Head to Head

Lester C. Thurow

• Publisher: HarperCollins e-books
• Year: 2009
• Print ISBN: 9780060536398
• eBook ISBN: 9780061882074
• Topic: Economics
• Subtopic: Economic Theory
• Index: Economics

The classic text on the post-Cold War economic battle.

Starting with the fall of communism, influential economist and former dean of MIT's Sloan School of Management Lester Thurow deftly explores how head-to-head competition -- not military might -- among Japan, the United States, and the newly united European countries would produce the next world leader.

As Thurow explains, in the 1990s the race for economic supremacy was only just beginning. In a world no longer governed by two military superpowers, the stage was set for a dramatic shoot-out among the world's most powerful national economies. Using analytical data, key insights, and common sense, Thurow presents a solid economic game plan for the United States to follow in order to win this battle and attain dominance in the global economy.

Chapter 1

THE BEAR IN THE WOODS IS GONE

There is a bear in the woods. For some people, the bear is easy to see. Others don’t see it at all. Some people say the bear is tame. Others say it is vicious and dangerous. Since no one can really be sure who’s right, isn’t it smart to be as strong as the bear—if there is a bear.

—Reagan TV advertisement, fall 1984

Most of the last half century has been devoted to worrying about the Soviet bear in the woods. Democracy and capitalism faced off against dictatorship and communism. In the late 1940s it looked as if the Soviet bear, helped by the newly triumphant Red Chinese dragon, wished to conquer the world. Aid to Greece and Turkey, NATO, rearming Japan and West Germany, and the Korean War were all efforts at containing the bears and dragons in the woods.

In the 1950s the Soviet bear’s military power seemed to be matched by its economic and technological capabilities. The Russian Sputnik flew; the American equivalent did not. In the 1950s the Soviet Union was growing faster than the United States. If economic trends were projected forward, the Soviet gross national product (GNP) would pass that of the United States in 1984—a year with ominous literary overtones. Containment was not a problem limited to Eastern Europe. In the Third World, communism, based on the economic success of the USSR, was widely seen as the only model for economic development. Communist Cuba, just ninety miles from the United States, was the wave of the future. When Nikita Khrushchev banged his shoe on the table at the United Nations and threatened to bury the industrial democracies militarily, technologically, and economically, everyone took him seriously. It looked like it was happening.

John F. Kennedy’s 1960 campaign for the presidency revolved around getting the country moving again—on all fronts—militarily, technically, and economically. With the construction of the Berlin Wall and the Cuban Missile Crisis, occurring shortly after his election, the Bear loomed ever larger in the early 1960s. At middecade President Lyndon Johnson spotted a North Vietnamese offspring of the Red Chinese dragon in the jungles of Vietnam. For the next ten years the dragon’s offspring got most of America’s attention and resources.

Two oil shocks and the discovery that the Chinese dragon was a friendly dragon—if not an ally, at least not an enemy—temporarily diverted attention away from the Soviet bear in the mid-1970s. But with a Soviet military buildup in the 1970s (now in dispute as to whether it really occurred), the American humiliation in Iran, and the USSR’s invasion of Afghanistan, the bear was back—bigger, badder, and more dangerous than ever. In response to the glimpse of this enormous bear in the woods, President Ronald Reagan doubled America’s military budget in the first half of the 1980s. A huge high-tech Star Wars program would be necessary to control the bear and his “evil empire.”

Suddenly, the bear disappeared. The Berlin Wall came down, East Germany and West Germany were united, democracy and capitalism arrived in the formerly communist countries of Middle Europe, the Red Army withdrew to the east, the Warsaw Pact was abrogated, the Soviet Union split asunder, and communism ended in Europe, its birthplace. Democracy and capitalism had won. Together they had beaten dictatorship and communism.

