U.S. DEPARTMENT OF STATEBUREAU OF INTERNATIONAL INFORMATION PROGRAMS

http://www.america.gov/publications/books.html

O U T L I N E O F T H E

U. S. ECONOMY2 0 0 9 E D I T I O N

O U T L I N E O F T H E

U. S. ECONOMY2 0 0 9 E D I T I O N

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Outline of the U.S. Economy2009 Edition

Published in 2009 by: Bureau of International Information ProgramsUnited States Department of Statehttp://www.america.gov/publications/books.html

STAFF

Editor in Chief: Michael Jay FriedmanManaging Editor: Bruce OdesseyDesign: David HamillGraphs: Vincent HughesPhoto editor: Maggie Sliker

FRONT COVER: top illustration © Dave Cutler / Stock Illustration Sourcebottom illustration © Jane Sterrett / Stock Illustration Source

ABOUT THE AUTHORThis edition of Outline of the U.S. Economy has been completely revised by Peter Behr, a for-mer business editor and reporter for the Washington Post. It updates several previous editionsthat were issued first by the U.S. Information Agency and then by the U.S. Department ofState beginning in 1981.

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Out l ine o f the U .S . Economy

CHAPTER 1: The Challenges of this Century 1The world’s largest and most diverse economy faces the most severe economic challenges in a generation or more.

CHAPTER 2: The Evolution of the U.S. Economy 8The economy has expanded and changed, guided bysome unchanging principles.

CHAPTER 3: What the U.S. Economy Produces 43The large U.S. multinational firms have altered their production strategies and their roles in response to globaliztion as they adapt to increasing competition.

CHAPTER 4: Competition and the American Culture 55Competition has remained a defining characteristic of the U.S. economy in the American Dream of owning asmall business.

CHAPTER 5: Geography and Infrastructure 67Education and transportation help hold together widelyseparated and distinct regions.

CHAPTER 6: Government and the Economy 79Much of America’s history has focused on the debate over the government’s role in the economy.

CHAPTER 7: A U.S. Economy Linked to the World 101Despite political divisions, the United States shows no sign of retreat from global engagement in trade and investment.

CHAPTER 8: A New Chapter in America’s Economic Story 115The United States, in its democratic way, faces up toimmense economic challenges.

C O N T E N T S

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Out l ine o f t he U .S . Economy

P R E F A C E

“The panic itself was felt in every part of the globe,” The Wall Street Journal reported. “Itwas as if a volcano had burst forth in New York, causinga tidal wave that swept with disastrous power overevery nation on the globe.” One of the after-effects: “anaccumulation of idle money in the banking centres.” Thedate of this item? January 17, 1908.

Given the sobering news that of late has arrived with distressingfrequency, preparing this edition of Outline of the U.S. Economy hasbeen a real challenge. We have tried to approach the task with asense of historical consciousness. In addition to the 1908 eventsdepicted above, the United States has endured a Great Depression(began 1929), a Long Depression (began 1873), a Panic of 1837—“an American financial crisis, built on a speculative real estatemarket,” says Wikipedia—and assorted other recessions, panics,bubbles, and contractions, and emerged from each with its eco-nomic vigor restored and its republican institutions vibrant.

We hope that our readers will find this new entry in our Outlineseries frank, informative, and above all useful. We offer it in thespirit of optimism embedded deeply in American life.

—The Editors

The Challenges of this CenturyThe world’s largest and most diverse

economy currently faces the most severe economicchallenges in a generation

or more.

C H A P T E R

© photosbyjohn/Shutterstock

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The financial crash of 2008 brought a sudden,traumatic halt to a quarter-century of U.S.-led global eco-nomic growth. The final consequences of this shock for the U.S.and world economies remain uncertain at this writing. But in themidst of the crisis, Americans chose new national leadership in apeaceful transfer of power that demonstrated again the strength ofthe country’s democratic process and the people’s confidence in theultimate resilience of the American economy.

Since the election of Ronald Reagan as president in 1980, the UnitedStates had championed globalization of trade and finance. It opened itsdoors wider to foreign products and investment than any other major econ-omy. America’s entrepreneurial culture was the world’s model. The synergyof U.S. political freedoms and free markets appeared vindicated by the Sovi-et Union’s collapse in 1991. At home, a bipartisan consensus emerged infavor of further economic deregulation, which, in turn, spurred a freewheel-ing expansion of new types of investments that helped fuel a vast increase ininternational finance and commerce.

But America’s growth came to rely increasingly on debt. Consumers, busi-nesses, home buyers, and the U.S. government itself borrowed heavily in thebelief that the value of their investments—including, fatefully for many, theirhomes—would continue to grow. The ready availability of credit on easyterms drove home prices, in particular, ever higher.

When the housing boom finally collapsed in 2007, it exposed a fragile layerof high-risk home loans made over a decade to families that could not affordthem, particularly if the economy weakened. Some borrowers had purchasedhomes they could not afford, trusting that in a rising market they could alwayssell their properties at a profit. As housing prices fell, homeowners who nolonger could keep up with their mortgage payments were unable to pay theirdebt by selling their homes. These home loans thus were the unstable founda-tion for a massive but largely invisible speculation on mortgage securities andfinancial contracts sold around the world.

The United States “continues to surprise…It continues to renew itself.”

SECRETARY CONDOLEEZZA RICE

U.S. Department of State2008

© AP Im

ages

Above: From left, Vice President-elect Joe Biden and his wife, Jill, President-electBarack Obama and his wife, Michelle, stop in January 2009 on their way to inaugu-ration and big challenges. Previous spread: Times Square in New York City, theU.S. financial capital, is reeling from the global financial collapse but still pulsatingwith economic energy.

underpin the United States’ represen-tative democracy and its economy.Chapter 4 profiles the makeup of theU.S. economy—what it produces,exports, and imports. Chapter 5 focus-es on the major regions of the countrywhose cultures are responsible formuch of America’s diversity, and thelinkages of infrastructure and educa-tion that have tied the country togeth-er. Chapter 6 describes the ongoingdebate over the government’s role inthe economy. Chapter 7 examines theimpact of globalization and trade onthe U.S. economy, its companies, andits workers. And Chapter 8 sums upthe hurdles that confront the Ameri-can economy in a fast-changing andless-predictable world.

An Economy Driven by Competition

Many economists agree that anunderstanding of the Americaneconomy begins with Adam Smith’sconcept of the “invisible hand.”Smith, considered the father of eco-nomics, wrote in his 1776 book TheWealth of Nations that an economyperforms best when buyers and sell-ers seek the best outcome for them-selves, as if guided by an unseenhand. The sum of their many inde-pendent transactions is the most effi-cient use of a nation’s resources, hereasoned. In freely operating mar-kets, prices are determined by theinteractions of buyers and sellers.Competition results in better prod-ucts and wider prosperity on averagethan a government-run economycould deliver—as the failure of com-munism in Russia so clearly attests,market economists say.

An American version evolved fromSmith’s doctrine and other features ofBritain’s merchant economy. Its cen-terpiece remains a matrix of laws, in-

stitutions, and traditions that haveshaped the American economy. Theframers of America’s 1776 Declara-tion of Independence from Britainand 1789 U.S. Constitution hadgiven the new United States “stars tosteer by,” in historian David McCul-lough’s words, meaning the basicpolitical freedoms and restraints ongovernmental power that Americanshave prized—and debated—sincethe country’s founding.

But even the strongest supportersof market capitalism acknowledge thatit does not provide all the answers.“For various reasons, the invisiblehand sometimes does not work,” saideconomist N. Gregory Mankiw, a for-mer member of President George W.Bush’s Council of Economic Advisers.A manufacturer won’t pay the envi-ronmental and health costs of the pol-lution emitting from its smokestacksunless government requires that it doso. A monopolist or group of domi-nant companies can charge higherprices than a competitive marketwould allow. Another former WhiteHouse adviser, Nobel Prize winnerJoseph E. Stiglitz, says, “The reasonthat the invisible hand often seemsinvisible is that it is often not there.”

Every generation of Americans hasproduced critics of the nation’s eco-nomic arrangements. Historian HenrySteele Commager, writing in the1950s, said that “whatever promisedto increase wealth was automaticallyregarded as good, and the Americanwas tolerant, therefore, of specula-tion, advertising, deforestation, andthe exploitation of natural resources,and more patient with the worstmanifestations of industrialism.”

Others have pointed to numerouscontradictions both seeming and realin the American economic formula:

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Triggered by the housing collapse,this edifice toppled in 2008. Foreclo-sures grew, and panic followed. GiantWall Street financial firms fell, reorga-nized, or were combined with largercompetitors. Stock markets plunged,and the world’s economies headedinto the worst crisis since the GreatDepression of the 1930s.

The catastrophe revealed weak-nesses unheeded during the boom.U.S. consumption had for too longoutpaced savings. Financial regulators’faith in the efficiency of economicmarkets led them to underestimatethe mounting risks. Optimism andambition among many Americansbred excess and recklessness.Lessons from past booms and crash-es were ignored as many focusedonly on the present.

But the crisis also revealed theability of the American governmentto respond quickly and decisively tothe challenge. Even at a peak of thecrisis in the last two months of 2008,foreigners viewed the United Statesas among the most economically safeand politically stable investment are-nas. So eager were they to purchaseU.S. Treasury securities that thereturn on these investments droppednearly to zero: Once again, the dol-lar was a refuge in financial storms.

Washington officials respondedwith unprecedented measures tohead off a global collapse of lending.The federal government and theFederal Reserve central bank seizedcontrol of the two largest U.S. homemortgage firms and bailed out lead-ing banks and a major insurancecompany, actions that would havebeen politically unthinkable beforethe crisis. An initial $700 billionbank rescue plan won bipartisan sup-port in the U.S. Congress.

