Chapters 7, 8, and 9
Study Guide by James R. Martin, Ph.D., CMA
Professor Emeritus, University of South Florida
The Future of Capitalism Main Page
Chapter 7: Plate Five: A Multipolar World with No Dominant Power
After World War II everyone had to buy from or sell to Americans since the U.S. had two thirds of the world's industrial production capacity and the only people with money to spend. America's leadership of global capitalism was the result of a sequence of events that followed the war. It was the only place where equipment could be purchased to repair what the war had destroyed. But the system was in gridlock because the war-torn countries did not have the money to buy the equipment. The solution came when the Marshall Plan (European Recovery Program) was enacted in 1948 to jump start the system. The program involved large amounts of money and was sold to the American people as anti-communism. But now, if communism is gone, why should America pursue an international strategy?
After World War II, American leadership of the non-Communist bloc was a necessity since it was the only country with the military power to resist global communism. The United States focused on the alliance's military and economic needs and did not worry about its balance of payments. The Japanese took advantage of the situation and limited American access to the Japanese market while at the same time acquiring unlimited access to the U.S. market. The explicit goal of the post-World War II system was to create a global environment where other countries could become as rich as the United States. The measurements include purchasing power parity (the cost of an identical basket of goods), and market exchange rates of per capita GDP. Based on these calculations, there are now a substantial number of countries that are as wealthy as the U.S., and some that are wealthier, although the two measurements do not always agree. For example, Japan has a purchasing power parity only 79 percent of U.S., but exchange rate per capita GDP 80 percent higher than the United States.
It was inevitable that U.S. global leadership would decline as its economy became smaller relative to the rest of the world. In 1960 the U.S. represented more than 50 percent of world GDP. Today the U.S. represents less than 25 percent of world GDP based on exchange rates. (Note: In 2018, it was about 15 percent). The rest of the capitalist world does not need U.S. economic leadership as much as it did in the past, and the United States is less willing to offer leadership.
The Implosion of the USSR
With the USSR imploding into fifteen different countries and the Russian military withdrawal from central Europe, other countries no longer need U.S. military protection. NATO was viewed as an alliance for keeping the Russians out, the Germans down, and the Americans in. Now the Russians are out, the Germans are up, and there is less need to keep the Americans in.
In the Far East, North Korea potentially threatens China, Russia, Japan, and South Korea, but there is no straightforward American national interest at stake. America is the only superpower with nuclear weapons, delivery systems, and global logistical capabilities, but all that is unusable and irrelevant in the era ahead. The American voter will eventually realize that he is paying for a military establishment that will never be used, and NATO will fade away as an American-led military alliance. The American taxpayer will not be willing to pay for the defense of those richer than themselves from an enemy that no longer appears to be a threat.
America's Trade Deficit
Theoretically, America's trade deficit should have nothing to do with global leadership, but in reality it does. Trade deficits cause the dollar to be undervalued, and a lower valued dollar means international political and military activities cost much more than they would otherwise. Fewer foreigners want to hold dollar assets, foreign investment becomes more expensive for American firms and the world has less willingness to hold dollars as foreign exchange reserves. All of this undercuts America's ability and willingness to be a global leader.
In other parts of the world, when currency values fall, inflation accelerates. But in the U.S., import prices rise relatively little when the dollar plunges because foreign firms hold dollar prices constant to preserve their American sales. As a result, imports hold down domestic prices despite the falling value of the dollar.
A New World Trading System
The single-polar world of the old system is gone and a multipolar world has emerged. The GAAT-Bretton Woods trading system was an American dominated system, but it is not capable of solving the issues facing the new global economy (e.g., intellectual property rights in China, or the persistent trade surpluses of Japan). A paper organization (World Trade Organization) has been created to develop the rules for the new multipolar economy, but it is incapable of writing those rules, and the U.S. could not create a new system even if it wanted to do so. The U.S. no longer has the ability to force everyone to come to the table, sit down and agree to an American-designed trading system that would fit today's realities. In whatever new system evolves, the U.S. will have fewer voting rights and less influence.