In many ways the retreat of communism is just as mysterious as Genghis Khan’s abandonment of his conquest of Europe 770 years earlier. While it was clear that the 1950s vision of the Soviet Union as an economic superpower was wrong, the USSR was not, if the CIA is to be believed, an economic basket case in the 1970s and early 1980s. As Gorbachev came to power, the CIA’s Directorate of Intelligence was estimating that the USSR had grown at a rate of 2.1 percent from 1975 to 1985—a rate slightly slower than America’s 2.9 percent over the same period—but nothing that dictated radical reforms were necessary.¹ In the mid-1980s the USSR was doing even better. In 1983 a 3.3 percent growth rate was recorded, and in 1986 an even better performance, 4.1 percent, was achieved. There were no signs of collapse. Quite the contrary, this was the period when plans for President Reagan’s Star Wars program topped the American political agenda. The economic problems that are now highly visible all arose under Mikhail Gorbachev and explain why he is so unpopular at home.

The USSR’s inability to deliver civilian consumption goods probably guaranteed that communism could not have lasted forever, but if the intellectual will had been there it could have continued for a long time. Just as he was about to conquer Europe, Genghis Khan turned around and disappeared into central Asia. In many ways the sudden disappearance of communism is no less mysterious.

By undercutting the authority of the old central-planning system that had been in place, Gorbachev created a situation where it was not possible to return to the past. What happened was much more fundamental than his opening the door to change. Once the door was open a crack, the old system was not so much ripped up by Gorbachev as it was dismantled by thousands of Soviet citizens who simply became unwilling to cooperate with it. When their voluntary cooperation vanished, the old system vanished. Even if the leaders of the abortive 1991 coup had succeeded, they could not have restored old-fashioned communism any more than Genghis Khan could once again sweep out of the Mongolian steppes.

Everyone from the far right to the far left in the former Soviet Union understood that the old system had come to the end of the line. Intellectually, this is why the 1991 coup failed. Its leaders had no program to offer to persuade other members of the Army and KGB to join them. If the issue was just personal survival, jumping on the Yeltsin bandwagon was a better option for personal success, which is exactly what the head of the Soviet Air Force did. With the Army and the KGB divided, no coup could succeed.

In many ways the coup and its failure are favorable developments. It is now crystal clear that there is no possibility that the former Soviet Union will go back to the status quo ante. It is no longer a military superpower. Its economy is not strong enough to permit it to regain its previous military status. The Soviet Army no longer sits in the middle of Europe. The Soviet Union of the past seventy years is now only a historical subject. No matter how many or how few countries emerge from the remains of the Soviet Union, no matter who rules, and no matter what system of government triumphs, the USSR is gone.

A sudden unexpected victory creates psychological problems for the victor. Its populace wants to tell glorious tales about how victory was achieved. In America, after the fall of the Berlin Wall, there was a flurry of talk about the “end of history.”^{2, 3} The American system would be adopted everywhere and last forever. To worry about boredom at the end of history, however, is not a problem any human being will ever have to solve. History is far from over. A new competitive phase is even now under way.

In 1945 there were two military superpowers, the United States and the Soviet Union, contending for supremacy and one economic superpower, the United States, that stood alone. In 1992 there is one military superpower, the United States, standing alone, and three economic superpowers, the United States, Japan, and Europe, centered on Germany, jousting for economic supremacy. Without a pause, the contest has shifted from being a military contest to being an economic contest.

THE NEW GAME

When systems fail, the need for change is obvious. Communism failed. That part of the world controlled by communism will change as a result. From it will emerge new players in the world economy. The transition from communism to capitalism is going to be difficult. Some of the new players from the Second World will join the First World; others will join the Third World.

Failure requires change, but so does success. If economies are successful, they slowly alter the circumstances under which they operate. Success generates new conditions, and these new conditions often require different institutions and altered operating procedures if success is to continue. So it is in the world of the successful market economies. In the past half century the world has shifted from being a single polar economic world revolving around the United States to a tripolar world built upon Japan, the European Community, and the United States. In Europe an economic giant, the European Community, is in the process of being created. For the first time in modern history, an oriental tiger, Japan, has emerged as a competitor fully equal to any in Europe or North America.