Since the start of the global crisisin 2008, U.S. government agenciesand the central bank had pledged anastonishing $12.8 trillion—equal tonearly the entire U.S. annual eco-nomic output—in loans, loan pur-chases, and credit guarantees seekingto halt the financial freefall. The Fed-eral Reserve also promised to buymore than $1 trillion in bonds backedby devalued home mortgages. Aleading economist observed that “noone else—not even China—had a bigenough balance sheet” to mount sucha response.

The crisis erupted in the midst ofthe 2008 presidential election andhelped clinch victory for SenatorBarack Obama, the Democratic Partycandidate. Many interpreted the elec-toral triumph of the United States’first African-American president, aman who rose rapidly from humbleorigins, as an affirmation of thenation’s signature traits of optimismand faith in this country. As PresidentGeorge W. Bush’s secretary of state,Condoleezza Rice, put it, one can “gofrom modest circumstances to extra-ordinary achievement.”

This edition of the Outline of theU.S. Economy is a primer on how theU.S. economic system emerged, how itworks, and how it is shaped by Ameri-can social values and political institu-tions. Always present, given the tryingtimes during which this edition nearedcompletion, is a sense of how all thesefactors may guide the nation’s respons-es to the extraordinary economic chal-lenges that lie ahead.

This chapter offers a brief over-view of the U.S. economy today. Chap-ter 2 follows the historical evolutionof the economy from colonial times tothe present. Chapter 3 concerns thebeliefs, traditions, and values that

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standard for the world. The averageAmerican worker produced morethan $92,000 worth of products andservices in 2007. This is nearly 20percent more than that of the aver-age of a dozen leading Europeancountries and 85 percent higher thanthat of China, according to the U.S.Conference Board. U.S. productivityexpanded by an average 2 percent ayear from 2000 through 2006, twicethe gain in most of Europe. In onestudy of 16 major industrialeconomies, only South Korea, Swe-den, and Taiwan had higher produc-tivity growth than the United Statesover the same years. These increasesin productivity have helped the Unit-ed States maintain relatively lowunemployment and inflation.

The World Economic Forum,whose annual conferences are a gath-ering of top international governmentand corporate leaders, has regularlyranked the United States as theworld’s most competitive economy.Major U.S. companies have stayedatop international markets through adetermined focus on innovation, costreduction, and the return of profitsto shareholders. Of the 2007 Fortunemagazine list of the 500 largest cor-porations worldwide, 162 were head-quartered in the United States.Japan was second with 67, andFrance third with 38.

American technology leadershipcontinues to expand from currentfoundations in computers, software,multimedia, advanced materials,health science, and biotechnology intothe frontiers of nanotechnology andgenetics. Although the euro is gainingsupport as a currency of choice, theAmerican dollar remains the center-piece of international commerce.

When Barack Obama took officeas president in January 2009, theimmediate crisis dominated hisagenda, and beyond that lay grave,longer-range challenges. Recordfederal budget deficits stemmingfrom the government lending in thecrisis could challenge the stability ofthe U.S. dollar. The federal govern-ment’s rising retirement and healthcare commitments to an aging popula-tion will test the government’s abilityto pay for itself. American business-es, shareholders, and consumerscould face heavy costs in adaptingprocesses and products to conservenatural resources and meet the chal-lenges of climate change. Disparitiesin educational attainment couldincrease. Foreign competition andtechnological change could displacemore U.S. jobs.

Harvard University economistBenjamin Friedman and otherswarn that America’s continued polit-ical support for a free flow of tradeand finance and its openness to theworld hinge critically on a continuedprosperity for the large majority ofits citizens.

President Obama acknowledgedthe severity of the challenge in aspeech shortly before his inaugura-tion. But he also reminded thenation of its heritage and of itsinherent strengths. “We shouldnever forget that our workers are stillmore productive than any on Earth.Our universities are still the envy ofthe world. We are still home to themost brilliant minds, the most cre-ative entrepreneurs, and the mostadvanced technology and innovationthat history has ever known. And weare still the nation that has overcomegreat fears and improbable odds.”

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a consumer-led society long onmaterialism but short on saving forthe future; a nation of abundant nat-ural resources that has at timesabused this bounty; a political systemgrounded in civic equality but relianton income inequality to motivate cit-izens to work hard and invest inlearning; a nation with astonishingwealth at the top and more relativepoverty than in many of the world’srich countries.

But the large majority of Ameri-cans subscribes to the idea of a dynam-ic economy that embraces competition,invites striving and invention, heapsrewards on winners, and gives secondchances to those who fail. With all itscontradictions, the United States hasachieved a highly flexible economicsystem that arguably offers morechoices and opportunities than anyother, and one that has displayedrepeatedly its capacity to repair mis-takes and adapt to recessions, wars,and financial panics, gaining strengthfrom its trials. The United States “con-tinues to surprise,” Secretary Rice said,following Obama’s election. “It contin-ues to renew itself.”

The U.S. Economy TodayEven in crisis, the America’s econ-

omy remains the world’s largest andmost diverse. The total output of U.S.goods and services—the gross do-mestic product—stood at $14 trillionin 2007, nearly three times the size ofJapan’s economy and five timesChina’s, based on the purchasingpower of each country’s currency.With just 5 percent of the world’spopulation, the United States isresponsible for 20 percent of totaleconomic output.

The U.S. gross domestic productper person was nearly $45,000 in2007, compared to a worldwide aver-age of $11,000. The economy pouredout $40 billion a day in goods and ser-vices that year, drawing its fuel fromthe know-how of the 150 millionAmericans who make up the work-force. Capital provided more fuel: the$5.5 billion in nongovernmental fundsthat Americans invested daily in theirbusinesses and homes. And there arethe nation’s resources of minerals,energy, water, forests, and farmland.

The productivity of Americanworking men and women remains a

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The Evolution of the U.S.EconomyThe economy has

expanded and changed,guided by some

unchanging principles.

C H A P T E R

Courtesy of Library of Congress

“Those who labor in the earth are the chosen

people of God, if ever he had a chosen people.”THOMAS JEFFERSON

1787

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By the time that General George Washington tookoffice as the first U.S. president in 1789, the young nation’seconomy was already a composite of many diverse occupationsand defined regional differences.

Agriculture was dominant. Nine of 10 Americans worked on farms, mostof them growing the food their families relied on. Only one person in 20lived in an “urban” location, which then meant merely 2,500 inhabitants ormore. The country’s largest city, New York, had a population of just 22,000people, while London’s population exceeded one million. But the handful oflarger cities had a merchant class of tradesmen, shopkeepers, importers,shippers, manufacturers, and bankers whose interests could conflict withthose of the farmers.

Thomas Jefferson, a Virginia planter and principal author of America’sDeclaration of Independence, spoke for an influential group of the country’sFounding Fathers, including many from the South. They believed the coun-try should be primarily an agrarian society, with farming at its core and withgovernment playing a minimal role. Jefferson mistrusted urban classes, see-ing the great cities of Europe as breeders of political corruption. “Those wholabor in the earth are the chosen people of God, if ever he had a chosen peo-ple,” Jefferson once declared.

Opposing Jefferson and other supporters of a farm-based republic was asecond powerful political movement, the Federalists, often favored by north-ern commercial interests. Among its leaders was Alexander Hamilton, one ofWashington’s principal military aides in the American Revolutionary War(1775-1783), in which the American colonies had won recognition of theirsovereignty from Britain. Hamilton, a New Yorker who was the nation’s firstsecretary of the Treasury, believed that the young, vulnerable Americanrepublic required strong central leadership and federal policies that wouldsupport the spread of manufacturing.

In 1801, Jefferson became the third U.S. president and headed the Demo-cratic-Republican political party, later to be called the Democratic Party. In1828, war hero Andrew Jackson from Tennessee won election as the candi-

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Courtesy of Library of C

ongress

Above: Harper’s Weekly published scenes of U.S. farm life in the 1860s, years whenAmerica was poised to become a world manufacturing power. Previous spread: Salem,Massachusetts, in New England, was one of the most important seaports in the Americancolonies at the time of the Revolutionary War.

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date of Jefferson’s wing, becomingthe first U.S. president from a fron-tier region. His combative advocacyfor “ordinary” Americans became amain theme of the Democrats. Hedeclared in 1832 that when Congressacts to “make the rich richer and thepotent more powerful, the humblemembers of society—the farmers,mechanics, and laborers” who lackwealth and influence—have the rightto protest such treatment.

Hamilton argued that America’sunbounded economic opportunitiescould not be achieved without a sys-tem that created capital and rewardedinvestment. Hamilton’s Federalistsevolved into the Whig Party and thenthe Republican Party. This majorbranch of American politics general-ly favored policies to spur the growthof U.S. industry: internal infrastruc-ture improvements, protective tariffson the import of goods, centralizedbanking, and a strong currency.

A Balancing of Interests

The U.S. Constitution, ratified in1788, sought to ground the newnation’s experiment in democracy inhard-won compromises of conflict-ing economic and regional interests.

“The framers of the Constitutionwanted a republican government thatwould represent the people, but rep-resent them in a way that protectedagainst mob rule and maximizedopportunities for careful deliberationin the best interests of the country as awhole,” says professor Anne-MarieSlaughter of Princeton University.“They insisted on a pluralist party sys-tem, a bill of rights limiting the powerof the government, guarantees forfree speech and a free press, checksand balances to promote transparentand accountable government, and a

strong rule of law enforced by anindependent judiciary.”

The lawmaking power was dividedbetween two legislative houses. TheSenate, whose membership was fixedat two senators from each state (anduntil 1914, who were chosen by thestate legislatures rather than by directelection), was assumed to reflect business and landholder interests.The Founders created the House ofRepresentatives, with membershipapportioned among the states bypopulation and elected directly by thepeople, to adhere more closely to theviews of the broader public.