The End of American Internationalism
The fall of communism permits a slow withdrawal from American international responsibilities. It might be called the new American isolationism. Rhetorically, the age of American leadership is not over, but there has been a gradual shift in attitudes. In 1994 the new Republican Congress started by announcing that it was opposed to many of the international institutions underlying the global system. Proposals would end UN peacekeeping missions, the Arms Control and Disarmament Agency, and the Agency for International Development. Both parties talk about expanding NATO but then vote to cut the infrastructure investments needed to maintain it.
The United States is no longer willing or able to be the global leader it was after World War II. But there is no other country, or set of countries that could take its place. In addition to its economic size and military power, it had the world's business language, a system of higher education open to foreigners, and a mass media that dominated the world.
Holding the System Together Without a Leader
The threat of communism unified the countries inside the American bloc, but without communism there is nothing to hold the system together. Neither capitalism nor democracy is a unifying ideology since both stress the individual, not the group. Without a unifying ideology, unity is found by directing anger against some set of despised insiders (immigrants, the poor). Today there are no threats, ideologies, or leaders strong enough to hold the world system together. No one clearly understands the threats or opportunities and what it takes to lead. The more disorganized the world looks, the less the citizens of a country want their leaders to spend their time trying to manage what looks like a hopeless global mess. The world trading system needs to be managed, but in the new global environment potential leaders don't know in what direction to go, and followers have no reason to follow. Leaders without followers are not leaders.
Chapter 8: The Forces Remaking the Economic Surface of the Earth
The 1970s and 1980s were inflationary decades that lead to the war against inflation. Inflation during those periods is attributed to the misfinancing of the Vietnam War, the OPEC oil shocks, other food shocks, and the use of cost-of-living indexes to adjust both labor and supplier contracts. To fight inflation, world growth was deliberately slowed with higher interest rates and tighter fiscal policies (higher taxes and lower expenditures). The negative side effects of these policies were falling real wages, rising inequalities, and higher unemployment. In addition, there were a large number of underemployed workers including millions working in temporary jobs, and many more self-employed independent contractors. Eleven million legal and illegal immigrants entered the United States from 1980 to 1993 adding to the excess supply of labor. This sea of excess labor, technological advancements, and global trade combined to drive wages down.
Factor Price Equalization in a Global Economy with a Skill-Intensive Shift in Technology
In a global economy the factors of production move around the world. Services, goods, and natural resources move from where they are cheap to where they are expensive, while the production of goods moves from where it is expensive to where it is cheap. Wages rise in countries with low wages and fall in countries with high wages (factor price equalization). The wage premiums obtained when national economies were isolated no longer exist. The advantages enjoyed by the unskilled of the first world are gone. Raw materials can be purchased at world prices and cheaply transported to where they are needed. Everyone borrows capital on an equal-access basis on world capital markets in New York, London, or Tokyo.
In the long run, wage differentials can only exist if they are justified by the skills that produce higher productivity. Technology that is moving in a skill-intensive direction, together with various business methods to improve operational effectiveness (e.g., just-in-time techniques, statistical quality control, removing functional barriers, pushing decisions down the hierarchy, and teamwork) all require a more skilled work force. Although total employment has grown, high wage jobs have disappeared in manufacturing while the increases went to low-wage jobs in the service sector. What all this means is that the unskilled in the first world will need first world skills to earn first world incomes. In an era of man-made brainpower industries, countries that do not make the right investments in skills, R&D, infrastructure, and plant and equipment will have a large group of people at the bottom of their workforce with very low and falling wages.
Who Altered the Wage Structure
This section deals with some unanswered questions such as why returns on capital did not rise when each unit of capital was working with more labor, why imports from third world countries did not seem large enough to explain the huge changes in earnings that occurred, and how the United States became a first world economy with a third world economy inside of it. These side-line issues of economic analysis are interesting, but they do not change the broad causes of falling wages or the recommended remedies.