Because of their different histories and present circumstances, both of these new players are going to be infusing the capitalistic economic game with strategies very different from those found in the Anglo-Saxon world. They will force the economic leaders of the nineteenth and twentieth centuries, the United Kingdom and the United States, to alter their modes of playing the economic game. The United Kingdom’s traditional procedures will essentially disappear as it is absorbed into the European Community. Sharp changes will be forced upon the United States as for the first time in a long time it confronts economic and technological equals.

Today’s rules for the international economic game, the GATT (General Agreement on Tariffs and Trade)-Bretton Woods system, were written after World War II and built on the realities that then existed. They were designed to help most of the industrial world rebuild from the destruction of World War II and to catch up with the United States. They succeeded. But their very success altered the nature of the system. Rules, procedures, and institutions designed for a unipolar world don’t work in a multipolar world. As a result the system that governed the world economy in the last half of the twentieth century will not be the system governing the world economy in the first half of the twenty-first century. A new system of quasi trading blocks employing managed trade will emerge.

While economic success slowly undermined the post-World War II economic system, new technologies were blowing up the old strategies for economic success. The green revolution and the materials-science revolution have reduced the importance of natural resources in economic development. Having natural resources did not now make one rich; not having natural resources did not now stop one from being rich.

A telecommunications-computer-transportation-logistics revolution has permitted global sourcing and the development of a world capital market. Both have made it easier for poor countries to export to rich countries and for rich countries to source abroad in poor countries. Effectively, everyone now has access to the same world capital market. More equal access to capital has reduced the edge that being born in a rich country used to give.

In the future sustainable competitive advantage will depend more on new process technologies and less on new product technologies. New industries of the future such as biotechnology depend upon brainpower. Man-made comparative advantage replaces the comparative advantage of Mother Nature (natural-resources endowments) or history (capital endowments).

Objectively, the changes necessary to be successful in the formerly communistic world are much larger and more difficult to manage than those that will be required in the capitalistic world. Subjectively, the required changes may be more difficult in the capitalistic world. If change is required by success rather than failure, there is an instinctive human inclination to think that emerging problems can be solved by going back to the “ancient Roman virtues.” It is difficult to admit that the world has changed and that one’s ancient Roman virtues are no longer virtues. It is very hard to recognize that new realities force the creation of new virtues—new procedures, new rules, and new institutions.

Nowhere are the necessary changes going to be harder to make than in the United States, for in the past century it has been the most successful economy in the world. After World War II the United States did not have economic competitors. It stood alone with effortless economic superiority, by far the world’s strongest economy, playing a game designed to fit its strengths. In the next century the United States will be just one of a number of equal players playing a game where the rules increasingly will be written by others. Among the capitalistic economies it will have to make the largest changes. Those changes will be very difficult psychologically—even if objectively they would not look large to an outside observer who did not have to carry the heavy baggage of a successful history.

Looking forward, the next half century will be a competitive-cooperative three-way economic game among Japan, Europe, and the United States. In jockeying for competitive advantage, they will force each other to adjust. To mutually prosper, they will have to cooperate to create a world economy that works and a global environment that allows them to survive and to enjoy what they produce.

THE PROBLEMS OF CAPITALISM

While most of the problems of capitalism are those of success, there are some failures. If one looks at the growth rate of the non-communist world, it slowed from 4.9 percent per year in the 1960s to 3.8 percent per year in the 1970s, and then again fell to 2.9 percent per year in the 1980s.⁴ In the 1980s per capita growth in the gross national product (GNP) was only 40 percent of what it had been in the 1960s (1.1 percent versus 2.8 percent per year), and much of the Third World had falling real per capita incomes over the decade.

