Executive Summary: The 10th anniversaries of The Way the World Works and Polyconomics, Inc. invite reflection on a scenario for the next decade. Paul Kennedy's thesis of a great-power decline is considered and rejected by the opposite view of a Reagan wave carrying the U.S. and the rest of the world to ascending levels of prosperity. The dynamics of such change invite trade tensions in the three major trade and currency blocs now forming the dollar, yen and ecu blocs. European integration is the key to proving the game will be worth the candle. Triangular competition to widen global markets should minimize protectionism, thus averting a world recession that would upset our scenario. Bush has the clear edge over Dukakis on both the preferred policy mix and experience in foreign economic policy, although a Dukakis presidency would likely avoid gross errors. Neither has refined an approach to the reform impulses in the USSR and Eastern bloc. It is critical the West assists Gorbachev in transferring relative power to the Soviet citizen from the Soviet state. The neo-Keynesians at the IMF pose a threat to China and the USSR as they continue to prevent growth reforms in the Third World. An anticipated acceleration of supply-side successes, the "Reagan Wave on the Laffer Curve," could see an end to Third World poverty by century's end.
A Growth Path to the 21st Century
It was 10 years in May that my 1978 book, The Way the World Works, was published. It was 10 years ago in July that I left The Wall Street Journal and founded Polyconomics, Inc. with a single client, Chrysler Corporation. (The assignment to develop a rationale for a government bailout of the company.) On July 26 of 1978 I wrote my first client letter, "A Bull Market Scenario," a supply-side framework for what it would take to get the Dow Jones Industrials to 3500 in the 1980s.
The anniversaries invite reflection, on where we've been and where we are, leading to contemplation of a scenario that will take us into the 21st Century. This essay isn't an attempt at forecasting the future, but simply an analytical exercise in the dynamics of political economy. It seemed clear to me a decade ago that conditions were ripening for a global resurgence of democratic capitalism built around classical economic theory. It seems clear now that there is little but inertia standing in the way of an extension of these momentous forces. We may already be in the foothills of a great Golden Age, perhaps the dawning of a new American Century, a Pax Americana to rival the Pax Britanica of the 19th century.
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A Great Power in Decline?
Reflection begins with the opposite view, the current notion being presented that the United States is in fact on the threshold of decline as a great power. It suggests we are near the end of a brief American Era that began in 1945, already exhausted by the burdens of global leadership. This view is worth examining. Every society in every age needs its Cassandras. Warnings are useful whether heeded or not. At the moment the doomsayers have fixed on the thesis of Paul Kennedy's much acclaimed book, The Rise and Fall of the Great Powers. Kennedy, a British expatriate now at Harvard, asserts that the great powers of history foundered as they overextended themselves militarily.
To be sure, military strength depends on economic strength. But what Kennedy is saying is quite different, arguing that if a nation spends too much of its productive income on an unproductive military apparatus, its vitality will be sapped, and this is why, he asserts, the great powers of the past declined.
The warning is that the United States is on this path, and unless it cuts back on its military apparatus forthwith, it will soon be a former great power. In the October 1988 issue of American Heritage, Kennedy tells an interviewer: "I sense that America's military commitment-- perhaps I should say its conception of its role is unrealistic. That is, I am sorry to say, an old story that we can trace back to the Hapsburg monarchy in the sixteenth century, and no doubt much earlier: too many fronts to defend, too many 'enemies,' too large a military burden to be borne by the economy. In America's case it means devoting too large a proportion of its best scientific and skilled manpower to ends that do not add to the growth of the economy. If history teaches us anything, it is that an emphasis on military power over economic vitality leads to a deterioration of both."
The thesis is clearly worth contemplating. It is in fact one of the strands of thinking in the Democratic quest for the presidency this year. But we must wonder why it is not more clearly applied to the Soviet Union, which spends a far higher percentage of its meager productive assets on the military. Kennedy's emphasis may simply be misplaced. National security is the equivalent of personal insurance. Great powers decline not because they are spending too much to protect their wealth, but rather because they have forgotten how to create wealth. The United States spends 6% of its annual income on national defense, the Soviet Union 25%. South Korea spends 6% of its income on national defense, North Korea 25%. At the height of the British Empire, roughly 1850 to 1914, the United kingdom spent a very small portion of national income on its military apparatus. Tiny contingents of the British army "occupied" the vast Indian subcontinent, which submitted to the relatively benevolent colonial rule as long as the commercial and political benefits outweighed the deficiencies of undemocratic rule.
