Is America In Decline? It Will Be Unless We Reform Entitlements, Education and Energy – Time To Reaffirm Faith In US As An Opportunity Society That Nurtures Innovators

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By Paolo von Schirach

February 6, 2012

WASHINGTON – Remember Yale historian Paul Kennedy and his 1987 tome “The Rise and Fall of the Great Powers“? At that time there was a lot of interest in, and indeed concern about his fairly comprehensive narrative focusing on how all major Western Powers, primarily because of the huge cost of maintaining their Empires, suffered progressive economic decline and eventual decay. This had been Spain’s fate, and Britain’s –in Kennedy’s argument– and this is where America was headed.

Spirited debate

The book sparked a spirited debate about the future of the US as the leading power of the last century. The combination of a sputtering economy, structural budget deficits, (compared to what we have today, then they were only ”200 billion a year deficits, as far as the eye can see”), relentless Japanese competition and rising security expenditures necessary to maintain the American Empire would lead to national ruin, perhaps bankruptcy and thus to the inevitable –if sad—retreat from global ambitions.

The competitiveness issue

At the time, Kennedy’s work contributed to a new self-reflective atmosphere that gave rise, among other things, to efforts aimed at investigating the soundness of the main pillars that sustain the edifice of America’s might: a sound economy, high education standards, innovation and good governance. Think tanks, the Congress, and the Federal Government launched studies, initiatives and task forces on “US Competitiveness” –or lack thereof. The newly formed bipartisan Concord Coalition started warning Americans as to the structural damage caused by runaway deficits due in large part to the unstoppable growth of spending on entitlement programs.

Imperial overstretch

So, according to the conventional wisdom of the late 1980s, we were overstretched militarily because of Cold War security commitments, highlighted by the 300,000 troops permanently stationed in Europe as our most visible contribution to NATO, and by the questionable idea of spending billions of dollars on the Star Wars program, the most unfortunate nickname attached to research in space based ballistic missile defenses, a concept that had its strong moment during the Reagan administration. Besides, we had lost our edge in economic innovation. We were assaulted by the Japanese bulldozer from the East. Most ominously, it seemed that we were becoming dependent on Japan for the supply of critical electronic components absolutely vital for our new weapon systems.

Japanese economic onslaught

This was the time, we should remember, in which the trade deficit was about Japan, not China; while Japanese conglomerates had started a buying spree in America that, according to many, including serious observers, had all the markings of a progressive take over of our economy.

Meanwhile, the “Europe 1992” agenda, the solemn commitment on the part of the then European Community to pull down residual internal barriers and create a brand new, vibrant market protected by an external tariff seemed to foretell a new era of economic primacy for the Old Continent, engineered behind the walls of a “Fortress Europe” that –it was feared– would exclude Americans.

Too much spending

Here at home, because of misguided fiscal policies and unhealthy personal spending habits, we –the Government and the citizens– were slowly but surely drowning in debt. (Nothing like today’s debt. But this does not mean that, at the time, it was not serious. It only means that today we are totally unserious about the size of our much worse fiscal predicament. More on this later). That was the picture then. Indeed, it was the widely shared notion that the economy was on the verge of collapse, especially after the mild recession of 1991 that propelled technocrat Bill Clinton and his panoply of new, original economic ideas, (never really implemented, by the way), to the White House.

Unexpected developments

But, in the meantime, the unexpected happened –on many fronts. November1989 did not just give us the promise of eventual German reunification. It was the first shock wave that signaled the collapse of the Soviet Empire and thus the end of the only existential threat to US and European security. The final demise of the USSR was the justification to significantly cut defense spending and international commitments in the 1990s. This dramatic change, combined with a resurgent faith in small government, especially after the Republican revolution of 1994 masterminded by Georgia Congressman and then House Speaker Newt Gingrich, meant that runaway federal spending could be contained. In fact, the US enjoyed budget surpluses for a few years.

The IT revolution to the rescue

At the same time, without the support of any particular blueprint devised in Washington, the information revolution was unfolding. Rather than creating a new economy, as people were predicting, the massive adoption of IT by all businesses meant a massive leap forward for US productivity and competitiveness. With Bill Clinton in the White House and Robert Rubin at Treasury we had spectacular growth, year after year, record low unemployment and high tax receipts that combined with spending cuts gave us for the first time in decades a federal budget surplus.