Capitalism has its virtues and vices. It is a wonderful machine for producing abundant goods and services, but it is hard to get started. Third World failures far outnumber First World successes. The Second World, the formerly communist world, is finding it very hard to get capitalism started. Free markets also tend to produce levels of income inequality that are politically incompatible with democratic government. Witness rising inequality and homelessness in the United States, and note the need for large social-welfare income-transfer payment systems in every major industrial country.

Left to itself, unfettered capitalism has a tendency to drift into either financial instability or monopoly. Tulip mania, the South Sea Bubble, numerous nineteenth-century financial panics, and the stock-market collapse of 1929 were all forerunners of the current mess in America’s deregulated financial markets. The current consolidations in the U.S. airline industry are not unlike the great monopolistic trusts of the last half of the nineteenth century.

If government had not come to the rescue, finance capitalism, as it is practiced in the United States, would now be collapsing. Most of America’s savings and loan banks (S&Ls) are in government receivership. Large numbers of commercial banks have not yet gone broke but are broke in the sense that they could not be liquidated to pay off their depositors if that should have to be done. The ultimate cost may not end up being as big as that for the S&Ls, but it is going to require a lot of the taxpayer money. If the banking system had not been bailed out by government, panic would have set in as individuals lost their savings accounts, and a repeat of the Great Depression would probably now be under way.

Paradoxically, as Eastern Europe privatizes, America nationalizes. With the collapse of much of its banking sector, by early 1991 the American government had been forced to take over two hundred billion dollars in private assets and was expected to end up owning three hundred billion dollars in private assets before the hemorrhaging stopped.⁵ A government corporation, the Resolution Trust Corporation, has become by far the largest owner of property in America. To these totals must be added the large sums that will be needed by the Pension Benefit Guaranty Corporation, the government fund that guarantees pensions, to fulfill its obligations to protect private pension funds. Pension funds hold 30 percent of those dubious junk bonds, and the bankruptcies that are flowing from the financial excesses of the 1980s will require billions in government aid to insure that the private pensions that have been promised are in fact paid. The pension funds of the airlines that were already in bankruptcy by mid-1991 will require more than two billion dollars in taxpayer money all by themselves.⁶

The same problems afflict the insurance sector. Here the guarantees have been given by state governments. Forty-seven states guarantee life-insurance policies, most up to $300,000 per person. In early 1991 the states of California and New York took over the management of Executive Life, a company with thirteen billion dollars in assets, two thirds of which were invested in junk bonds.⁷ By midyear three other large insurance companies (First Capital Life, Monarch Life, and Mutual Benefit Life) were under state jurisdiction. To prevent the feared bankruptcy of an out-of-state holding company from bringing down an in-state insurance subsidiary, Massachusetts stepped in to start running an insurance company that had not yet gone broke.

In the industrial sector America has just seen the tip of the iceberg of the corporations that have loaded up with too much debt and gone broke because of the merger and takeover wars. Airlines and large retailing firms lead the parade into bankruptcy, but there is a lot of the parade yet to come. With these industrial bankruptcies will come the need for even more government (taxpayer) help (unemployment insurance for those who end up unemployed, deposit insurance to cover the banks that go broke because they have lent to companies that go broke, and pension insurance to pay the pensions of those who were owed pensions by bankrupt corporations). Unfettered Anglo-Saxon capitalism is finding it difficult to cope with the present and may not be the unstoppable wave of the future that pundits on the political right like to extol.

MILITARY AND ECONOMIC POWER

If this were a book about military power, the book would focus almost entirely upon the United States. The rough military parity between the Soviet Union and the United States in the last half of the twentieth century has disappeared. At least at the beginning of the twenty-first century, there is only one military superpower—the United States....

Table of contents

• Cover
• Title Page
• Dedication
• Contents
• Introduction
• Chapter 1
• Chapter 2
• Chapter 3
• Chapter 4
• Chapter 5
• Chapter 6
• Chapter 7
• Chapter 8
• Chapter 9
• Notes
• Searchable Terms
• Acknowledgments
• About the Author
• Other Books by Lester C. Thurow
• Copyright
• About the Publisher