Britain's awesome growth in wealth from 1815 to 1914 had come to dwarf the costs of its military. Britain's decline came steadily and inexorably after World War I as it left in place the debilitating war taxes enacted in 1914. Meanwhile, the United States, under Presidents Harding and Coolidge, slashed tax rates. Margaret Thatcher is the first prime minister of the U.K. to do serious damage to the "supertax" rates that lingered from 1917 into the 1980s, and the U.K. is finally on the move. Paul Kennedy, by the way, has not been an admirer of Mrs. Thatcher. In his American Heritage interview, he reveals another strand in his thinking that is reflected in the austerity wings of both the Democratic and Republican parties:
Politicians running for office may use slogans like 'Hard choices,' but they don't spell out those choices. None of them are willing to talk about raising taxes in order to increase the growth potential of the nation. None of them are even willing to mention raising taxes to the levels that were around before Mr. Reagan gave people a lot of pocket money. What I call the 'thinking classes' are already wrestling with these notions. But the American electorate is not, and neither party wants to be the first that mentions it.
Still, the thesis is correct that the United States could increase its chances of remaining a great power by reducing the percentage of income spent on military expenditures. Indeed, this is happening now and will continue through the expansion of U.S. income and wealth not by an absolute reduction of defense spending. In the 1990s, military spending should continue to decline as a share of the U.S. Gross National Product as U.S. economic ascendancy continues. Indeed, even the notoriously pessimistic Congressional Budget Office now projects defense spending will fall from 6.1% of GNP to 5.2% by 1994.
Ascendancy does not mean the United States will increase its share of global GNP. It should not even aspire to this, for it would suggest an alarming decline abroad. A nation's greatness is not measured by how far it can lift itself above the poverty of its neighbors. The gap between rich and poor is always of real concern because of the political tensions it invites. It would be much healthier for the U.S. share of global production to steadily decline throughout the rest of the century, as will very likely be the case. The rest of the world will simply grow faster than the U.S. through the spread of classical, supply-side economic reforms and accompanying democratic institutions. When U.S. GNP doubles to $10 trillion by the end of the century, the rest of the world's GNP (ROW) should more than double, to perhaps $50 trillion.
A great part of the advance in the ROW should come in the Eastern bloc, which can show greater percentage gains in production because it has for so long been held back from potential by experiments in command economies. It will not be long before the Soviet Union is in economic ascendance, through precisely these classical reforms. China, of course, arrested its decline a decade ago with the culmination of the Cultural Revolution, the defeat of the Gang of Four, and the ascendance of the "capitalist readers" led by Deng Xiao Peng. A good idea cannot for long be resisted. Socialism is optimum only when alternative forms of political economy break down, as with monarchical capitalism in 1914, and democratic capitalism in 1929 (Smoot-Hawley) and again in 1971 (the breakdown of the Bretton Woods international monetary system). At the moment, socialism is a spent force, its elites clinging to power as they try to inch their way to the new milieu. The United States' power and prestige climbs through the magnetism of its growth ideas as well as the political institutions in which they flourish. A central task of the next President will be to assist the forces of growth in Moscow and Beijing along the road of democratic capitalism.
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The Reagan Wave
The Reagan years have not been easy for the liberal intelligensia, and its leaders are thrilled to see him go. But they make the mistake of thinking the Reagan influence ends with his departure. So writes Arthur Schlesinger Jr. in the lead position of the May 1 Sunday Washington Post opinion section, "Wake Up Liberals, Your Time Has Come:"
I don't suppose that it will greatly surprise my readers if I begin by noting that the prospects for liberalism in the United States seem pretty good these days. Reaganism is finished, used up, over. At last, it is bedtime for Bonzo. The Reagan Revolution or, more precisely, the Reagan Counter-Revolution is evaporating....
Reagan's real innovation was to use tax reduction and defense spending to create vast budgetary deficits and then to use deficits to force the cutback of social spending. That strategy will have a further and ironic consequence. Reagan's deficits not only deny government easy resort to social spending. They also deny to government fiscal stimulus in the event of a recession as with drugs, when you increase the dose too much, fiscal stimulus may become lethal. Keynesianism is a conservative policy because it deals in economic aggregates and leaves the structure of private economic decision intact. Now that Ronald Reagan has made the fiscal stimulus unavailable, the only recourse in the next economic crisis will be direct government intervention. So Reaganism may well end by opening the door to the planned economy.
It's important we understand the significance of these comments. Schlesinger, after all, is the historian of the New Deal, the keeper of the flame of modern American liberal thinking. He is here essentially repeating the standard liberal view that Communism might have taken root here in the 1930s had not John Maynard Keynes saved capitalism through his imprint on the Roosevelt administration with "demand-side economics," the management of aggregate demand. If the United States is soon to be plunged into decline because of Ronald Reagan's misuse of fiscal policy, Schlesinger and the liberals are saying, don't look to Keynes for salvation. Statism of some sort is just around the corner.