Another essential constitutionalfeature was the separation of powersinto three governmental branches:legislative, executive, and judicial.James Madison, a primary author ofthe Constitution and, beginning in1809, the nation’s fourth president,said that “the spirit of liberty…demands checks” on government’spower. “If men were angels, no gov-ernment would be necessary,” hewrote, in defense of the separationprinciple. But Madison also believedthat the separations could not beabsolute and that each branch oughtproperly to possess some influenceover the others.

The president thus appointssenior government leaders, chieffederal prosecutors, and the top gen-erals and admirals who direct thearmed forces. But the Senate may ac-cept or reject these candidates. Con-gress may pass bills, but a president’sveto can prevent their becoming lawunless two-thirds of each congres-sional house votes to override theveto. The Supreme Court successful-ly claimed the right to strike down a law as unconstitutional, but thepresident retains the ability to nomi-

nate new Supreme Court justices.The Senate possesses an effectiveveto over those choices, and theConstitution assigns to Congress thepower to fix the size of the SupremeCourt and to restrict the court’sappellate jurisdiction.

The Constitution outlined thegovernment’s role in the new repub-lic’s economy. At Hamilton’s insis-tence, the federal government wasgranted the sole power to issuemoney; states could not do so.Hamilton saw this as the key to cre-ating and maintaining a strongnational currency and a creditworthynation that could borrow to expandand grow.

There would be no internal taxeson goods moving between the states.The federal government could regu-late interstate commerce and wouldhave sole power to impose importtaxes on foreign goods entering thecountry. The federal governmentwas also empowered to grant patentsand copyrights to protect the work ofinventors and writers.

The initial U.S. protective tariffwas enacted by the first Congress in1789 to raise money for the federalgovernment and to provide protec-tion for U.S. manufacturers of glass,pottery, and other products by effec-tively raising the price of competinggoods from overseas. Tariffs immedi-ately became one of the youngnation’s most divisive regional issues.

Hamilton championed the tariffas a necessary defensive barrieragainst stronger European manufac-turers. Hamilton also promoted adecisive federal hand in the nation’sfinances, successfully advocating thecontroversial federal assumption andfull payment of the states’ Revolu-tionary War debts, much of which

had been acquired at low prices byspeculators during the war. Thesemeasures were popular among Amer-ican manufacturers and financiers inNew York, Boston, and Philadelphia,whose bonds paid for the country’sindustrial expansion.

But the protective tariff infuriatedthe predominantly agricultural South.It raised the price of manufacturedgoods that southerners purchasedfrom Europe, and it encouragedEuropean nations to retaliate byreducing purchases of the South’sagricultural exports. As historianRoger L. Ransom observes, westernstates came down in the middle,objecting to high tariffs that raisedthe prices of manufactured goods butenjoying the federal tariff revenuesthat funded the new roads, railroads,canals, and other public works pro-jects that their communities needed.The high 1828 barriers, dubbed the“Tariff of Abominations” by southernopponents, escalated regional angerand contributed to sectional tensionsthat would culminate in the U.S. CivilWar decades later.

By 1800, the huge tracts of landgranted by British kings to colonialgovernors had been dispersed. Whilemany large landholdings remained,particularly the plantations of theSouth, by 1796 the federal govern-ment had begun direct land sales tosettlers at $2 per acre ($5 per hectare),commencing a policy that would becritical to America’s westward expan-sion throughout the 19th century. Therising tide of settlers pushed the con-tinent’s depleted Native Americaninhabitants steadily westward as well.President Jackson made the displace-ment of Indian tribes governmentpolicy with the Indian Removal Act of1830, the forced relocation of the

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Choctaw tribe to the future state ofOklahoma over what came to becalled “the trail of tears.”

The first regional demarcationsfollowed roughly the settlement pat-terns of various ethnic immigrantgroups. Settlers from England fol-lowed the path of the first Puritans tooccupy New England in the north-eastern part of the country. Pennsyl-vania and other Middle Coloniesattracted Dutch, German, andScotch-Irish immigrants. There wereFrench farmers in some of theSouth’s tidewater settlements whileSpain provided settlers for Califor-nia and the Southwest. But thesharpest line was drawn by theimportation of African slaves, whichbegan in America in 1619.

In the South, slave labor under-pinned a class of wealthy planterswhose crops—first tobacco, then cot-ton, sugar, wool, and hemp—were thenation’s principal exports. Small farmholders were the backbone of manynew settlements and towns and wereelevated by Jefferson and many oth-ers as symbols of an “American char-acter” embodying independence,hard work, and frugality.

Some of the Founding Fathersfeared the direction in which theunschooled majority of Americans, a“rabble in arms” in one author’sfamous description, might take theirnew country. But the image that pre-vailed was that of the farmer-patriot,once captured by the 19th-centuryphilosopher Ralph Waldo Emerson’sdepiction of the “embattled farmers”who had defied British soldiers, fired“the shot heard round the world,” andsparked the American Revolution.

President Jefferson’s purchase ofthe Louisiana territory in 1803 dou-bled the nation’s size and opened a

vast new frontier that called out tosettlers and adventurers.

The South and Slavery

The South’s economy relied onthe labor of slaves, a fundamentalcontradiction of the principle of equal-ity on which America was founded.Congress outlawed the importation ofslaves in 1808 but not slavery itself,and the domestic slave populationkept expanding. American politics inthe half-century preceding the CivilWar (1861-1865) were increasinglydominated by the South’s tenaciousdefense of its “peculiar institution”and growing northern demands forslavery’s abolition. In 1860, in the 11southern states that would secedefrom the Union, create their ownConfederacy, and launch the CivilWar, four out of 10 people were slaves,and they provided more than half ofall agricultural labor.

One crop stood out above all oth-ers in the region. “Cotton is king,”declared James Henry Hammond, aSouth Carolina senator and defend-er of slavery, in 1858. Cotton was thenation’s most important export, vitalto the economies of North andSouth. The low cost of slave-pro-duced cotton benefited U.S. andBritish textile manufacturers andprovided cheaper clothing for theurban centers. Southerners boughtthe output of northern manufactur-ers and western farmers.

The Civil War’s devastating eco-nomic impact widened the dispari-ties between the victorious Northand a defeated South. An earliergeneration of historians argued thatthe war stimulated the great manu-facturing and commercial expansionof the decades that followed. Morerecent research asserts that the U.S.

economy would have expandedgreatly with or without the war. Thevictorious North, in any case, movedto new heights, stumbled during aseries of financial panics, but recov-ered and continued to advance.

The South mostly adopted a sys-tem of tenant farming that effective-ly broke up the plantation system onwhich the region’s economy had pre-viously depended. While the Recon-struction years immediately followingthe Civil War saw real efforts toimprove the lot of former slaves, thepolitical will to see through thesereforms ebbed, especially after 1877.The promised political and economicfreedoms thus were not delivered.Instead the repressive system of “JimCrow” segregation took hold through-out the South. By the end of the 19thcentury, poverty was widespreadamong blacks, as it was among manyrural whites.

The Civil War marked the great-est threat to the Union’s survival, butit was also an opportunity for the war-time Congress—in the absence of rep-resentatives from the rebellioussouthern states—to expand the powerof the national government. Thefirst system of national taxation waspassed; a national paper currencywas issued; public land-grant univer-sities were funded; and constructionof the first transcontinental railroadwas begun.

A Spirit of Invention

Across the country, a flow ofinventions sparked dramatic increas-es in farm output. Jefferson himselfhad experimented with new designsfor plow blades that would cut theearth more efficiently, and the driveto improve farming equipment neverslackened. In Jefferson’s time, it took

a farmer walking behind his plowand wielding his sickle as many as300 hours to produce 100 bushels ofwheat. By the eve of the Civil War,well-off farmers could purchase JohnDeere’s steel plows and CyrusMcCormick’s reapers, which cut, sep-arated, and collected farmers’ grainmechanically. Advanced windmillswere available, improving irrigation.

In the next 40 years, steam trac-tors, gang plows, hybrid corn,refrigerated freight cars, andbarbed wire fencing to encloserangelands all appeared. In 1890,the time required to produce 100bushels of wheat had dropped tojust 50 hours. In 1930, a farmerwith a tractor-pulled plow, com-bine, and truck could do the job in20 hours. The figure dropped tothree hours in the 1980s.

Eli Whitney’s cotton gin, intro-duced in 1793, revolutionized cottonproduction by mechanizing the sepa-ration of cotton fibers from stickyshort-grain seeds. Cotton demandsoared, but the cotton gin also multi-plied the demand for slave labor.Whitney, a Massachusetts craftsmanand entrepreneur, fought a long, frus-trating battle to secure patent rightsand revenue from southern planterswho had copied his invention, one ofthe earliest legal struggles over theprotection of inventors’ discoveries.

Whitney did succeed on anotherfront, demonstrating how manufactur-ing could be dramatically acceleratedthrough the use of interchangeableparts. Seeking a federal contract tomanufacture muskets, Whitney, asthe story was told, amazed Washing-ton officials in 1801 by pulling partsat random from a box to assemblethe weapon. He illustrated that thework of highly trained craftsmen,

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turning out an entire product oneat a time, could be replaced withstandardized processes involvingsimple steps and precision-madeparts—tasks that journeymen couldhandle. His insights were the foun-dation for the emergence of amachine tool industry and massproduction processes that madeU.S. manufacturing flourish, even-tually producing “a sewing machineand a pocket watch in every home,a harvester on every farm, a type-writer in every office,” journalistHarold Evans notes.