Japan imploded, Europe lost steam

At the same time, without the US lifting a finger, most feared Japan, because of its social, rather than economic contradictions, fizzled. Europe also lost its luster. The predictions of the rise of a robust, innovative and economically powerful Europe proved to be quite wrong. And so, we had the American roaring ‘90s: a prolonged period of US unchallenged economic primacy. Under president Bill Clinton the US was first in everything: innovation in high tech, creation of new employment, record productivity increases.

US glory days also faded

But it all seemed to have ended somewhat ignominiously with the beginning of the new millennium. Just as Clinton had left the scene, we had the bust, (do you remember when the NASDAQ was at 5,000?), accompanied by the Enron, WorldCom, Adelphia and other well known gigantic corporate scandals which ushered the Wall Street contraction and the ensuing long bear market. The 9/11 attacks, occurring during this downward spiral, certainly did not help, nor did the enormously costly military actions taken as a response to terrorism.

And then we had the horrible 2008-2009 recession from which we are still slowly emerging. While the combination of a real estate bubble and financial markets madness cannot be considered a systemic problem, the magnitude of this downturn has been so huge that it contributed to sink a country already weakened by high spending, growing debt and the considerable cost of the wars first in Afghanistan and then in Iraq.

Fast forward to 2012

And now, where are we now? There are disturbing signs that would indicate that Paul Kennedy and others were after all right in predicting decline. Only they were incorrect as to how close it was and what would trigger it. The root cause is not “Imperial Overstretch“, and not even the 2009 recession, bad as it was. It was and is the erosion of US competitiveness due to lack of investments in both human capital and needed infrastructure, accompanied by the unstoppable growth of entitlement programs.

Sure enough, at this time we also have the cumulative cost of long conflicts. The prolonged Iraqi campaign just concluded at the end of 2011 had become stupendously expensive. Afghanistan, whatever the final disengagement calendar, drags on. But, regardless as to one’s own political opinion about the wisdom of both wars, these commitments would be economically affordable, provided a healthy US economy.

Wars, entitlements, low education standards

Indeed, while wars and and years of increased Pentagon budgets are a drain on public finances at the expense of productive investments, by historic standards defense spending as a percentage of GDP is not high, in fact it is lower than what we had during the Cold War.

The real systemic problems are in the same factors that were identified 25 years ago, at the time of the “competitiveness debate“, by most sensible analysts: a more and more expensive welfare state that cannot sustain itself financially, and the progressive erosion of the education advantage that had made America the principal player in yesterday high tech environment, now morphed into today’s knowledge economy.

The large entitlement programs, especially Medicare, need to be reconfigured. If not, if we continue to affirm that large segments of the American society, mostly the elderly, have an inherent right to subsidized benefits that represent an excessive drainage of diminished US national resources, the federal government, assuming its continued commitment to finance these obligations at current levels, not only will have nothing left for productive investments, it will go bankrupt.

The secondary public education system, in turn, provides mediocre graduates, while the poor and minorities, on balance, do a lot worse than the already low average. It is impossible to sustain this increasingly complex economy without a dramatic improvement in the quality of the labor force. It is important to note that this problem was already identified as a national crisis by the seminal 1993 Report “A Nation at Risk“. Perhaps with some hyperbole, the authors argued that, if a foreign power had tried to impose on the United States the inferior public education system that we had chosen, we would have rightfully “viewed it as an act of war“. Well, bad as the system was then, it has not improved much. The OECD sponsored comparative tests under the Program for International Student Assessment, (PISA), show US high schools students doing poorly in most areas and leading in none. Sadly, the Nation is still at risk.

Trade deficits

The fantastic explosion of the trade deficit is the manifestation of eroded competitiveness. The 40 billion dollar deficits that scared us about Japan in the 1980s are pocket change compared to the 220 plus billion that we have nowadays with China alone, (not to mention the increased cost of our energy habits: at 360 billion in 2010, higher than the trade imbalance with China).

Unfortunately, the argument on how best to rebalance our trade accounts has been successfully framed by a strange medley of simplistic romantics and demagogues who point the finger at the combined perils of free trade and outsourcing. By opening ourselves to foreign producers –so the refrain goes– we allow cheaper goods to come in. This means that US companies that have much higher costs go out of business or move overseas. Good American jobs go abroad because greedy corporations want to save money by having cheaper foreigners perform jobs previously held by higher paid Americans.