The idea that "Reaganism is over, used up," is far from being an accurate observation. If we think of the world political economy as a lake, imagine that President Reagan has dropped a huge boulder into that lake. The boulder may almost be out of sight, with Reagan's years at the White House waning. But the waves he's made will run well into the next century. He has not only made Keynes and the New Deal social democratic ideas obsolete for the moment by reviving the critical elements of democratic capitalism, but also has succeeded in inviting the Soviet Union and entire Eastern Bloc to the party. A decade ago it was barely possible to even imagine a peaceful transformation in the Soviet Union to a system of democratic capitalism. It is now easy to contemplate such scenarios.
American conservatives tend to dismiss Gorbachev's reforms, perestroika and glasnost, as parallels to Lenin's early reform movement of the 1920s, the New Economic Policy (NEP). What these critics do not readily acknowledge is that the NEP's incentive elements had scarcely taken root when the United States crippled the world economy with the 1929-30 protectionist trade legislation. The implosion of global commerce spawned intense redistributionist political impulses everywhere. Republican laissez faire gave way to the New Deal in the U.S., the Weimar Republic gave way to National Socialism in Germany, and the NEP gave way to Stalinism in the Soviet Union. Such was the result of the boulder Herbert Hoover dropped into the global lake.
The Protectionist Impulse
Protectionism, seen in this light, is truly a dangerous "ism." The idea of seeking the protection of the state against foreign (or domestic) competition is as old as civilization. It's the dark side of humanity, a vestige of pre-civilization when the laws of natural selection governed. It's a universal impulse, one that we observe in siblings, appealing to their parents for favored treatment over their brothers or sisters. Children appeal to the authority figures in school and playground for a favored edge over their competitors. In these zero-sum contests, we admire those parents, teachers and governments who act wisely in refusing rewards to some at the expense of others. There's probably not a saint who did not at one point in his life relish the idea of being protected from competitors by the state. It's axiomatic that when the strongest members of a society can gain protection from the state at the expense of the others, it is the weakest who pay the price. The net effect is a subtraction from civilization, a throwback to natural selection and the law of the jungle. History will not excuse Hitler, Stalin, or Pearl Harbor. It seems clear, though, that the United States will also not escape the harsh judgment of history -- having initiated the world economic contraction that brought them into play by a failure of leadership.
In this context, we can posit that the broad capitalistic impulses making their way through China, the Soviet Union and Eastern Europe are dependent upon continued expansion in the West. Deng Xiao Peng and Mikhail Gorbachev have as much to fear of the protectionist forces in the United States as do our trading partners. Enactment of the protectionist trade bill last month cast a long shadow over the world economy because it invites trading conflict that would slow growth and bring recession. It will be up to a President Bush or a President Dukakis to contain this threat by wise use of the mechanisms created by the new trade legislation. Arthur Schlesinger is at least correct in his assumption that if the United States leads the world into a deep recession, the political forces here and elsewhere will retreat from democratic capitalism in favor of authoritarian redistributionist economies. A "planned economy" by its very nature is undemocratic, a power elite deciding who gets protected and who does not.
The Policy Mix: Bush vs. Dukakis
The 70 months of economic expansion in the United States is most likely to be continued in a Bush administration rather than in a Dukakis administration, mainly because the Mundellian "policy mix" of monetary tightness and fiscal ease is more secure in the GOP. It's really the essence of Reaganomics, embraced by George Bush and embedded in the Republican platform. As much as Governor Dukakis strains to create a texture of economic growth in his campaign, emulating John Kennedy, he's not yet made the break with the James Tobin influence in the Democratic Party which dominated the Carter Administration. In his speech to the Atlantic Council June 16, Dukakis stated it plainly: "I'd like to see tighter fiscal policy in this country and more liberal monetary policy, not the reverse and that's what we've been living with, and I think that's a bad policy."
This is the same direct route to higher taxes, dollar devaluation, and more inflation that we got under Presidents Johnson, Nixon and Carter. Dukakis, though, is mindful of the dangers of tampering with the Reagan tax reforms. Tax increases would be a "last resort," and he'd do everything possible to leave the personal and corporate rate schedules intact knowing a weak economy and higher misery index in 1992 would leave him extremely vulnerable to a Republican supply-side challenge. But what does "last resort" mean? My guess is that as long as the federal deficit continues to decline as a percentage of GNP, a Dukakis administration will find every excuse to stall on a tax increase. A steady pattern of increase, which would occur in a slowed economy or recession, would produce the "last resort." Even then, Dukakis would first opt for excise tax increases on tobacco, alcohol and gasoline. Senator Bill Bradley of New Jersey has been talking lately about raising $25 billion in this manner. In this scenario, with such increases occurring in a slowed economy, Congress would spend the revenues faster than they came in and the deficit would still rise as a percent of GNP.