The 19th century delivered otherstartling inventions and advances inmanufacturing and technology,including Samuel Morse’s telegraph,which linked all parts of the UnitedStates and then crossed the Atlantic,and Alexander Graham Bell’s tele-phone, which put people in directcontact across great distances. In1882, Thomas A. Edison and hiseclectic team of inventors introducedthe first standard for generating anddistributing electric energy to homesand businesses, lighting offices alongNew York’s Wall Street financial dis-trict and inaugurating the electric age.

And a transportation revolutionwas launched with the completionof the first transcontinental rail-road, when converging rail linesfrom the East and the West met inUtah in 1869.

“The American economy after theCivil War was driven by the expan-sion of the railroads,” writes historianLouis Menand. During the war, Con-gress made 158 million acres (63 mil-lion hectares) available to companiesbuilding railroads. Railroad construc-tion fed the growth of iron and steelproduction. Following the first con-nection, other lines linked the coun-

try’s Atlantic and Pacific coasts creat-ing a national economy able to tradewith Europe and Asia and greatlyexpanding U.S. economic and inter-national political horizons.

Convulsive Changes

Convulsive changes caused byindustrialization and urbanizationshook the United States at the end ofthe 19th century. Labor movementsbegan and vied for power, withimmigrants helping to adapt Euro-pean protest ideologies into Ameri-can forms.

By the 1880s, manufacturing andcommerce surpassed farm output invalue. New industries and railroadlines proliferated with vital backingfrom European financiers. Major U.S.cities shot up in size, attracting immi-grant families and migration from thefarms. A devastating depression shookthe country in the first half of the1890s, forcing some 16,000 business-es to fail in 1893 alone. The followingyear, as many as 750,000 workers wereon strike, and the unemployment ratereached 20 percent.

Farmers from the South and West,battered by tight credit and fallingcommodity prices, formed a thirdnational political organization, thePopulist Party, whose anger focusedon the nation’s bankers, financiers,and railroad magnates. The Populistplatform demanded easier credit andcurrency policies to help farmers. Inthe 1894 congressional elections, Pop-ulists took 11 percent of all votes cast.

But American politics historicallyhas coalesced around two large par-ties—the Republican and Democraticparties have filled this role since themid-1800s. Smaller groupings servedmostly to inject their issues into eitheror both of the main contenders. This

In the post-Civil War Gilded Age, a generationof immensely wealthy industrialists rose to promi-nence. Hailed as “captains of industry” by admirers

and as “robber barons” by critics, these titans dominatedentire sectors of the American economy. By the end of the19th century, oil had its John D. Rockefeller, finance its J.Pierpont Morgan and Jay Gould, and tobacco its James B.Duke and R. J. Reynolds. Alongside them were many others,some born into wealthy families, and some who personifiedthe self-made man.

None climbed further than Andrew Carnegie. He was theson of a jobless Scottish textile worker who brought his fam-ily to the United States in the mid-1800s in hopes of betteropportunities. From this start, Carnegie became “the richestman in the world,” in the words of Morgan, who along with

his partners would in 1901 purchase what became U.S. Steel. Carnegie’s personal share ofthe proceeds was an astonishing $226 million, the equivalent of $6 billion today, adjusted forinflation, but worth much more than that as a percentage of the entire U.S. economy then.

Carnegie’s life exemplifies how an industrializing America created opportunities forthose smart and fortunate enough to seize them. As a teenager in Pennsylvania, Carnegietaught himself the Morse code and became a skilled telegraph operator. That led to a job asassistant to Thomas A. Scott, a rising executive in the Pennsylvania Railroad, one of thenation’s most important lines. As Scott advanced, becoming one of the most powerful rail-road leaders in the country, his valued protégé Carnegie advanced too, sharing lucrativefinancial investments with Scott before going into business himself to build iron bridges forthe railroad. By the age of 30, Andrew Carnegie was a wealthy man.

After quitting the railroad, Carnegie also prospered in oil development, formed an ironand steel company, and shrewdly concentrated on steel rails and steel construction beamsas railroad, office, and factory construction soared. His manufacturing operations set stan-dards for quality, research, innovation, and efficiency. Carnegie also availed himself ofsecret alliances and advance knowledge of business decisions, practices forbidden by today’ssecurities laws as “insider” transactions but legal in Carnegie’s era.

Andrew Carnegie was a study in contrasts. He fought unionization of his factories. Asother industry leaders did, Carnegie imposed hard, dangerous conditions on his workers. Yethis concern for the less fortunate was real, and he invested his immense wealth for society’sbenefit. He financed nearly 1,700 public libraries, purchased church organs for thousandsof congregations, endowed research institutions, and supported efforts to promote interna-tional peace. When his fortune proved too great to be dispensed in his lifetime, Carnegie leftthe task to the foundations he had created, helping to establish an American tradition ofphilanthropy that continues today.

The Richest Man in the World

Andrew Carnegie. ca. 1886

Above: (Detail) A 1910 panoramic photograph of a Carnegie steel plant in Youngstown, Ohio.

© Getty Images

Courtesy of Library of Congress

1918

would be the fate of the 1890s Pop-ulists. By 1896, the new party hadfused with the Democrats. But signif-icant parts of the Populist agendasubsequently found their way intolaw by way of the trans-party Pro-gressive movement of the 20th cen-tury’s first two decades. Among theinnovations were direct popular elec-tion of senators and a progressivenational income tax.

American Progressivism reflecteda growing sense among many Amer-icans that, in the words of historianCarl Degler, “the community and itsinhabitants no longer controlledtheir own fate.” Progressives relied ontrained experts in the social sciencesand other fields to devise policiesand regulations to reign in perceivedexcesses of powerful trusts and otherbusiness interests. Writing in 1909,Herbert Croly, author of the hugelyinfluential The Promise of Ameri-can Life and first editor of the NewRepublic magazine, expressed theProgressive’s credo in this way: “Thenational government must step inand discriminate, not on behalf ofliberty and the special individual,but on behalf of equality and theaverage man.”

The influence of Progressivethought grew rapidly after the assas-sination of President William McKin-ley in 1901 thrust Vice PresidentTheodore Roosevelt into the WhiteHouse. Adventurer, naturalist, andscion of wealth, “Teddy” Rooseveltbelieved the most powerful corpo-rate titans were strangling competi-tion. Businesses’ worst excesses mustbe restrained lest the public turnagainst the American capitalist sys-tem, Roosevelt and his allies argued.

The New York World newspaper,owned by the influential publisher

Joseph Pulitzer, editorialized that“the United States was probably nevernearer to a social revolution thanwhen Theodore Roosevelt becamepresident.” Roosevelt responded withregulations and federal antitrust law-suits to break up the greatest concen-trations of industrial power. Hisadministration’s antitrust suit againstthe nation’s largest railroad monop-oly, Northern Securities Company,was a direct attack on the nation’sforemost financier, J.P. Morgan. “If wehave done anything wrong,” Morgantold Roosevelt, “send your man to myman and they can fix it up.” Rooseveltresponded, “That can’t be done.” TheSupreme Court’s ultimate decisionagainst Northern Securities was abeachhead in the government’s cam-paign to restrict the largest business-es’ power over the economy.

A Modern Economy Emerges

Electric power surged throughoutthe U.S. economy in the first decadesof the 20th century, steadily replacingsteam and water power in industrialplants. It lighted offices and house-holds, illuminated department storesand movie theaters. It reshapedcities, lifting elevators in new sky-scrapers and powering street cars andsubways that enabled people to workfarther from home. By 1939, electric-ity provided 85 percent of the prima-ry power for U.S. manufacturing. Theability to transfer power easily overthin electric wires spurred totally newmanufacturing processes favoringautomation, the use of specializedparts, and the rise of skilled labor.

But the Great Depression of the1930s brought economic expansionto a devastating halt. Its causes werecomplex. After a decade of increas-ingly reckless stock speculation, the

stock market crash of 1929 wiped outmillions of investors and crippledconfidence among business execu-tives and consumers.

The United States and other eco-nomic powers waged a destructivebattle over trade, raising tariff barriersagainst each other’s imports andpushing their currency values down inan unsuccessful effort to make theirexports more competitive. Prices col-lapsed, impoverishing businesses andfamilies. Drought and poor plantingpractices led to dust storms in the U.S.farming heartland and drove thou-sands of farmers from their homes.The nation’s worst banking crisisshut down 40 percent of the banksdoing business at the Depression’sbeginning. The national unemploy-ment rate exceeded 20 percent.

Some desperate and disillusionedAmericans looked to communism andsocialism as better alternatives, otherseyed the fascist alternative pioneeredin Italy by Benito Mussolini, and manyfeared the United States was ap-proaching a breaking point politically.

The New Deal

The inability of President HerbertHoover (1929–1933) to meet demandsfor economic relief set the stage forthe 1932 election of Democrat Frank-lin D. Roosevelt as president and theenactment the following year of thefirst of his “New Deal” economic pro-grams. The president, known by hisinitials, FDR, was a wealthy patricianfrom New York State with a gift forcommunicating his message to Amer-icans in those hard times. He used thenew medium of radio to do so direct-ly. In his inaugural speech uponassuming the presidency, Rooseveltassured the country, “The only thingwe have to fear is fear itself.”

Roosevelt then launched a tide ofnew laws and programs to halt the par-alyzing banking crisis and create jobs.New agencies such as the Civilian Con-servation Corps, the Works ProgressAdministration, and the Public WorksAdministration put millions of unem-ployed Americans to work on govern-ment projects. The AgriculturalAdjustment Administration worked tosupport farm prices by reducing out-put, fining farmers in some cases forexcess production. Overall, the pro-grams marked “the return of hope,”said long-time Democratic congress-man Emanuel Celler of New York.

