design happens to be "flexible." That is, you could take its modular parts out, or move them around, or move them someplace else, and they'd still work, Lego-like. Workers are trained to use lots of different machines. The facility fits into a far-flung network of plants, each handling a discrete part of the supply chain. That makes the system more capable of dealing with changes in technology or demand.

Flexible is a good description for what the Flint area's economy has become as well. It plugs right into a larger regional economy. Its companies and its institutions and its people no longer look only to GM for sustenance but to ever-widening networks of customers and suppliers and employers. Even the county's landscape, with its McMansion-filled subdivisions, Home Depots, and Applebee's Neighborhood Grills, has a certain modularity to it--it's often hard to tell if you're in suburban Flint, as opposed to suburban Atlanta or suburban Indianapolis.

This is not an unalloyed good, of course. Walking through the historical exhibits at Flint's Alfred P. Sloan Museum, the sense of loss is almost palpable. For much of the 20th century, Flint was a vibrant, raucous home to world-changing industrial innovation, epic labor struggles, and mass prosperity. Now it is, at best, "the northern edge of the southeastern Michigan economy."

What's more, the very definition of a flexible economy is one in which individual jobs are less secure. And for most of the past two decades, economic growth has done little to benefit low-income Americans (it certainly hasn't done much for folks still stuck on Flint's north side). If the wrenching changes of the past 20 or 30 years haven't paved the way for greater prosperity, then we sure have put a lot of people through a lot of hard times for nothing.

But was it really all for nothing? Or to paraphrase Ronald Reagan, are we better off now than we were 20 years ago? Certainly. The better question may be, Are we better off than we were 35 years ago, when the U.S. economy was last firing on all cylinders? By some concrete measures of living standards--like how many color TVs we have in our living rooms--we are. We just haven't been on the kind of sustained upward trajectory for everything that Americans became accustomed to in the post-war decades.

The last years of the 1990s offered tantalizing glimpses that the U.S. might be returning to an age of increasing opportunities and rising living standards. After years of stagnation, real hourly wages began rising, even for the lowest-paid workers. The percentage of Americans below the poverty line declined from 15.1% in 1993 to 11.3% in 2000. The flexible, responsive, modular economy was starting to deliver the goods.

Of course, Sept. 11 made it clear to a lot of Americans that there's more to life than supply chains and securitized mortgages. It's a dangerous world out there, and if the Taliban hadn't fallen so quickly in Afghanistan, the economy might not be so perky right now. With war raging on the West Bank, and Osama bin Laden still presumably out there plotting mayhem, a lot of bad stuff could still happen.

Those thoughts went through my mind as I leaned close to the window of Bruce Steinberg's office, trying to get a better look at the spot a couple of hundred yards away where the Twin Towers once stood. The thought of the hell that raged there can still get in the way of positive economic thinking.

Not that Steinberg, who was there Sept. 11, seemed overly concerned. "Some people just look for things to worry about," said the Merrill Lynch chief economist. "There's always something to worry about. But that shouldn't detract from the main point that our economy is incredible. It shrugs off shocks; it grows and grows. It is the most flexible and dynamic economy in the world."

I took a cab down to Steinberg's office just after my visit with Henry Kaufman. It seemed appropriate: In the 1970s, Kaufman became the most famous guru on Wall Street by being the most bearish man around at a time when bearishness turned out to be absolutely the right call. Now Steinberg, a 16-year Merrill veteran (and former FORTUNE writer) who became chief economist in 1997, is casting himself as the most bullish economist around--with growth forecasts almost invariably more optimistic than those of his peers at other investment banks.

Steinberg's argument that the economy is resilient is hard to dispute. Assuming faster growth in the future is more of a leap of faith. "When you look at the long sweep of economic history, you find that growth comes in multidecade spurts and then peters out as what was driving the growth fades," he said. His bet is that all that flexibility and opportunism discussed above are the ingredients of such a spurt, one that only got its start in the mid-1990s. There's no guaranteeing he's right. But as scenarios go, it sure beats gloom.