If a tax increase isn't proposed unless the economy slows, then it cannot be a tax increase that causes the economy to slow. Something other than taxes has to trigger the recession. Monetary policy could do it, of course, if the Greenspan Fed got it into its head that a recession would be good for all of us to "fight inflation." But the most conservative Keynesians still at the Fed, including the vast, largely Keynesian staff, are now having to confront arguments about exchange rates and commodity prices as objective indicators of inflation. The monetary policy debate has shifted dramatically in the Reagan years, not only at the Fed, but also at central banks throughout the world, which are forced to respond to commercial pressures for price and exchange-rate stability. It seems only remotely possible that the Fed would lead us into a new deflationary recession.
The Drift Toward Trading Blocs
Trade protectionism seems the most likely trigger to a recession. The drift of the world trading system continues inexorably toward major trade and currency blocs: an American dollar bloc, including Canada and Latin America; a European ecu bloc that will eventually take in the USSR; and a yen bloc that dominates the Asian Pacific and takes in China. There's nothing wrong with this development. Indeed, it's a necessary evolutionary step toward a global integration, what used to be thought of as world federalism. Civilization will eventually find itself with a common global currency, a single free-trade zone, and open migration. It isn't realistic to think political institutions are yet flexible enough to rearrange all this furniture in the 21st century. Worldwide democracy is an absolute prerequisite to global political union, which is why the incipient reforms in China and the Soviet Union are so promising. But trial-and-error is very time consuming. Even in the space age, computer age, the limiting factor to progressive change is legitimate vested interest.
The most important of the evolutions of the 1990s we must watch is the development of the European bloc, which will influence the shape of trading relationships in the rest of the world. Robert Hormats, the investment banker who was Assistant Secretary of State for Economic and Business Affairs in 1981-82, wrote in "A 'Fortress Europe' in 1992?" his August 22 New York Times essay: The date now set for the economic unification of the 12 countries in the European Community is 1992. Not since Napoleon's quest to unite Europe has anything so ambitious been attempted."
The worry expressed by Hormats is of central concern to financial, industrial and political leaders everywhere. It is that in integrating an economic bloc of 320 million people with a combined GNP of $4.6 trillion, Europe will arrange a painful adjustment period of protectionism. To some degree, external barriers to trade will replace the demolished internal barriers. This will be done in order to minimize the upheavals that will face the weakest of the legitimate vested interests that are being forced to adjust, the subsidized or tariff-pro tec ted widgetworkers that exist throughout the present, splintered Europe.
Some of this is unavoidable. Italian widgetworkers who are going to have to go head on against German widgetworkers are going to resist going cold turkey against Japan as well. But how much of this will occur? If the European integration adds X to global GNP, but new external barriers subtract X + Y, the exercise invites global recession. It will take substantial political leadership inside and outside Europe for the game to be worth the candle, to prevent retaliatory trade wars creating three fortresses at odds with each other: Fortress Europe, Fortress America and Fortress Asia. The Reagan Administration is already waving the new trade legislation at Europe, warning it against caving to their protectionist forces or we will retaliate! The European response has been to accuse Washington of making the first suspicious moves, by accepting the protectionist trade bill as an implicit threat to them. Trade wars don't start suddenly, any more than shooting wars do. First is a chip on the shoulder, then retaliation, then escalation.
It's useless trying to predict the degree of trade tensions likely to develop in the next decade, given the great number of major political and economic variables. All we can say for sure is that in an epoch of global manufacturing and international banking, opportunity for trade tension will be plentiful. It is worthwhile reviewing the parallels with the 1930s, though, since so much has been made of the contrasts with the Smoot-Hawley era. The great difference is in political attitudes, the United States now being a much more mature world power. In the 1928 election between Herbert Hoover and Al Smith, for example, we recall that the GOP boasted of being more protectionist than the Democratic Party and the Smith campaign acted defensively on the issue. It wasn't until 1932 that the fledgling internationalist wing of the Democratic Party began developing a free-trade position based on reciprocity. It wasn't until 1940 that an internationalist wing took hold in the GOP with "One World" Wendell Wilkie the party nominee.
In the current era, protectionism is a dirty word. The trade wars of the 1930s left such profound scars on world history that we now have a worldwide array of mechanisms to blunt protectionist impulses. The most important is probably the annual economic summit of the seven leading western heads of state. There's also the G-7 meetings of finance ministers, the regular monthly gatherings of the leading central bankers, the GATT bureaucracy in Geneva, the OECD, IMF and World Bank bureaucracies, the United Nations itself. None of these channels of communication, which serve to mediate, arbitrate and conciliate trade disputes, existed in the 1930s.