The solutions advocated? Essentially close our borders, so that the jobs stay in and the foreign goods out. In this new era of global and irreversible interdependencies, the notion that this way we shall be able to regain, maintain and for ever keep our supposedly God given infinite prosperity is bizarre; but, nonetheless, it has strong emotional appeal.

The bad side of globalization

However, if it is clearly futile to try and close our borders to keep cheap goods out or to prevent businesses from outsourcing, we still have a huge problem which is indeed caused by globalization. But not the globalization demonized by the protectionists. It is caused by the global spreading of the knowledge economy model developed first in America whose successful exploitation gave the US the edge for a number of years.

The formula for US innovation may be replicated

We have to come to terms with the fact that the genie of IT innovation has been out of the Silicon Valley bottle for a long, long time. We cannot restrict inventiveness and entrepreneurship –the key components of the American success story– to the American soil. At least some of the key ingredients of a knowledge based economy are transferable and so, (despite many copy cat failures and other clumsy attempts), they are transferred elsewhere today and more so in the intervening years.

True, the 1990s triumph of America’s reacquired competitiveness was due to a truly American innovation eco-system that cannot all be easily reproduced. The lively, free wheeling, almost chaotic mixture of entrepreneurs, academics, venture capitalists and their interactions with established corporate entities that buy, absorb and invest in new ventures, as yet has no equivalent elsewhere around the world, in terms of depth and scope. But some of its elements can and will be replicated. No doubt, by trial and error, in time others will manage to produce adequately funded innovative clusters that will be able to quickly direct new discoveries to a hungry global marketplace.

Bangalore and more

The celebrated Bangalore example in India is illustrative. The Indians have managed to create and aggregate in productive clusters world class human capital, (scientists, engineers, software programmers), and harness it effectively to competitive IT enterprises. To keep things in perspective, we should remind ourselves that Bangalore is still mostly about outsourcing and not much about innovation. Moreover, the whole Indian high tech phenomenon is only a small speck within a still primitive Indian economy which is constrained by horribly inefficient public administration, corruption and crumbling infrastructures. India has an enormous population that is still largely poor or very poor. So, the days of Indian high tech supremacy in the context of a nimble knowledge economy are still in the distant future.

High tech in poor countries

But Bangalore, Hyderabad, Chennai and other such examples in India and around the world will multiply, as more and more people gain access to higher education, IT literacy and other skills that cannot be kept within the West and America. The very information revolution unleashed by the American genius becomes the vessel that greatly expedites the transfer of knowledge that will create new centers of excellence where none existed before and thus the new challenge to America’s leadership in innovation.

Furthermore, India illustrates how centers of competitive high tech can be established even without the fertile ground of an already developed economy that has already successfully dealt with creating a favorable macroeconomic environment. The Indian example proves that emerging economies can create islands of modernity that can compete on many levels with counterparts in advanced economies.

Eventually these new high tech enterprises, especially those established in business friendly developing countries where the cost of professional for many years to come will continue to be much lower than America’s, are bound to gain world market share, inevitably at our expense. If even a small fraction (as a percentage of the total population) of Indians and Chinese become good scientists, their absolute numbers will be sufficient to tip the balance.

US: stay innovative, move up the value chain

Our only hope to stay competitive is in continuing to invest in new technologies and new ideas so that superior innovative products and services will continue to be created in America.

But here we have a serious problem. Americans are so used to primacy that they do not believe that the ingredients that make it possible need to be nurtured, refined and upgraded, especially now that we are confronted with new, capable competitors that have the added edge of a lower cost structure.

For instance, it took the specter of bankruptcy for the ossified and slow moving, (no pun intended), US automobile industry to have a collective awakening. It took the prospect of extinction to get corporate managers and the unions to buy into a massive Washington funded and led rescue plan.

And remember that previous turnaround strategies announced by Detroit’s managers were only partial and half- hearted. It took this near death experience to get people focused and moving.

Simplistic remedies for lost competitiveness

But for the rest of the economy we are still in the dark. While discussions about the negative impact of globalization abound, for the time being, not much in term of workable national policies aimed at strengthening US competitiveness. Unfortunately, to the extent that the general public has been brought into the conversation, it is fed gross distortions and oversimplifications.

