Sunday, February 6, 2011

Potemkin America

As wages stagnate and unemployment booms, U.S. prosperity appears as illusory as that of the old Soviet Union.

By Paul Craig Roberts

In 1961 I was a member of the student exchange program to the Soviet Union. It was the second year of the exchange and part of a diplomatic effort to achieve some thaw in the Cold War.

There were three groups of us totaling approximately 35 American students. The Soviet authorities were not comfortable with us hanging out with Russian students, so we were kept constantly on the move. Consequently, we saw a lot of the communist country and its empire.

My group went in through Yugoslavia and Romania, spent time in Moscow, Leningrad, Kiev, Tashkent, Samarkand, and a Soviet sports camp on the Black Sea in Georgia, and came out via Poland and East Germany during the construction of the Berlin Wall. We were in the Caucasus mountains when Yuri Gagarin made the first spaceflight, a propaganda success for the Soviet Union.

What was most striking about the Soviet Union was that, except for the sparkling clean Moscow subway with its gleaming marble floors and walls and some beautiful old buildings built by the czars, there was nothing there. There was no traffic on Moscow’s boulevards. The small food stores were empty. The department store, GUM, had nothing to sell us for our fistfuls of rubles we had been paid for our Levi jeans, button-down shirts, and penny loafers, clothes literally bought off our backs on the streets.

I remember being on a bus in Tashkent when a meat delivery truck appeared. The carcass was hanging on a rail in the open air. The few vehicles on the street were following the delivery truck. The bus driver deviated from his route to follow the delivery.

Bus passengers came alive with anti-cipation. People began coming out from shops and office buildings. By the time the truck arrived at the small butcher’s shop, a long line had formed.

In the Soviet Union people kept a sharp eye out for deliveries of any kind. People would line up to purchase whatever was available as it could be bartered to obtain other goods. As goods of all kinds were scarce, money was not an effective medium of exchange.

My time with the Soviets made me immune to the exaggerated claims made for Soviet economic performance. During my years in graduate school, it was taken for granted that central economic planning enabled the Soviet economy to continuously generate growth rates that were very high compared to those of market economies. In 1962, G. Warren Nutter’s study, Growth of Industrial Production in the Soviet Union, was published by Princeton University Press for the National Bureau of Economic Research. Nutter concluded that the official index of Soviet industrial output exaggerated Soviet growth, and that Soviet growth was not remarkable compared to that of the United States in similar stages of development. Nutter’s conclusions provoked much controversy, and he had few defenders at the time.

Even as late as the 1980s, the view still prevailed in the CIA that the Soviet Union could triumph in an arms race because central control over investment meant that the Soviets could cause their economy to grow at whatever rate it took to counter an American arms buildup. When the Soviet economy collapsed, the CIA arranged for me to explain to the agency’s analysts why they had been mistaken about their enemy’s capabilities.

The Soviet economy failed because it used more valuable inputs to produce less valuable outputs. The outputs would be measured as statistical product, but the values of the outputs were less than the values of the inputs. In other words, instead of producing value, the Soviet system was destroying value.

This was the result of ideological aversion to using prices and profits to allocate resources and investments. Instead of profit serving as a manager’s success indicator, managers were judged according to whether they fulfilled a plan measured in gross physical output, such as weight, number, square meters.

For example, the success indicator for the construction industry was the number of projects under construction. Consequently, Moscow was littered with unfinished projects because all activity was concentrated in starting new ones. The plan produced a housing shortage because the incentive was to start new constructions not to complete ones already underway.

If a shoe factory’s gross output indicator was a specified number of pairs of shoes, there would be plenty of baby shoes, but none for large feet, because the same amount of material could be used to produce one large pair or several small pairs.

If nails were specified in number, there would be small nails but no large ones. If specified in terms of weight, there would be assortments weighted heavily with large sizes. A famous Soviet cartoon shows the manager of a nail factory being awarded Hero of the Soviet Union for over-fulfilling his quota. In the factory yard are two giant cranes holding one giant nail.

If light fixtures were specified in number, they would be small. If in weight, they would be heavy. Nikita Khrushchev complained of chandeliers so heavy that “they pull the ceilings down on our heads.”

An abundance of natural resources with low extraction costs and the minimal allocation of resources to consumer needs permitted the Soviet economy to continue despite its enormous waste of resources in terms of consumer satisfaction and economic efficiency. But it couldn’t go on forever.

In contrast, the U.S. economy during the 1960s was efficient. Prices and profits were the signals that allocated resources and investments. As the goods and services produced by American firms for American consumers were made by American labor, the profits made by corporations were indications that the economy was serving consumer welfare. American real wages and living standards were rising with the productivity of the economy.