Even the protectionists shun the label, preferring to call themselves "fair traders." Instead of the straightforward plea of the 1930s for tariff walls, the modern mercantilists ask for a "level playing field." This includes relief from foreign competition that they allege engages in predatory pricing or dumping, practices known in the domestic market as discounting and fire sales. It also includes a cheaper currency at home or a stronger currency in the home of the foreign competitor, on the spurious theory that the result will be more exports and fewer imports even though recent experience has gone the other way. Since 1971, the two bogeymen of world trade, Japan and Germany, have been beaten on repeatedly by Washington to strengthen their currencies to permit trade flows to adjust in this fashion. Yet Japan's trade surplus has widened steadily as its currency has strengthened, from 360 yen to the dollar to 130 yen; West Germany's trade surplus has soared as the Deutsche Mark climbed from 25 cents to 55.
The Trade Issue: Bush vs. Dukakis
We have in George Bush and Michael Dukakis two presidential hopefuls who fancy themselves as theoretical free traders ("in a perfect world," as they say) and pragmatic fair traders, in the "real world." Yet on a free-trade spectrum, they clearly have behaved on the promising end. Bush's rhetoric was ardently free trade in his primary debates with the protectionist-leaning Bob Dole and Pat Robertson. Dukakis clearly led the less protectionist wing of his party. And although Lloyd Bentsen shepherded the trade bill through his Senate Finance Committee and managed it on the floor, he's not been identified as a protectionist in his long years in Congress naturally excepting the oil interests. In general, Massachusetts and Texas have been identified with the international wing of the Democratic Party on trade matters, as opposed, say, to Pennsylvania, the rust-belt states, and the Carolinas.
Still and all, we'd have to feel more comfortable with Bush than with Dukakis on this terrain. We already know his Secretary of State will be Jim Baker, who will have had eight years experience in the international arena, including close relationships with the other G-7 ministers. As Secretary of State, he could lean even further toward free trade than he did at Treasury, where his portfolio was heavily weighted with domestic interests. At State, Baker would find himself making sure President Bush doesn't let the new Super 301 mechanism get out of hand. Of course, Dukakis might come up with someone as effective or better than JBIII at State, but we can't think who it would be.
Perhaps more importantly is Bush's experience itself. It's conventional to think of Bush as having a big edge over Dukakis in "foreign policy" in the national security area. But the edge also applies to foreign economic policy, given Bush's personal relationships with many of the world leaders who will be grappling with these matters in the decade ahead. With his service at the UN, CIA, China and as Vice President, the very least you can say of Bush is that he knows plenty of people from every corner of the planet, a very reassuring thought when we ponder the threats of economic conflict ahead.
Dukakis could be brought up to speed in textbook fashion, briefed by international experts, etc., but given his limited exposure to foreign places, people, and perspectives, it seems reasonable to assume his own comfort zone as President would be domestic, not international. He has served in the army in Korea, as a student had an important exposure to Latin America, and manages several foreign languages. He hasn't been to the important capitals of Europe, however, in this day and age perhaps the sharpest reminder of his parochial experience. His chief economic adviser, Lawrence Summers of Harvard, does not seem an especially positive force on trade issues; he carries the "Reciprocity!" banner that dresses up the protectionist cause. On the assumption that the most critical issues facing the next American President will be international, not domestic, Bush's advantage is evident and will almost certainly come through in his debates with Dukakis.
The Evolving Liberal Agenda
When New York's Governor Cuomo and New Jersey's Senator Bradley chose not to run for President 18 months ago, one notion that made the rounds in Democratic circles was that for the long run it might be better if the Republicans won the Presidency in 1988, because a deep recession is inevitable within the next few years. The Democrats would be ready in '92 to pick up the pieces, a la FDR in 1932, and regain dominance for another 20 or 30 years. This gloomy appraisal of the state of the union reflects the bankruptcy of the old liberal agenda. The new liberal agenda is still developing, still uncertain and tentative as the younger growth forces struggle with the Old Guard. We see self-styled "supply-side Democrats" clashing with party elders, Midwestern "fresh-water" economists contesting with Eastern "salt-water" (austerity) economists. The Reagan years have shattered the self-confidence of the movement liberals in America and while a new dialectic is underway, the synthesis has not yet arrived. Governor Dukakis seems to be the crucible for these competing factions, which is why his own agenda and the Democratic platform is so muddy. But if George Bush is President, he will have to keep the Reagan legacy rolling or by 1992 there will be a new Democratic Party waiting to take over.
The key positions to be filled in any event will be international posts: U.S. Trade Representative, chairman of the International Trade Commission, Undersecretary of State for Economic Policy, Director of the Agency for International Development, Assistant Secretary of Treasury for International Affairs, U.S. Representative at the IMF, UN Ambassador. In 1981, at the outset of the Reagan years, these posts were filled willy-nilly. Except for the UN, they amounted to back-burner positions, getting low priority and low energy. In the 1990s, even the nominations to the ITC will be as closely watched as we now watch Fed appointments.