The simple explanation is that we are losing ground because the others (read China) cheat and Washington does nothing to stop this. The conversation is mostly on allegedly bad trade policies and greedy corporations that outsource good American jobs. If we could only change Washington’s direction on trade, policy all will be well. Indeed, the debate is mostly about identifying culprits and quick fixes. So, according to these critics, beyond Washington’s international trade policy incompetence, (close to treasonous behavior), the enemies are the Asians, (yesterday Japan, today China), who do not play by the rules, and the illegal and legal immigrants who steal our jobs while depressing US wages. This sort of populism may work with many constituencies in hard economic times; but it explains nothing about the causes of our ailments and its remedies would cure nothing.

Systemic problems

The reality is that we have structural, systemic problems of our making that need to be addressed now, so that we can begin to change course and hopefully improve our conditions for the long term. While the misbehavior of others is real, (think of Chinese exploitative low wages, their undervalued currency and their disregard for intellectual property rights; think of the Mexican government actively encouraging the emigration to America of the their country’s surplus labor), there are inherently domestic structural deficiences that slow down America and that have eroded its ability to compete. To name a few critical ones: a deteriorating education system, the unsustainable cost of the welfare state and the lack of a serious energy strategy.

Attracting talent: Europeans

Clearly America’s soft underbelly is a mediocre to bad secondary public education system right at the time when others are improving their own standards. For a long time America’s high quality public education had nurtured domestic talent while, by design or by default, the US was able to attract first class minds from around the world. Think about the massive intellectual migration to America from Nazi occupied Europe. After all, Albert Einstein, Enrico Fermi and Edward Teller were not Americans. But they were welcomed in America, and the American intellectual and scientific environment was able to absorb their uncommon talent and greatly benefit from it. Hard to think of the Manhattan Project and the US Atom bomb without the intellectual contribution of all these high quality immigrant.

Attracting talent: gifted Asians

In more recent years there has been a significant influx of gifted Asians. More than 50% of the prestigious Ph.D degrees in science and technology are now earned by foreigners. A vast percentage of high tech start ups are led by foreign born, mostly Asian, entrepreneurs. But now the pull of America is not as compelling as it used to be, in the light of the fact that good opportunities are developing elsewhere in Asia. And this is a problem. America used to be “the magnet“. Reclaiming that status should be a primary objective of public policy at all levels.

Low education standards

At the same time, it is now apparent that the American public education system, the incubator that should nurture the future scientists, engineers and entrepreneurs, is at best mediocre, deeply flawed in its worst components and certainly inadequate to create the world class work force that will have to compete on quality, as we operate in a high cost economy. The existence of several world class American universities is not sufficient to guarantee that the broader US workforce will be able to compete with increasingly more sophisticated foreigners. A sub par work force will make it difficult to compete, let alone strengthen, our positions in high value, strategic areas.

Of course, America is far from being finished. American resilience if not always primacy in high value, technologically complex industries, (think of Intel, Apple, Microsoft, IBM, HP, GE, 3M, Monsanto, United Technologies, Caterpillar, Boeing among many others), show that, despite higher labor cost, superior quality, when it can be reinforced by constant refinement, still counts.

By the same token, we still have an edge in services, (FedEx and UPS, come to mind). But this is entirely dependent on the continuous waves of IT innovation. The day we can no longer be at the forefront of IT, because we can no longer compete with increasingly more competent but much cheaper Indians and Chinese, we shall have lost the competitiveness contest. And it would be unwise to count on the narrow edge provided by a few great schools fed by a relatively small pool of quality US students coming from private schools. America needs to restore high quality public education so that we can broaden the base and nurture human capital.

Entitlement reform

Much has been said about the increased welfare costs due to the demographic changes that America is experiencing, along with most other developed countries. The core question is whether it is smart public policy, in the long run, to have a central government whose main function is to distribute benefits, at the cost of everything else.

Even now, while immediate solvency is not an issue, the federal government devotes smaller and smaller portions of its resources to productive investments, given the overwhelming weight of the entitlement obligations that represent about 60% of overall federal spending. All projections indicate that, if do not bend the cost curve, in the future this is only going to get worse.

Serious reform deemed politically explosive

That said, as the current political debate shows, it is clear that trying to take something away from people who believe that they have “earned“ subsidized health care and subsidized Social Security in their old age is extremely hard. But there is an opportunity cost in spending most of our revenues on welfare and little on competitiveness enhancing investments. Unfortunately, nobody really tries to show the thousands of research projects or new infrastructure that could be financed by the federal government, with long term broad based gains for America, assuming a substantial reduction of entitlement programs costs.