FDR was far more an improviserthan an ideologue, historians agree.His budget policies were inconsistent:Spending cuts in the middle of hispresidency probably extended theDepression. Some New Deal mea-sures proved contradictory or hugelycontroversial. The National RecoveryAdministration negotiated a series of industry-wide codes establishingminimum prices, wages, and otherparticulars. Many small businessescomplained that the codes favoredlarger competitors. Others saw in theclose NRA-engendered ties betweengovernment and big business a “cor-poratist” outlook fundamentally atodds with America’s traditionallylooser, more free-wheeling economicarrangements. The Supreme Courtagreed, declaring the law establishingthe NRA unconstitutional, an exerciseof Congress delegating power to thepresident beyond that granted by theConstitution’s commerce clause.

But other New Deal measuresproved long lasting. The federal gov-ernment tightened regulation of bank-ing and securities, and it providedunemployment insurance and retire-ment, disability, and death benefits

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for American workers under a socialsecurity program funded by payrolltaxes on employees and employers.The New Deal established a federalsocial safety net that has helped Amer-icans through hardships, but whosecosts today pose huge future finan-cial challenges for the government.

Before Franklin Roosevelt’s ad-ministration, the federal governmenthad taken a predominantly hands-offattitude toward business, except for itsregulation of banking and the rail-roads, and the campaigns against themonopolistic trusts. FDR took thecountry far in the other direction,injecting the federal government intoeconomic activities previously deemedthe domain of the private sector. Onenotable example was his creation in1933 of the Tennessee Valley Authori-ty, a federally chartered corporationformed to control flooding and gener-ate electric power in an impoverishedregion of the South.

Roosevelt and his supporters sawthe government-run TVA as a way to set a benchmark for fair pricing ofelectricity that would show whethercustomers were being overcharged byelectric power companies. The TVAstood for the New Deal’s confidencein government’s ability to define andsolve society’s problems. David Lilien-thal, whom Roosevelt appointed as aTVA director and later its chairman,once said, “There is almost nothing,however fantastic, that a team of engi-neers, scientists, and administratorscannot do.”

To its opponents, the TVA wassocialism, violating the basic principlesof free enterprise. Roosevelt’s Republi-can predecessor, Herbert Hoover,had opposed earlier proposals forgovernment power projects and eco-nomic development programs in the

Tennessee Valley, saying it would“break down the initiative and enter-prise of the American people.… It isthe negation of the ideals upon whichour civilization has been based.”

Americans differed as well overmore practical questions: How couldany private power company competewith the virtually unlimited resourcesof the federal government? And oncea federal agency determined to act,what would be the check on itsauthority? The same hand of govern-ment that built dams to producepower and limit floods also uprootedthousands of people from their farms.Although the TVA complex of damswas built and the TVA remains thelargest U.S. public power producer,Roosevelt’s efforts to adopt the TVAmodel in other parts of the countrywere shelved by growing politicalopposition and by World War II.

American industry and officesmobilized to fight Germany, Japan,and the other World War II Axis powers. The last U.S.-made automo-bile of the war years left its factory inFebruary 1942. In its place, industryproduced 30,000 tanks in 1943 alone,nearly three per hour around theclock, more than Germany could buildin the entire war. A piano manufactur-er produced compasses, a tablewarecompany turned out automatic rifles,and a typewriter company deliveredmachine guns, author Rick Atkinsonnotes. The weight of U.S. industrialmight was irresistible. American facto-ries supplied armed forces in both theEuropean and Pacific theaters, withmore to spare for the British, the Sovi-ets, and other Allied armies.

At the war’s end, much of Europeand Asia were in ruins, and Americastood alone as the world’s economicsuperpower.

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Above: The Social Security retirement pension system was part of President Franklin Roosevelt’sNew Deal.

Courtesy of Library of Congress

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Organized Labor: Prosperity and Conflict

The end of wartime economiccontrols unlocked pent-up demandsby American workers for betterwages, leading to a series of majorlabor strikes that polarized Americanattitudes toward unions, as in the1890s. In 1935, the Democratic-con-trolled Congress had enacted theNational Labor Relations Act of1935 establishing the right of mostprivate-sector workers to formunions, to bargain with managementover wages and working conditions,and to strike to obtain theirdemands. A federal agency, theNational Labor Relations Board, wasestablished to oversee union elec-tions and address unfair labor com-plaints. The Fair Labor StandardsAct of 1938 established a nationalminimum wage, forbade “oppres-sive” child labor, and provided forovertime pay in designated occupa-tions. It declared the goal of assuring“a minimum standard of living nec-essary for the health, efficiency, andgeneral well-being of workers.” But italso allowed employers to replacestriking workers.

After World War II, a Republi-can-controlled Congress passed theTaft-Hartley Act of 1947, whichreduced union power in organizingdisputes, strengthened the rights ofemployees who didn’t want to join aunion, and allowed the president toorder striking workers back on thejob for an 80-day “cooling-off ”period if he determined a strikecould endanger national health orsafety. United Mine Workers presi-dent John L. Lewis called it a “slavelabor” law. President Harry S. Tru-man vetoed it, but was overriddenby the required two-thirds congres-sional majorities.

Together, the Fair Labor Stan-dards Act and the Taft-Hartley Actestablished the broad legal parame-ters within which organized laborcontended with business leadershipand union opponents for economicand political influence. In 1950,when American automobile compa-nies enjoyed substantial global marketshare, General Motors Corporationand the United Auto Workers unionnegotiated a contract affordingworkers extensive health care andretirement benefits. From theemployer’s perspective, generouspay and benefits ensured freedomfrom strikes and motivated theemployees. The costs of these bene-fits, the companies reasoned, couldbe passed on to consumers. With therise of competition from Japanese,European, and other foreign auto-makers, American industry becameless willing or able to pass throughsuch labor costs.

These issues played out in thepolitical realm as well. As a general-ization, labor unions mostly support-ed Democratic candidates withmoney and manpower, while busi-nesses backed Republicans. Eachside hoped that electoral victorieswould secure more favorable treat-ment. But global economic develop-ments intervened. With the recoveryof industry in other nations, U.S.industrial unions generally declinedin membership. At the end of WorldWar II, one-third of the workforcebelonged to unions. In 1983, it was20 percent. By 2007, the figure haddropped to 12 percent, with unionmembership totaling 15.7 million.

Union growth today is mostly inarenas less susceptible to foreigncompetition: the services sector, par-ticularly among public services

employees such as teachers, policeofficers, and firefighters. In 2007,just over one-third of public-servicesworkers belonged to unions, only 7.5percent of private-sector workerswere in unions, and union member-ship among workers under 24 yearsof age was less than 5 percent.

One symbol of organized labor’srelative decline came in 1981, whenPresident Ronald Reagan fired strik-ing air traffic controllers. Public em-ployees such as the controllers typi-cally enjoyed great job security but,in turn, were prohibited from strik-ing “against the public.” This is notto say that public employees neverstruck: Sometimes they did, and usu-ally the illegality of the strike was for-given as part of the settlement. Notthis time. Reagan ordered the con-trollers back to work, citing the fed-eral law against government employ-ee strikes. He then fired more than11,000 controllers who refused toreturn, replaced them with newworkers, and broke the union.

Even as unions gained, then lost,influence, other major currentshelped shape the postwar Americanworkforce. The civil rights move-ment began in the mid-1950s withdemands to end state and local lawsin the South that segregated schools,public facilities, and public trans-portation, separating blacks andwhites, as well as restrictions onAfrican-Americans’ voting rights.After a strife-filled decade, the non-violent campaign for racial justiceled by the late Dr. Martin LutherKing Jr. led to passage of federal lawsto combat racial discrimination andpoverty. A wide-ranging series oflaws that Democratic President Lyn-don Johnson called his Great Societyprogram followed. Education and

employment opportunities forminorities expanded. While Ameri-cans have debated the fairness of“affirmative action” preferences forminorities in hiring and collegeadmissions, the 1960s’ laws openedincreasing workplace opportunitiesfor minorities.

The 1960s civil rights movementalso led to laws forbidding discrimi-nation in employment againstwomen, emerging from a far-reach-ing movement by women to gainequal status with men in the econo-my and society. Only one-third ofadult women had jobs in 1950, butby the end of the century three ofevery five women were in the work-force. Female chief executive officershave led such major corporations astechnology giant Hewlett-Packardand the Ogilvy & Mather advertisingfirm. Other women have builtcareers in virtually every arena, fromacademia, politics, and medicine tomanufacturing, the constructiontrades, and the military. A wage gapbetween men and women is shrink-ing, but still remains. In 2000 womenworking full time earned 77 cents forevery dollar paid to men throughoutthe workforce, while 20 years earlierwomen earned just two-thirds ofwhat men received.

Another major impact was thearrival of the “baby-boom” genera-tion in the workforce. Between theend of World War II and 1964, 76million Americans were born, anunprecedented surge that mayhave reflected the nation’s postwaroptimism. This population bulge,in the midst of a long upward eco-nomic trend, triggered a sustainedboom in housing construction andthe expansion of a consumer-focused economy.

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The Political Pendulum Swings

The 1960s Great Society legisla-tion, comprising 84 different newlaws, was the crest of a wave of politi-cal action begun by Franklin Roo-sevelt to use government’s power toset economic and social agendas. Vot-ing rights for minorities, employmentopportunity, public education, thesafety of consumers and motorists,environmental protection, and healthinsurance for the elderly and poor allwere addressed by the new laws.

The adoption of Lyndon John-son’s agenda was based on his land-slide victory in the 1964 presidentialelection and the decisive majoritieshis Democratic Party achieved inCongress that year. But Johnson’spolicies energized opposition fromconservatives who felt the govern-ment had intruded too far in thelives of private citizens and had puttoo great a burden on employers,threatening the vitality of the econo-my. The civil rights measures John-son championed embittered manysouthern whites, whose allegianceshifted to the Republican Party.