These positions will be critical in order to move the entrenched bureaucracies in directions that are likely to keep world trade open, minimizing the inevitable frictions that accompany growth. They're important to the thrust of the economic summits, which will play larger roles in the 1990s as integration requires more coordination and more attention from world leaders. They're crucial to moving the west along the path of international monetary reform that Jim Baker began at Treasury and will undoubtedly pursue at State if Bush wins the White House. The team will have to refine the Baker Plan for the Third World, to actually get developing countries developing again, instead of consumed by debt payments. They'll have to develop imaginative ways to pull South America into the flow of the emerging trading blocs and encourage integration of markets in Central America and sub-Sahara Africa. They'll have to grapple with the fears and suspicions of the Asians toward the United States and Europe, and of Europe toward Asia and the U.S., all the while trying to manage a more sensible allocation of expenses in the maintenance of international security.
Growth in the Soviet Empire
The most important assignment of all will be to assist Mikhail Gorbachev in his bold but awkward attempts to reform the Soviet economy. In the epilogue to The Way the World Works, written in September 1977, I observed:
If China can find a way to unlock the nation's intellectual capital through incentive systems, for industry as it has for agriculture, rapid growth can follow. Unity with Taiwan is historically inevitable, as is unification of North and South Korea. But it is now not outlandish to consider the possibility that the completed results will mean a China and Korea that more closely resemble Taiwan and South Korea than Marxist models, which has been the conventional assumption by both liberal and conservative intellectuals in the West....
On a glacially descending line the Kremlin ruling class has been shedding [its] paranoia, and is beginning to sense that the Laffer Curve exists independent of ideological systems as with Brezhnev's restoration of one-acre plots. The next generation of Soviet leadership should progress more rapidly along this line....And they must....if the Soviet Union is to withstand the competition of a broad economic expansion by both the West and the People's Republic of China....
Conflict is more likely to come as a result of uneven advance. If all members of a family unit save one are developing, the one left behind will cause trouble, drain the resources of those who have been advancing, and create tensions and strife that will block the advance of the unit as a whole. If the West, China and the Third World manage a major economic advance in the 1980s as the result of simultaneous moves down the Laffer Curve, but the Soviet Union is unable to break through the crusts of ideological dogma that would enable it to advance as well, one would expect an increase in the potential for conflict. A happier outcome would be a general global advance, with the fresh economic and political impulses of Eastern Europe spreading into the heartland of Russia.
As it happens, as the 1980s close the Soviet Union is finally struggling to break through the crusts of ideological dogma that have held it back. The Gorbachev reforms are squarely aimed at increasing the free-expression of the individual, verbally and economically. The obstacles he faces are colossal, not only within the Kremlin bureaucracy, but throughout the Communist Parties of Eastern Europe. Everywhere in the empire, those whose vested interests are tied to the power of the state are going to resist transfers of power to the individual. We can be sure this Darth Vader side of the empire will strike back whenever it can.
As long as the Eastern bloc economy can expand, the dark forces can be held at bay. In China, Deng Xiao Peng has demonstrated it is possible to maneuver through these political minefields. If the West is to assist Gorbachev in his endeavor, the last thing it should be doing is offering the Soviet state loans and credits! It should advise the Soviet state on how to get loans and credits to its own citizens, permitting at least curbstone trading and cooperative banks, farms and enterprises. Both the USSR and China have to liberalize finance to have any hope of catching up and keeping up with the West. This means bond markets and stock markets, developed around a convertible ruble and yuan. The Soviet Union and China have all the capital they need within their borders, capital that is now suppressed by laws prohibiting its formation.
A serious worry at this early stage of economic development in the socialist bloc is the influence of the international financial institutions, especially the IMF. The neo-Keynesians who still dominate the IMF, after several decades of playing the bull in the china shop, have already been successful in getting the ears of policymakers in Beijing urging their poisonous brew of "tight fiscal policy and easy money" on the regime. It's only natural that the Socialist nations, if they are to grow along the capitalist road, will have huge trade deficits that match the private capital inflows seeking investment opportunities there. It was just such a trade deficit that led the IMF to counsel Beijing to devalue its currency in the last two years, to discourage imports and promote exports! The devaluation of course has produced a troubling inflation in China, leading the government back to toward price freezes. A steady dose of these neo-Keynesian ideas from the West's collection of Nobel Prize winners would undermine the free-market reforms in the USSR and People's Republic of China just as surely as they have ravaged the Third World.