Other Possible Causes
A number of other factors have been suggested as reasons for the decline in wages. For example, Reagan's deliberate strategy of deunionization along with alterations in labor laws and forced decertification elections in the private sector help explain the decline in unions and the increase in wage differentials. Also wage reductions may appear to be worse than they really are if skill related inflation causes workers to be recorded as having skills that they really do not have. Another possible cause is that deregulation led to wage reductions in some industries (e.g., trucking and the airline industry).
Looking Forward
The integration of the second world into the first world, and a very different competitive third world lies ahead. China will generate hundreds of millions of medium-skill workers, and third world countries with billions of people (Indonesia, India, Pakistan, Mexico) will want to become export oriented. Exports from these countries are likely to be much larger in the years ahead. As a result, the real wage declines and increases in wage dispersion caused by factor price equalization will be larger in the future. In addition to these changes, firms have learned how to reduce white-collar and middle management jobs by using information technology to raise white-collar productivity.
Conclusions
Various forces including the end of communism, increased migration, new technologies, and a global economy with no dominant economic leader have created an environment with large supplies of cheap well-educated labor from the second world, a lot of smart but unskilled labor from the third world, a skill-intensive shift in production technologies, and factor price equalization that together increase wage differentials as they drive wages down.
Chapter 9: Inflation: An Extinct Volcano
As noted in Chapter 8, the 1970s and 1980s were inflationary decades that lead to the war against inflation. Wage and price controls were tried in various countries including the United States, but inflation was not conquered. The causes of inflation in the 1970s and 1980s simply disappeared as structural changes occurred in the global economic system. Although inflation no longer existed in the 1990s, the Federal Reserve Board continued to fight inflation by raising short term interest rates. The implicit price deflator for gross domestic product (The broadest measure of inflation) was 2.2 percent in 1993 and 2.1 percent in 1994. Officially the rate of inflation measured by the consumer price index was 3.0 percent in 1993 and 2.6 in 1994, but the Fed Chairman (Greenspan) testified to Congress that the CPI was overstated by as much as 1.5 percent for a number of reasons. Others have estimated an even higher upward bias in the CPI of 1.0 to 2.4 percent.
There is no empirical evidence that modest rates of inflation adversely affect economic growth, and an argument can be made that capitalism works best with an inflation rate of around 2 percent. When prices are falling people are motivated to hold on to their money and postpone purchases. Some real wages need to fall to induce labor to move from declining industries to the new developing industries. Therefore, a zero level of inflation is not a target for capitalist economies interested in growth. When the Federal Reserve Board raised interest rates in 1994 it was chasing a ghost. Inflation was dead. The Fed does not seem to grasp the fact that structural changes have occurred that make it impossible for inflation to have an afterlife. (See the graphic below for more recent results). Downward pressure on prices and wages from low-cost producers can only accelerate. Governments will continue to talk about restoring a high-wage economy with growing real incomes, but these are outcomes that they will not be able to deliver.
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Go to the next Chapter. Thurow, L. C. 1996. The Future of Capitalism: How Today's Economic Forces Shape Tomorrow's World. William Morrow and Company. (Chapter 10).
Related summaries:
Friedman, T. L. 2005. The World Is Flat [Updated and Expanded]: A Brief History of the Twenty-first Century. Farrar, Straus and Giroux. (Note).
Martin, J. R. Not dated. A note on comparative economic systems and where our system should be headed. (Note).
Milanovic, B. 2019. Capitalism, Alone: The Future of the System That Rules the World. Harvard University Press. (Summary).
Oser, J. 1963. The Evolution of Economic Thought. Harcourt, Brace & World, Inc. (Summary).
Porter, M. E. and M. R. Kramer. 2011. Creating shared value: How to reinvent capitalism and unleash a wave of innovation and growth. Harvard Business Review (January/February): 62-77. (Summary).
Rosenfeld, G. D. (Editor) and J. Ward (Editor). 2023. Fascism in America: Past and Present. Cambridge University Press. (Summary).