The 1970s was a trying decade forthe U.S. economy. In the middle ofhis first term in office, PresidentRichard M. Nixon was confrontedwith rapidly rising prices, triggeredin part by the costs of the VietnamWar waged during his and Johnson’sadministrations. Nixon broke withhis Republican Party’s traditionalsupport for balanced budgets toaccelerate federal spending to stimu-late economic growth, even thoughthat swelled federal budget deficits.

Nixon similarly embraced wageand price controls in an effort to haltan inflationary cycle in which risingwages led corporations to increaseprices, and higher prices then led to

new demands for higher pay byworkers. “Now, I am a Keynesian,”Nixon said in 1971, putting himselfin the camp of British economistJohn Maynard Keynes, who hadadvocated deficit spending duringtimes of slow economic growth.

Nixon’s wage-and-price controlprogram failed. To cite just oneexample, the price of cotton was notcontrolled because of the politicalinfluence of cotton farmers. But theprice of plain cotton fabric was regu-lated, and when fabric manufactur-ers’ profits were squeezed, they cutback on production, causing short-ages, according to former FederalReserve Chairman Alan Greenspan.

The lesson from Nixon’s experi-ment was a lasting one: The U.S.economy was far too complex, chaot-ic, and fast moving to be managed inany detail by government officials. Anew consensus formed that controlscould not overcome inflationaryforces, but instead stifled innovation,risk taking, and competition.

Two oil price shocks that followedthe Arab-Israeli War of 1973 and theIslamic Revolution in Iran in 1979battered U.S. economic perfor-mance. Oil prices tripled. Long linesformed at gasoline stations. At theend of the decade, inflation was high-er than at any time since World WarI, and unemployment had jumped tomore than 9 percent. The impact hithardest during the administration ofPresident Jimmy Carter, a Democratelected in 1976. The U.S. economywas gripped in a “malaise,” asCarter’s advisers put it, and nothinggovernment did seemed an answer tohigh unemployment, high prices,and stagnant stock markets.

During economic travails, Ameri-can voters have often punished the

party in power, and 1980 was a casein point. Polls that year showed two-thirds of the public believed thecountry was faring badly. Many Amer-icans sought a change in direction,and they found it in the candidacy ofCalifornia’s former Republican gov-ernor, Ronald Reagan. At the cam-paign’s only televised presidentialdebate, Reagan asked the viewerssimply, “Are you better off than youwere four years ago?” Analysts calledit Reagan’s knock-out punch.

Reagan’s election to the presidencymarked another directional change ingovernment’s role in the economy.Reagan declared in his 1981 inaugur-al address that “in this present crisis,government is not the solution to ourproblem; government is the problem.”He added, “It is time to check andreverse the growth of government.”

“Reaganomics” sought to cut U.S.tax rates, even if one result was grow-ing federal budgetary deficits. Criticsprotested that this was an indirectway of forcing cuts in domestic socialspending and to programs of whichthe new administration disapproved.

Reagan and his advisers arguedthat lower marginal tax rates wouldrevive the economy. It was better, theybelieved, to leave more money in thehands of business and consumers,whose savings, spending, and invest-ment choices collectively would gener-ate more economic growth than wouldgovernment spending. This theory,called supply-side economics, heldthat the resulting economic growthalso would generate more revenuethan would be lost through the lowertax rates, and that the federal budgetcould be balanced in this manner.

The Reagan tax cuts did help liftthe U.S. economy, but contrary tothe supply-siders’ predictions, fed-

eral budget deficits persisted andgrew. Nevertheless, the “Reaganrevolution” was a political turningpoint toward smaller governmentand individualism, and Reagan leftoffice as one of the most popularU.S. presidents.

Deregulating Business

The 1980s tax cuts were only onepart of a broad movement to reducegovernment’s economic role. Anoth-er was deregulation.

During the 1970s, a number ofthinkers attributed some of thenation’s economic sluggishness tothe web of laws and regulations thatbusinesses were obliged to observe.These regulations had been put inplace for sound reasons: to preventabuse of the free market and, moregenerally, to achieve greater socialequity and improve the nation’soverall quality of life. But, criticsargued, regulation came at a price,one measured by fewer competitorsin a given industry, by higher prices,and by lower economic growth.

During the economically trying1970s and early 1980s, many Ameri-cans grew less willing to pay thatprice. President Gerald R. Ford, aRepublican who succeeded RichardM. Nixon in 1974, believed thatderegulating trucking, airlines, andrailroads would promote competi-tion and restrain inflation moreeffectively than government over-sight and regulation. Ford’s Democ-ratic successor, Jimmy Carter, reliedheavily on a key pro-deregulationadviser, Alfred E. Kahn. Between1978 and 1980, Carter signed intolaw important legislation achievingsubstantial deregulation of the trans-portation industries. The trendaccelerated under President Reagan.

opment of renewable electricity gen-eration and an expanded powertransmission grid. Instead, state gov-ernments have been the principalpolicy innovators.

Technology’s Upheaval

Technology is changing the fun-damentals of economic competition,and often faster than government,political leaders, and the public cankeep pace. The computer age grewout of a confluence of discoveries onmany fronts, including the first com-puter microprocessor, created in1971. This breakthrough combinedkey functions of computer process-ing that had been separate opera-tions—the movement of data andinstructions in and out, the process-ing of data, and the electronic stor-age of results—onto a single siliconchip no bigger than a thumbnail. Itwas the product of scientists at IntelCorporation, a three-year-old start-up technology company that hadattracted the support of wealthy ven-ture capitalists willing to bet largeinvestments on new, unproven entre-preneurs. The raw material for semi-conductors gave the name SiliconValley to the California region southof San Francisco that became thecenter of U.S. computer innovation.

Before the invention of the siliconcomputer chip, computers were mas-sive devices serving governmentagencies and large businesses, andoperated by specialists. But in 1976,two secondary school dropouts, SteveJobs and Steve Wozniak, developed asmall computer complete with micro-processor, keyboard, and screen.They called it the Apple I, and itbegan the age of personal computingand the dispersal of computer powerto every sector of the economy.

The personal computer rapidlybecame an indispensable communi-cations, entertainment, and knowl-edge tool for homes and offices. IBM,the computer giant that had domi-nated mainframe computers since the1950s, produced a personal comput-er in the 1980s that quickly overtookApple’s lead. But IBM, in turn, wasdriven from PC manufacturing bycompetitors in the United States andAsia who outsourced component fab-rication to lowest-cost manufacturersand minimized production costs of anincreasingly low-margin item.

The biggest winner in this compe-tition was Microsoft, a Redmond,Washington-based start-up groundedin software, not manufacturing. Itsfounder, Bill Gates, had seized on theimportance of dominating the inter-nal operating software that made thepersonal computer work. As rivalcomputer manufacturers rushed tocopy the IBM model, Microsoft’s soft-ware became the standard for thesemachines, and they steadily andrelentlessly gained market share atthe expense of other operating sys-tem vendors. Gates’s company woundup collecting half of every dollar ofsales by the PC industry.

Gates moved into a realm of wealthcomparable to that of John D. Rocke-feller and Andrew Carnegie, two titansof an earlier age of dynamic eco-nomic growth. Like his two predeces-sors’ companies, Gates’s Microsoftwas attacked by competitors and gov-ernments for its dominance. AndGates, like Rockefeller and Carnegie,became one of history’s most generousphilanthropists, committing billionsof dollars to long-term campaigns tofight illnesses in Africa, improveeducation in America, and supportother humanitarian causes.

The intellectual and politicaltrends favoring deregulation werenot limited to the United States.Movements to empower private busi-nesses and reduce government’sinfluence gained momentum inGreat Britain, Eastern Europe, andparts of South America. In the Unit-ed States, courts and legislators con-tinued to carve away governmentregulations in important industries,including telecommunications andelectric power generation.

The most dramatic step was the1984 breakup of the American Tele-phone and Telegraph Company, thenationwide telephone monopoly.Prior to the government’s action,AT&T dominated all phone service,both local and long-distance, and itargued that admitting new serviceproviders would threaten networkreliability. AT&T obliged Americansto rent their telephones from itsWestern Electric subsidiary, a monop-oly that stifled the development ofinnovative types and styles of phones.A far smaller rival, MCI Communica-tions, contended that technologyadvances would enable competitionto flourish, benefiting consumers.

The federal government took upMCI’s cause, filing an antitrust suitasking a federal judge to end AT&T’smonopoly. AT&T capitulated, agree-ing to split off its local telephone ser-vice into seven new regional phonecompanies. This began an era ofintense competition and innovationaround the convergence of phones,computers, the Internet, and wirelesscommunications. (AT&T maintainedits long-distance network, but in 2005the company was purchased by one ofits former local phone subsidiaries.)While many American consumersfound the changes in phone service

confusing, they eagerly snapped up aspeedy parade of new communica-tions products.

The loosening of regulations onelectric power service in the 1990shas been far more controversial, andits benefits disputed. For a centuryfollowing Thomas Edison’s time,most Americans purchased electricityfrom companies that operated legalmonopolies in their regions. Statecommissions regulated these utili-ties’ local rates, while federal regula-tors oversaw wholesale sales acrossstate lines. Prices were generallybased on the costs of making elec-tricity, plus a “reasonable” profit forthe utility.

About half of the U.S. states choseto open electric service to competi-tion in the hope that new productsand lower prices would result. Butthese moves coincided with sharpincreases in energy prices beginningin 2000. A political backlash againstelectricity deregulation ensued, wors-ened by a scandal surrounding thefailure of Enron Corporation, aTexas-based energy company thathad been a key promoter of competi-tive electricity markets.