In the pallid debate between Governor Dukakis and Vice President Bush over how to manage U.S.-Soviet relations, there is almost no such refinement of thinking. Dukakis will cooperate. Bush will be skeptical. The American electorate surely wants both. Unless there is refinement to the debate and policy, U.S. and other western banks will find ways to step into the vacuum and shovel loans into Moscow, perpetuating the misallocation errors of the Soviet system and delaying the correct reforms. Nor should the United States give the Soviets most-favored-nation treatment on trade policy until the Soviet Union permits its individual citizens to trade with the U.S. Granting the state a privilege the state denies its citizens also perpetuates the system Gorbachev is trying to reform. Gorbachev should privately welcome these and any other conditions that would strengthen his hand with the Politburo and the stubborn Soviet bureaucracy. Unilateral gifts and concessions by the U.S., including premature defense cuts, only weaken Gorbachev's position. There's plenty of time for the West to cash in on defense outlays once the Soviets are reeled in, not merely hooked.
There's no reason this biggest of fish shouldn't be wrapped up before the end of the century, in the sense that it should be well on the way to becoming a modern industrial and financial power. That is the ultimate objective, isn't it? There's no inherent reason in a civilized world that adversarial relationships between nations and cultures be at swordpoint. Ploughshares can be competitive too, as we've learned dramatically from Japan. President Reagan was the first to see that the Evil Empire was suspended when glasnost was permitted in the USSR, the freedom of opinion and debate that allowed him to speak openly and critically at Moscow State University, under Lenin's nose, in a way a tribute to Gorbachev. Evil in Reagan's mind seems clearly associated with darkness, as it should be. An empire held together by the force of light is one to be admired.
2001: A Supply-Side Odyssey
What might the world look like at the turn of the century? Say if all goes well, with only the usual setbacks to the forces at work today, the Reagan Wave riding the Laffer Curve.
There would be great prosperity, of course, but more importantly we could see the virtual elimination of widespread desperate poverty. Not that we can expect to find a chicken in every pot and car in every garage in downtown Addis Ababa. But reports of populations starving or eating the bark off trees should no longer be routine. Is this too optimistic? Eleven years ago I was writing that the Third World debt problem is a problem that could be cleared up through Third World tax reform. My hopelessly optimistic assumption at the time was that this would be achieved simultaneously with reforms in the developed world. My surmise now is that reforms of this elemental kind do not spread from the rich to the poor until they first pass through the middle class. The integration of Europe in 1992 was probably always a prerequisite to reforms of a similar nature in the Third World. A hit show on Broadway doesn't appear in Port-au-Prince before it plays Detroit. The former colonial powers of Europe, once ensconced on the same level playing field of an integrated European Community, are more likely to be spreading the gospel in French West Africa, British East Africa and the Asian subcontinent than they are now.
We should expect at least four distinct relatively open trading blocs; closed blocs would indicate a breakdown of international leadership and a severe setback to this growth scenario: a dollar bloc taking in North and Central America and the Caribbean; a European ecu bloc; a Pacific yen bloc; and an Eastern European/Soviet ruble bloc. Surely the ruble will be a convertible currency by the year 2000, even gold convertible, if the Gorbachev reforms are any kind of a success. (At the moment of ruble convertibility, the Japanese and Europeans will propose that the Soviet head of state be represented at the annual economic summits!) The currency blocs would be linked through an international monetary accord. My 1978 scenario was also too optimistic in seeing Robert Mundell's idea of an IMF gold-linked SDR a reality by this time. The monetarist and neo-Keynesian currency floaters proved tougher adversaries than I realized, forcing the world through two more wrenching inflation/deflation cycles to demonstrate the colossal inefficiency of go-it-alone, nationalistic currency units.
The G-5 accord of September 22, 1985 at the Plaza Hotel finally began the march toward a new gold-linked exchange-rate system. Jim Baker's IMF speech of September 1986 formally introduced the idea of a gold/commodity basket to signal incipient inflations and deflations. The stock market crash of October 19, 1987 gave new impetus to the idea of international monetary coordination. The Dukakis Atlantic Council promise of easy money seems an anachronism, perhaps still popular at Harvard, but not at many finance ministries or central banks. Especially in a Bush Administration, with Jim Baker at State, formal agreements would surely be worked out in conjunction with the 1992 integration of Europe. George Shultz, an avid monetarist and floater, was a key figure in stalling exchange-rate reforms.
