THE AGE OF DIMINISHED EXPECTATIONS

U.S. Economic Policy in the 1980s

By Paul Krugman

MIT Press. 204 pp. $17.95

THE MYTH OF AMERICA'S DECLINE

Leading the World Economy Into the 1990s

By Henry R. Nau

Oxford University Press. 424 pp. $29.95

IS AMERICA about to lead the world into a new, post-Cold War era, in which the spread of democracy brings prosperity to every corner of the globe? Or is America instead doomed to drift, unable to muster the will to put its economic house in order and thus incapable of sustaining the American Dream even within its own borders? Two new books offer different perspectives on our likely national prospects as the new century approaches.

Paul Krugman, an MIT economist, sees the glass being half empty. As its title suggests, The Age of Diminished Expectations -- originally published as a limited edition "briefing book" by The Washington Post Co. -- argues that the startling feature of American life today is the equanimity with which Americans accept a level of economic performance that would have drawn protests two decades ago. For the first time in American history, our children cannot expect to live better than we have; public-policy initiatives seem perversely bent on widening the gap between rich and poor, and our spiralling national debt threatens to erode the independence we presume as our birthright. Yet in the face of these and other astonishing turnabouts, an indifferent polity yawns.

Krugman is not out to account for our apathy or to issue a call to action. Instead, his slim volume is a sophisticated guided tour through the major economic issues facing the nation today. Its clarity and reasonableness should make it an indispensable companion for anyone seeking to understand the true stakes behind the circus-like charades that pass for debate in Washington.

Krugman devotes chapters to the budget and trade deficits, inflation, the dollar and the role of the Federal Reserve. Special attention is paid to the free trade versus protectionism debates and the financial excesses of the 1980s that brought us the mergers and acquisitions binge, the S&L fiasco and the time bomb of Third World debt.

Krugman pauses at every juncture to ask why we should care about such abstractions as deficits, productivity or savings in the first place. Where controversy exists, he clearly summarizes the major points of view before offering his conclusions. And he routinely demonstrates that, despite the overheated rhetoric, our leaders are either tinkering at the margins or simply playing make-believe.

Take the trade deficit. While the question of America's "competitiveness" is important to address, Krugman explains, the accounting reality is that the trade imbalance is caused by our low national savings. This requires us to import huge quantities of foreign capital to maintain our levels of investment, which in turn means that other countries must run trade surpluses to generate the money to finance us.

The surest way to boost our savings is to eliminate the budget deficit, which represents massive government "dissaving." But this involves unpleasant choices, so politicians clamor instead for "get tough" trade policies that skirt the real issue, pander to economic jingoism and stand little chance of making more than a minor dent in the trade numbers.

Analyses that expose this kind of bipartisan make-believe fill the book. But Krugman also challenges pieties in a few areas that are bound to spark controversy.

In a chapter on trade policy, for example, Krugman calculates that a full-blown trade war would hurt the U.S. economy no more than a mild recession. But his analysis assumes that the world splits into three large trading blocs -- centered on Europe, Japan, and the United States -- within which much trade already flows. The results would be far more dire if all countries began closing their borders to all others.

If in the end there's one thing depressing about this excellent book, its the way Krugman instinctively takes for granted our political system's inability to deal directly with the problems we face. There's no reason to date dispute him and no one's saying he has to write a manifesto; but after a while it's like being around a doctor who's impersonally fascinated with your own creeping demise.

Henry Nau, by contrast, thinks we can and must do better. Nau, a dean at George Washington University who served in economic policy posts under presidents Ford and Reagan, writes to challenge the "American decline" fad sparked by Paul Kennedy's 1987 book, The Rise and Fall of the Great Powers.

Nau's basic argument is persuasive: the Cold War is over; American values have prevailed; and any relative loss of U.S. economic power in the world is the expected result of our policy of rebuilding nations that shared our political values. Moreover, because the international community increasingly shares these values, the United States can continue to exert influence without the degree of hegemony it enjoyed after World War II -- a dominance that was an historical accident in any event.

Having made this case for the enduring relevance of American leadership, Nau devotes the bulk of The Myth of America's Decline to culling from the postwar era the lessons for U.S. policy toward the international economy in the 1990s. Put briefly (an exercise that Nau's book might have benefited from), Nau's thesis is that the world economy thrives when price stability, flexible markets and free trade are in the ascendant -- and that these policies follow only when America's "national purpose" is devoted to their broad promotion.

Thus, Nau argues, America's compelling mission to rehabilitate the European democracies and preserve Western freedoms from Soviet threats harnessed a broad commitment to efficient economic policies from 1947-67. The result was liberalized trade, low inflation and minimal government intervention in markets. In the 1970s, however, when America doubted its self-worth and chose less efficient policies, its influence weakened and world economic performance suffered. Nau's occasional use of a shoehorn to fit events into his thesis is more than compensated for by the rich detail of postwar economic relationships he chronicles.

Nau finds cause both for worry and opportunity today. He rightly fears that the Reagan administration's failure to address the budget and trade deficits, combined with its reliance on trade restrictions and cosmetic currency manipulations, set the stage for a decade in which price stabilty and free trade are at risk.

The biggest losers under such a scenario are precisely the group for whom the end of East-West preoccupations should hold the most promise: the Third World. Languishing under a mountain of debt and without the clout to prevail in a world where trade becomes "managed" by bilateral deals, these nations' fates truly hang in the balance awaiting the next pendulum swing in America's agenda.

Will the post-Cold War international order realize its promise? Or will it become instead a kind of South Africa writ large, with "have" countries struggling to stay immunized from the desperate aspirations of the "have nots"? Nau remains hopeful. But the current parochial impasse in global trade talks (stalemated in part because of America's wildly protectionist textile policies) -- as well as the laughable-if-it-weren't-so-tragic budget gridlock we witness daily -- hardly inspires confidence that any revival of larger American purpose is imminent.

Matthew Miller, a New York management consultant, writes frequently on politics and economics.