The deregulation movementstopped in midstream after 2000,leaving an electricity industry partiallyregulated and partially deregulated,and divided by divergent regionalagendas. Some areas of the countryrely on coal to generate electricpower. Elsewhere, natural gas tur-bines, hydro-dams, or nuclear plantsare important sources of electricity,and in the 2000s, wind-generatedpower began to grow. These differ-ing regional interests slowed move-ment toward a national response toclimate change issues, includingsuch possible measures as the devel-

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willing to bet on any plausible “e-commerce” strategy, however chancy.

Federal Reserve Board ChairmanAlan Greenspan warned of “irra-tional exuberance,” but that did notdeflate the dot-com stock marketbubble. In March 2000, the NAS-DAQ Composite Index, a measure ofthe U.S. stock market specializing intechnology stock listings, had soaredto over 5,000—twice its level the yearbefore. Typical of the new breed ofcompanies was one called Pets.com,which offered cheap prices to cus-tomers ordering pet food online inthe hope that growing numbers ofconsumer visits to its Web site wouldattract paying advertisers.

Opportunism and Credulity

The dot-com boom was a charac-teristically opportunistic expressionof American economic optimism andcredulity. Americans’ fascination withpotential stock market windfalls wasnot a new phenomenon. America’sFounding Fathers had relied on lot-teries to raise money for the Conti-nental Army, and today Americanswager more than $50 billion annuallyin state-run lotteries whose proceedshelp fund education and other pro-grams. Investment manias sproutedin every generation, from colonial-eraland speculation, to railroads in the19th century, to biotech and comput-ers in the late 20th century.

In March 2000, the dot-com bub-ble burst. The immediate cause isdebated, although rising interestrates and a downturn in technologyinvestments by major companieshurt the investing climate. Investorconfidence was battered by investiga-tions showing that some prominentWall Street securities experts hadmisled the investing public about the

prospects for some of the Internetstocks. The NASDAQ Index fellclose to 1,000 in 2002, wiping out $5trillion in investors’ “paper” profits.The value of Pets.com fell from $11per share in February 2000 to $0.19the day it closed its doors at the endof that year.

The fallout claimed two of thehighest-flying companies of thetime. One was WorldCom, which hadused an aggressive acquisitions strat-egy funded by stock issues to claim aleading position in telecommunica-tions, taking over competitors suchas MCI. The other was Enron, origi-nally a provider of natural gas andelectricity, but later an online traderof energy services and commodities.Government investigations led toindictments and convictions of topexecutives of both companies fordefrauding investors through therelease of false financial information.

The dot-com bust was followed byanother massive flood of speculativeinvestment into U.S. real estate andthe home mortgage market. Two-thirds of American families own theirhomes, which are by far their mostimportant investment, absorbingone-third of their spending and sup-plying an average $75,000 in home-owner equity, a significant retirementcushion. Home ownership was a cru-cial part of the American dream,promoted by government leadersacross the political spectrum.

Lower interest rates early in the2000s decade encouraged a surge inlending by banks and nonbankmortgage companies and in borrow-ing by home buyers. The U.S. gov-ernment urged banks to make moremortgages available to lower-incomefamilies, increasing financial risksfor both borrowers and lenders.

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Rivaling the impact of the per-sonal computer was another epochalbreakthrough. The Internet, includ-ing the searchable World Wide Web,accelerated a global sharing of infor-mation of every form, from lifesavingtechnologies to terrorists’ plots, fromdating services to the most advancedfinancial transactions.

Like much American innovation,the Internet had roots in U.S. gov-ernment science policy. The idea of aself-standing highly redundant net-work to link computers was con-ceived as a way to defend governmentand research computers against afeared nuclear attack on the UnitedStates. But despite its ties to govern-ment, the Internet achieved its glob-al reach thanks to pioneering scien-tists such as Sir Tim Berners-Lee andVinton Cerf, who insisted that itmust be an open medium that allcould share.

The New Economy

The personal computer and theInternet were building blocks for thenew economy that took form in the1990s. Technology’s potential to cre-ate global markets, to make produc-tion and distribution more efficient,and to expand financial flows attract-ed hoards of innovators. At first,business’s introduction of computertechnology did not measurablyincrease American economic produc-tivity, to the bewilderment of govern-ment policy makers. By the end ofthe 1990s, however, productivity wasincreasing, giving hope that a new,sustained period of economic growthwas at hand for most Americans.

The sense of optimism drew sub-stantially on the astonishing gainsof technology companies on U.S.stock markets—particularly start-up

companies linked to commerceover the Internet. American andforeign investors threw money atuntested Internet companies at theend of the 1990s in search of whatauthor Michael Lewis called “thenew, new thing.”

Entrepreneurs perceiving a nichefor a new software strategy or prod-uct might determine to create abusiness to meet that need. Theymight charge initial costs to theirpersonal credit cards. Friends andfamilies would be asked to help. Andwith the right connections, such as adegree from a leading U.S. universi-ty, the entrepreneurs might get anaudience with some of the small,critically influential group of finan-ciers called venture capitalists. Theseinvestors typically had made greatwealth from earlier successes intechnology markets and were on thelookout for new prospects. If theyliked an entrepreneur’s idea, theywould invest millions of dollars inadvance funding in exchange forpart ownership in the company.

If all continued to go well, thecompany would be launched. If it en-joyed early success—or even if it wasonly well promoted—the entrepre-neur and the financial backers mightbe able to “take the company public,”selling shares of the company to thepublic on the stock market throughan initial public offering (IPO).

Low interest rates helped the start-up companies gather headway. Themost fabulous of the success stories—such as the rise of Microsoft, Apple,America Online (AOL), and, later,eBay, Yahoo, and other “dot-coms”(so named for the “.com” terminolo-gy incorporated in commercial Inter-net addresses)—created a euphoricmood among investors, who seemed

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In 1998, two graduate students at Stanford University in Californiathought they saw how to unlock the Internet’s rapidly expanding universe of informa-tion. A decade later, Google—as they called their invention—had become the domi-

nant Internet search engine in most of the world. Its revenue topped $20 billion in 2008,half from outside the United States, and its employees numbered 20,000. Its computerscould store, index, and search more than one trillion other Web site pages. So ubiquitoushad this search engine grown that its very name had become a verb: When most people wantto find something on the Internet, they “google” it.

Although this astonishing success has rarely been matched, its ingredients are a famil-iar part of the U.S. economic story. Google illustrates how ideas, entrepreneurial ambition,university research, and private capital together can create breakthrough innovations.

Google’s founders, Sergey Brin and Larry Page, started with particular advantages.Brin, born in Moscow, and Page, a midwesterner, are sons of university professors and com-puter professionals. “Both had grown up in families where intellectual combat was part ofthe daily diet,” says David Vise, author of The Google Story. They met by chance in 1995at an orientation for new doctoral students at Stanford University’s graduate school, and bythe next year they were working together at a new Stanford computer science center builtwith a $6 million donation from Microsoft founder Bill Gates.

As with other Internet users, Brin and Page were frustrated by the inability of the exist-ing search programs to provide a useful sorting of the thousands of sites that were identi-fied by Web queries. What if the search results could be ranked, they asked themselves, sothat pages that seemed objectively most important were listed first, followed by the nextmost important, and so forth? Page’s solution began with the principle that sites on the Webthat got the most traffic should stand at the top in search reports. He also developed waysof assessing which sites were most intrinsically important.

At this point, Stanford stepped in with critical help. The university encourages its PhDstudents to use its resources to develop commercial products. Its Office of TechnologyLicensing paid for Google’s patent. The first funds to purchase the computers used forGoogle’s searches came from a Stanford digital library project. Their first users were Stan-ford students and faculty.

The linkages between university research and successful business innovation have notalways thrived in regions where technology industries are not well rooted. But Stanford, inPalo Alto, California, stands at the center of Silicon Valley, a matrix of technology compa-nies, investment funds, and individuals with vast personal fortunes that evolved during thedecades of the computer industry’s evolution.

In 1998, Brin and Page met Andy Bechtolsheim, a co-founder of Sun Microsystems,an established Silicon Valley leader. Bechtolsheim believed that Brin and Page could suc-ceed. His $100,000 personal check helped the pair build their computer network andboosted their credibility. A year later, Google was handling 500,000 queries a day and win-ning recognition across the Internet community. Google’s clear advantages over its rivalsand the inventors’ commitment attracted $25 million in backing from two of Silicon Val-ley’s biggest venture funds. And the founders got the money without having to give up con-trol of the company.

A decade after its founding, Google’s goals have soared astronomically. As author Ran-dall Stross, author of Planet Google, puts it, the company aims to “organize everything weknow.” Its initiatives include an effort to digitize every published book in the world.

Google has emerged as a metaphor for the openness and creativity of the U.S. econo-my, but also for the far-ranging U.S. power that so worries foreign critics. Human rightsadvocates and journalists blasted Google’s 2006 agreement to self-censor its search enginein China at the direction of Beijing’s government. Google answers that these kinds of restric-tions will fade with the spread of democracy and individual freedoms. If that proves true,this example of American entrepreneurship will have been an agent of that change.

Unlocking the Internet

Above: Google’s agreement to self-censor its search engine in China has raised objections from human rights groups.Opposite: This Google logo commemorates the visit by Britain’s Queen Elizabeth II to Google’s London office.

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stunning reversal of decades of dereg-ulation and reliance on markets.

To some experts, the devastatingturn of events was a familiar one inthe American economic chronicle.“Booms and busts play a prominentrole” throughout U.S. history, thelate Federal Reserve Board memberEdward M. Gramlich had observed.“In the 19th century, the UnitedStates benefited from the canalboom, the railroad boom, the min-erals boom, and a financial boom.The 20th century saw another finan-cial boom, a stock market boom, apostwar boom, and a dot-com boom.