During the 1970s, worsening trade-offs developed between inflation and employment, raising the specter of stagflation. However, this proved to be a problem with economic policy, not a problem inherent in the capitalist economy. Keynesian macroeconomic policy had stimulated demand with easy money but restricted the response of output with high tax rates. Supply-side economists corrected this problem by reversing the policy mix: tighter monetary policy and lower tax rates. Consequently, the U.S. economy resumed economic growth without having to pay for it with rising inflation.

Ironically, when the Soviet Union collapsed in 1991, the consequence was to initiate ruin within the U.S. economy. “The end of history” caused Chinese communists and Indian socialists to join the winning side and to open their economies to First World capital. For the first time, American corporations had access to massive supplies of unemployed low-wage labor. The huge excess supply of labor in India and China meant that workers could be hired at wages far below their productivity, and the difference would flow in profits to executives, shareholders, and Wall Street.

The offshoring of American manufacturing separated Americans’ incomes from the production of the goods and services that they consumed. The advent of the high speed Internet made it possible to offshore professional service jobs, such as software engineering, which drove down the returns to a college education and the employment prospects of graduates. In an offshored economy, the profits of corporations are not a measure of the economic welfare of the population.

As American incomes stagnated—except for the rich, there has been no real increase in 20 years—the economy was kept going by the growth of consumer debt to take the place of the missing growth in take-home pay. Federal Reserve Chairman Alan Greenspan’s low-interest-rate policy fueled a real estate boom and drove home prices to new highs, permitting Americans to refinance their mortgages and to spend the equity. Anyone could obtain credit cards, and many Americans maxed out several.

By the 21st century, the U.S. economy was a Potemkin economy just as the Soviet economy had been. Rising consumer indebtedness had taken the place of income growth and had reached unsustainable levels just as the greed of the unregulated financial sector leveraged debt to irresponsible levels and caused a financial crisis that still threatens the Western world.

Traditional economic policy—low interest rates and large budget deficits—cannot put Americans back to work when the jobs have been sent overseas. The low interest rates deprive retirees and those living on their savings of interest income, thus further suppressing consumer demand. The massive deficits drive down the dollar’s value and threaten its role as world reserve currency. As the U.S. is an import-dependent country, a weaker dollar further suppresses consumer purchasing power.

In addition, the bailouts of the banks and the monetization of the federal deficit by the Federal Reserve, known as quantitative easing, suppress consumer incomes while threatening consumers with inflation and reductions in benefits, such as Social Security and Medicare, and cuts in income-support programs.

The Potemkin American economy pretends that it can afford trillion-dollar wars, trillion-dollar military budgets, and trillion-dollar bailouts despite having sent much of its tax base offshore and undermining the dollar and creditworthiness of the U.S. Treasury.

Amidst high and intractable unemployment, President Obama’s Deficit Commission finds the solution in squeezing the American people harder so that the rich are not deterred by taxes from monopolizing every dollar of wealth growth. Social Security recipients have been selected to pay for the wars and the bailouts by having the retirement age raised and benefits reduced. To spread the misery, commissioner Alice Rivlin wants a 6.5 percent national sales tax, which, if enacted, would further reduce consumer spending during the worst downturn since the Great Depression.

In the USSR, a defunct ideology prevented the Soviets from saving themselves by using price and profit signals, instead of gross output indicators, to organize their economy. In the United States, politically powerful interest groups, such as Wall Street and the military-industrial complex that President Eisenhower warned us about, prevent the measures that would rejuvenate the consumer economy by bringing the offshored jobs home and reduce the deficit by ending the counter-productive wars.

The advantage to corporations and the financial sector of cheap foreign labor can be offset by taxing corporations according to where value is added to their product: a low tax rate if value is added with American labor and a high tax rate if value is added with foreign labor. This simple change would bring jobs back to Americans, rebuild the ladders of upward mobility that made the U.S. an opportunity society, restore the tax bases of cities, states, and the federal government, and reduce the trade deficit by the amount of the goods and services that are produced offshore by U.S. firms for U.S. markets.

Yet just as the Soviet communist bosses held on to power to the point of their self-destruction, the American oligarchies will squeeze the U.S. economy to its death. Is President Obama’s failure to bring any change yet another indication that change in America will only follow catastrophe?

Paul Craig Roberts was assistant secretary of the Treasury under President Reagan. He is the author of Supply-Side Revolution: An Insider’s Account of Policymaking in Washington and Alienation and the Soviet Economy, among other works.

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