No energy strategy

The energy picture is also bad, even though somewhat improving, given increased fossil fuels discoveries in the last few years. The shale gas revolution, with massive amounts of new natural gas coming on line, (Marcellus shale, among other places), is a real game changer. Likewise, shale oil production in places like the Bakken basin in North Dakota will contribute to a larger domestic production that will help cut imports. And then, of course there is renewable energy.

But with all that, the US still lacks a comprehensive energy strategy that would encourage oil and gas production, conservation and higher efficiencies, especially in the transportation sector, in the near and medium term, while boosting R&D in renewable technologies for the longer term.

If we look at oil, despite increased domestic production, we still have excessive consumption, and a huge dependence on oil imports that is financially burdensome, (bigger than our trade deficit with China), while it creates a constant and worrisome strategic vulnerability. (In this respect it is important to note the Navy Department ongoing effort to develop reliable renewable energy supplies for all its needs. This is all about diminishing a well known strategic vulnerability).

America needs more than the tinkering provided by this or that pork laden energy bill. It needs a bold new energy strategy that would set realistic goals regarding long term alternatives to hydrocarbons. For the short and medium term, we need a good balance between encouraging US hydrocarbon production and increased imports from Canada, while actively discouraging consumption through revenue neutral gasoline taxes stay could be progressively phased in. For the long term, we must have cost effective renewable energy sources that will eventually replace hydrocarbons. In doing so, America would free itself from the straightjacket of imported oil, while possibly becoming the world leader in key new technologies related to alternative energy.

No political consensus

But in all these areas: education, welfare reform and energy, while there is a debate and many have offered sensible solutions, we are far from having reached the deep shared understanding that is the prelude to decisive action. In fact in Washington, while experts may discuss, policy makers are not involved. At this time, there is no productive debate on any of this. Potential platforms for credible bipartisan solutions, such as the Bowles-Simpson “Debt Commission” December 2010 Report, have been abandoned because of lack of political support.

Toxic political climate

Unfortunately, the now unfolding national political campaign is fiercely adversarial and this a bad omen for finding the bipartisan common ground that historically is always needed to engage in major reforms. Besides, while many are really worried, many others are led to believe that things are more or less fine and that we have enough slack to muddle through. And so, we hail 8.3% unemployment rates as great news, while we dismiss a 15 trillion national debt, since for the time being the US has no problem finding lenders that will gladly finance this debt at historically low interest rates.

None of this looks good. Even if we want to assume that soon we shall be past the nasty consequences of the Big Recession of 2009 and that we shall be back to where we were in 2008, before anybody had heard of sub-prime mortgages, let’s keep in mind that that was not a particularly good place to be. The real point is that America’s overall dynamism had already been eroded before the recession hit us so hard.

Coming defense cuts

Overspending in entitlements with consequent cash shortages for everything else has already forced the Pentagon to plan significant defense spending cuts. Some of them are on the table. More details will follow with the new federal budget that will be presented in just a few days. These defense cuts will inevitably translate into reduced operational capabilities and eventually into reduced American influence. Defense cuts, combined with social programs as the bulk of US federal spending, less money for innovation and lower education standards taken together do not paint a pretty picture for the country that only 20 years ago, after the demise of the USSR, was the unchallenged superpower.

Passive attitude

In hindsight, similar historic circumstances, characterized by a passive attitude that in effect allows the almost mindless sliding into national decay are ascribed to a state of mind of myopic denial and complacency affecting people who have lost their way. But this is usually the verdict of historians. And, when they pronounce it, it is too late to change anything. Among historians, important to single out Arnold Toynbee. Having studied human developments all his life, his observation was that civilizations do not die because of foreign invasions, famine or natural catastrophes. They end because they lose their sense of purpose and the will to go on. In a word, they commit suicide.

Reaffirming America as Opportunity Society

This is the bad news. The good news is that, since much of America’s unpromising predicament depends on our state of mind, it is obvious that our minds can be changed. But for that to happen, we should need a believable, collective reaffirmation of America’s unique brand of dynamism. Unique brand because it is grounded in a genuine Opportunity Society. This is what differentiated the American Republic from socially stratified Europe.

And opportunity is what made America immensely attractive to all who wanted to try something new. Reaffirming an Opportunity Society means recreating at a national level truly pro-innovation and pro-enterprise public policy, with good quality public education and basic services for all as the foundation on which to build it. Time to unleash American ingenuity, and time to work on non ideological, fact based, sound public policies that will sustain it.

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