The four distinct trading units would serve to limit the power of any one to exert hegemonic control over another, a kind of four-handed, high-stakes card game. Asian fear of U.S. protectionism in the 1990s, for example, is serving to pull together the yen bloc, Japan offering itself as protector of South Korea and Taiwan. It was fascinating and illuminating to see Prime Minister Takeshita at the Toronto summit meeting in June raise mild objection to the U.S. Treasury's bullying of Seoul and Taipei, trying to force currency deflations on them (as we had on Japan in 1986). A "Greater East-Asia Co-Prosperity Sphere" is surely emerging, China linking up with it, and the Soviet Union showing keen interest in developing warmer relations with it on its eastern flank. Gorbachev's Vladivostok speech of October 1986, a brilliant, timely diplomatic thrust into East Asia, amounted to Moscow playing its Asian card. With the Soviets meeting the conditions laid down by Beijing in answer to the card a pullout of Afghanistan, Hanoi's withdrawal from Cambodia, and a lower Soviet military posture on China's border a Sino-Soviet Summit is now just a matter of time. Japan, of course, is playing its diplomatic cards with finesse in both Moscow and Beijing.
All this is to the good. The United States gets to play its cards too. It will react to protectionist maneuverings in Europe against the dollar and yen blocs by cozying closer to the Pacific sphere, inching toward a dollar-yen bloc. Even feints in this direction would give the Europeans pause. The trick will be to get these separate free-trade blocs spreading like ink blots, the 12-nation European Community eventually pulling in the rest of Europe--Scandanavia, Turkey, etc., then merging with each other. In this fashion, economic and diplomatic competition would occupy the Twenty First Century.
I'd originally thought that the United States would take the lead in encouraging supply-side reforms in Africa and the Asian Third World. It now strikes me as unreasonable to think that U.S. benevolence would extend that far. An integrated common market of British East Africa or of French West Africa would naturally have its greatest links to the European bloc. Enlightened moves in that direction will more likely come from the European bloc itself. Asian reforms would contribute most to the yen bloc. It still falls to the United States to invite further integration of the North American bloc through reforms in Mexico and Central America. The greatest failure of the Reagan Administration has been its wretched record of aiding the forces of austerity in impoverishing our neighbors to the south. Tax and monetary reforms are essential throughout the region to permit growth. Coupled with a Central American common market, these would finally pacify the region's Marxists and eventually force reforms on an isolated Cuba.
This is very difficult to accomplish, however. There is simply a natural reluctance of the developed world to genuinely help the undeveloped grow, part of the mercantilist, protectionist dark side of human nature. As I wrote in 1977: "Resistance in the United States will come from those single-entry bookkeepers in American business and labor who fear that an expansion of Third World intellectual capital will just mean more competition. Do we really want Peruvians to be manufacturing steel instead of catching anchovies?"
What might help by way of enlightenment is a sense of growing competition for size and wealth within the individual trading blocs. A rapidly expanding Mexico and South America would mean more competitive complications to our mercantilists, but it would also give our trading bloc a greater mass. As U.S. employment reaches saturation levels, further profit opportunities can only be captured through labor arbitrage, exporting low value-added production to our unemployed or underemployed neighbors. The process would be greatly facilitated through supply-side reforms that permit this kind of growth instead of smothering it. Global manufacturing and banking are also in search of economies of scale, markets big enough and secure enough to carry the costs of rapidly turning investment. Perhaps these kinds of developments will finally overwhelm the narrower vested interests and trigger the Third World reforms that have been needed for more than 30 years and obviously needed for the past 10.
The other pressures that also work in this direction are the needs of the human species itself. When I wrote in 1977 about the need for growth reforms in the Third World, I had no idea there would be the hypothesis of a greenhouse effect, or a global AIDS epidemic, or a plague of drugs in the developed world. Yet each of these problems of the human species has at least some of its roots in the poverty of the Third World. AIDS has been traced back to the grinding poverty and miserable hygiene of sub-Sahara Africa. The source of drugs is in every case a debt-strapped Third World nation too weak to prevent the traffic, its officials too easily corrupted or overwhelmed by the drug trade. I'm still extremely dubious about the greenhouse hypothesis, but if it is real, a significant contributor is made by deforestation in the Third World, reducing the planet's ability to absorb carbon dioxide whether its denuding China of forests in the cultural revolution, stripping impoverished Haiti of its foliage, or the burning of the Amazon rain forests by poor Brazilians clearing land for farming. This latter development by itself is currently producing 10 percent of the planet's carbon dioxide. ("If all members of a family unit save one are developing, the one left behind will cause trouble, drain the resources of those who have been advancing, and create tensions and strife that will block the advance of the unit as a whole.")
My optimism that the world as a whole can make this kind of progress by the end of the century is founded on a real sense of the dramatic progress that's been made in the last decade. There are more people who have a stake in the success of the global supply-side revolution, who believe in it and are working for it. There are fewer who have a stake in its failure, whose own ideas failed when tried and who predicted ours would fare even worse. President Reagan may be about to exit right, but the idea has a momentum of its own. It will carry us at least into the next century, and maybe even a little longer.
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