We are undergoing a profound economic transformation that is barely recognized. This quiet upheaval does not originate in some breathtaking technology but rather in the fading power of forces that have shaped American prosperity for decades and, in some cases, since World War II. As their influence diminishes, the economy will depend increasingly on new patterns of spending and investment that are still only dimly apparent. It is unclear whether these will deliver superior increases in living standards and personal security. What is clear is that the old economic order is passing.
By any historical standard, the record of these decades -- despite flaws -- is remarkable. Per capita income (average income per person) is now $40,000, triple the level of 60 years ago. Only a few of the 10 recessions since 1945 have been deep. In the same period, unemployment averaged 5.9 percent. The worst year was 9.7 percent in 1982. There was nothing like the 18 percent of the 1930s. Prosperity has become the norm. Poverty and unemployment are the exceptions.
But the old order is slowly crumbling. Here are four decisive changes:
The economy is bound to lose the stimulus of rising consumer debt. Household debt -- everything from home mortgages to credit cards -- now totals about $10 trillion, or roughly 115 percent of personal disposable income. In 1945, debt was about 20 percent of disposable income. For six decades, consumer debt and spending have risen faster than income. Home mortgages, auto loans and store credit all became more available. In 1940, the homeownership rate was 44 percent; now it's 69 percent. But debt can't permanently rise faster than income, and we're approaching a turning point. As aging baby boomers repay mortgages and save for retirement, debt burdens may drop. The implication: weaker consumer spending.
The benefits from defeating double-digit inflation are fading. Remember, in 1979, inflation peaked at 13 percent; now it's 1 to 3 percent, depending on the measure. The steep decline led to big drops in interest rates and big increases in stock prices (as interest rates fell, money shifted to stocks). Stocks are 12 times their 1982 level. Lower interest rates and higher stock prices encouraged borrowing and spending. But these are one-time stimulants. Mortgage rates can't again fall from 15 percent (1982) to today's 5.7 percent. Nor will stocks soon rise twelvefold. The implication: again, weaker consumer spending.
The welfare state is growing costlier. Since the 1930s, it has expanded rapidly -- for the elderly (Social Security, Medicare), the poor (Medicaid, food stamps) and students (Pell grants). In 2003, federal welfare spending totaled $1.4 trillion. But all these benefits didn't raise taxes significantly, because lower defense spending covered most costs. In 1954, defense accounted for 70 percent of federal spending and "human resources" (aka welfare), 19 percent. By 2003, defense was 19 percent and human resources took 66 percent. Aging baby boomers and higher defense spending now doom this pleasant substitution. Paying for future benefits will require higher taxes, bigger budget deficits or deep cuts in other programs. All could hurt economic growth.
The global trading system has become less cohesive and more threatening. Until 15 years ago, the major trading partners (the United States, Europe and Japan) were political and military allies. The end of the Cold War and the addition of China, India and the former Soviet Union to the trading system have changed that. India, China and the former Soviet bloc have also effectively doubled the global labor force, from 1.5 billion to 3 billion workers, estimates Harvard economist Richard Freeman. Global markets are more competitive; the Internet -- all modern telecommunications -- means some service jobs can be "outsourced" abroad. China and other Asian countries target the U.S. market with their exports by fixing their exchange rates.
Taken at face value, these are sobering developments. The great workhorse of the U.S. economy -- consumer spending -- will slow. Foreign competition will intensify. Trade agreements, with more countries and fewer alliances, will be harder to reach. And the costs of government will mount.
There are also global implications. The slow-growing European and Japanese economies depend critically on exports. Until now, that demand has come heavily from the United States, which will run an estimated current account deficit of $660 billion in 2004. But if American consumers become less spendthrift -- because debts are high, taxes rise or benefits are cut -- there will be an ominous collision. Diminished demand from Europe, Japan and the United States will meet rising supply from China, India and other developing countries. This would be a formula for downward pressure on prices, wages and profits -- and upward pressure on unemployment and protectionism.
It need not be. China and India are not just export platforms. Billions of people remain to be lifted out of poverty in these countries and in Latin America and Africa. Ideally, their demands -- for raw materials, for technology -- could strengthen world trade and reduce reliance on America's outsize deficits. If so, exports (and manufacturing) could become the U.S. economy's next great growth sector. Already, the dollar has depreciated 15 percent since early 2002; that makes U.S. exports more price-competitive.
What's at issue is the next decade, not the next year. We know that the U.S. economy is resilient and innovative -- and that Americans are generally optimistic. People seek out new opportunities; they adapt to change. These qualities are enduring engines for growth. But they will also increasingly have to contend with new and powerful forces that may hold us back.