“The details differ, but each ofthese cases feature initial discoveriesof breakthroughs, widespread adop-tion, widespread investment, then acollapse where prices cannot keep upand many investors lost a lot ofmoney,” Gramlich said. “When thedust clears, there is financial car-nage, [but] the canals and railroads

are still there and functional, theminerals are discovered and in use,the financing innovations stay, andwe will have the Internet and all its capabilities.”

The carnage from the 2008 finan-cial crisis has reached staggering pro-portions and has fueled widespreaddemands for closer government regulation of lending and securitiesmarkets and far more accountabledisclosure of investment risk. Euro-pean and Asian leaders have insistedthat oversight of U.S. and otherbanking and financial sectors be aglobal responsibility. It is impossi-ble at this writing to determine howthe United States and other nationswill resolve these issues. But Ameri-can history chronicles an ongoingdebate over regulation. Today’sAmericans and tomorrow’s mustdetermine how best to balancedynamism and order, growth andsafety, innovation and stability.

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Mortgages sold to these families withlower-than-average incomes or shakyfinancial histories were called sub-prime mortgages (contrasted withstandard, or prime, loans to familieswith average or better financial posi-tions). In the quarter century before2007, Americans’ household debtincluding mortgages rose from 45percent of U.S. gross domestic prod-uct to 98 percent.

But the federal government tookno serious actions to regulate thesurge in mortgage lending that fol-lowed. Nor did regulators move torestrain abusive sales tactics bylenders that left unsophisticatedhome buyers with home loans theycould not afford. Home loans weresold by brokers whose fees rose witheach sale, motivating them to pushlower-income families into home pur-chases that strained their finances tothe limit. Often, low “teaser” interestrates were offered for the first years ofa mortgage, but the rates wouldincrease dramatically in later years.Studies later showed that many newhome buyers did not understand thefinancial risks they were taking on.

The mortgage industry sought tomanage these risks through a processcalled securitization. Riskier loanswere bundled with conventional homeloans into packages and divided intounits that were sold to investors, likebonds. These mortgage-backed secu-rities paid higher than standard inter-est because they entailed more risk,and they were eagerly snapped up byinvestors in the United States and,later, around the world. In 2005, forexample, sales of mortgage-backedsecurities exceeded $1 trillion. WallStreet financial “engineers” devel-oped a series of increasingly morecomplex and speculative investments

linked to the mortgage-backed securi-ties. These also sold well withinvestors. The result was a sharp glob-al expansion of speculative invest-ments financed heavily by debt.

As long as housing values keptgrowing, the process continuedapace, and housing sales flourishednot only in the United States, but alsoin Britain, Spain, and other nations.But when the overbuilt U.S. housingmarket crashed in 2007, many indi-vidual homeowners found themselvesowing more money on their mort-gage than their home was worth. Asteaser-rate periods expired, borrow-ers were faced with sharply highermonthly payments, higher in manycases than they could afford. Whenhome prices seemed as if they wouldcontinue to rise without limit, borrow-ers willingly assumed these debts,secure in the belief that they couldalways sell the home at a profit or refi-nance against the home’s increasedvalue. Once home prices began theirdecline, however, these calculationswere exposed as gambles gone bad.

These individual mortgage debtshad been packaged into increasinglyexotic securities and sold worldwide,causing the mortgage crisis tobecome a global epidemic. The Unit-ed States and major European andAsian nations committed trillions ofdollars to rescue impacted banks andinvestment funds. As fearful, capital-short lenders stopped making eventhe short-term and overnight loanswoven deeply into the everyday work-ings of the world economy, govern-ment treasuries and central banksbecame the lenders of last resort on amassive scale, pouring tax dollars intothe fractured financial sector and tak-ing direct control or major ownershippositions of banks and funds in a

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Above: Workers celebrate May 10, 1869, at completion in Utah of first U.S. transcontinental rail-road track.

Opposite page—clockwise from top: Alexander Hamilton, pictured standing, fought for policiesaimed at strengthening manufacturing and finance, including protective tariffs on imports and federal assumption of the states’ Revolutionary War debts; slaves pick cotton in the deep South;slaves load cotton aboard a steamship on the Alabama River in 1857; and colonial settlers plantcrops in South Carolina.

Below: 1888 Republican Party election campaign poster advocates protective tariffs, a divisiveissue throughout U.S. history.

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Above: Railway tunnel is under construction in Washington, D.C., circa 1904-1905.

Opposite page—clockwise from top left: Thomas Edison, circa 1883, holds incandescent light-bulbs, one of his many inventions; in New York City, telephone inventor Alexander Graham Bellmakes the first long-distance call January 1, 1892; a jumble of electric power lines hover overpedestrians on Broadway in New York City, circa 1900.

Below: A steam-powered tractor pulls a plow through Minnesota farmland.

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Above: During the Great Depression, men line up for soupoffered by a charitable organization called the SalvationArmy.

Left: Florence Thompson, destitute migrant worker mother ofseven children, comforts some of her children on a farm inCalifornia in 1936.

Below: In a wide region of the U.S. South and Midwest calledthe Dust Bowl, drought and poor farming practices createddust storms such as this one in Arkansas in 1936.

Above: Construction projects went on evenduring the Depression, including work on theRCA Building at Rockefeller Center in NewYork City, where workers are shown taking alunch break September 29, 1932.

Left: Workers lay catwalks for construction ofthe Golden Gate Bridge in San FranciscoSeptember 19, 1935.

Below: Completion is near July 22, 1935, onNorris Dam in Tennessee for the controversialgovernment-owned and -operated TennesseeValley Authority electric power utility.

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Courtesy of Library of Congress

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Above—clockwise from top left: Women at a plant in Cincinnati, Ohio, in 1942 assemble shellsin an aluminum factory converted to production of weapons for World War II; 1948 aerial imageshows Levittown, New York, a prototypical mass-produced suburban development; Dr. MartinLuther King Jr., third from right, leads a 1965 civil rights march in Alabama; the search for ener-gy goes on in 1953 at a shale oil mine.

Opposite page—clockwise from top left: Advertisement for a 1964 Ford Thunderbird represents a time of prosperity; motorists lined up for fuel in New York during the 1973-1974 gasoline short-ages; President Ronald Reagan pushed for tax cuts; a nanotechnology lab at the University ofMichigan represents potential economic activity ahead; mortgage foreclosure sign stands before a house in Shaker Heights, Ohio, in July 2008; farmer Gary Wagner in Crookston, Minnesota,uses satellite technology to map his fields; early Macintosh computers come down the assemblyline at an Apple Computer Inc. plant in Milpitas, California, in 1984.

Courtesy of Library of Congress Courtesy of Ford Motor Company

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The large U.S. multinational firms havealtered their productionstrategies and their roles in response to globaliza-tion as they adapt toincreasing competition.

What theU.S. EconomyProduces

C H A P T E R

Standing by itself, U.S. manufacturing wouldbe the eighth largest economy in the world.

U.S. MANUFACTURING INSTITUTE

2006

44 45

The U.S. economy is in the midst of its secondradical conversion. The first represented a shift from agri-culture to manufacturing. The past quarter-century has witnesseda further evolution toward finance, business services, retailing, spe-cialized manufacturing, technology products, and health care. The firstrevolution mated European capital to America’s burgeoning 19th-century

expansion, while the current transition reflects Americans’ response to

unprecedented global competition in trade and finance.Like other economies, the U.S. economy comprises a circular flow of

goods and services between individuals and businesses. Individuals buygoods and services produced by businesses, which employ individuals andpay them wages and benefits, providing the income that individuals use tomake new purchases of goods and services and investments, or to save.

The most common measure of the U.S. economy is the federal govern-ment’s report on the gross domestic product (GDP). GDP records the value indollars of all goods and services purchased in the United States by individualsand businesses, plus investments, government spending, and exports andimports from abroad. (It does not include sales by foreign companies located inthe United States or by American companies operating in foreign countries.)

GDP is made up both of goods and services for final sale in the private-sector market and nonmarket services, such as education and militarydefense, provided by governments. In principle, the value of goods and ser-vices in the market reflects an exchange between willing buyers and sellersand is not fixed by government, with some notable exceptions such as gov-ernment farm and energy subsidies.

In 2006, the $13.1 trillion U.S gross domestic product comprised approxi-mately $9.2 trillion in personal spending by American consumers; $2.2 trillionin private investments for homes, business equipment, and other purposes;and $2.5 trillion spent by governments at all levels, minus an internationaldeficit of $700 million—the difference between what the United States import-ed and exported and its net financial transactions with the rest of the world.

© AP Im

ages

Above: Robotic welders operate an auto van assembly line in Baltimore, Maryland.Previous spread: Starbucks has spread far and wide to nearly 50 countries since itsfirst store opened in Seattle in 1971. The corporation announced plans to close 600shops when the economic downturn struck in 2008.

duced more growth and more pro-ductivity gains between 2001 and2005 than any other sector of theU.S. economy.

Five manufacturing groups hadmore than $1 billion each in sales in2006: fabricated metal parts, a keyproduct for the construction industry;machinery; computers and electronicequipment; motor vehicles; and foodand beverages. U.S. manufacturingoutput that year included 4,500 civilaircraft, 11 million cars and lighttrucks, 87 million metric tons of rawsteel, 27 million computers, $127 bil-lion worth of pharmaceutical prepara-tions (excluding biological products),and $120.6 billion in semiconductorsand electronic components.

Retail businesses contributedabout 6 percent to 2006 economicoutput. Wholesale businesses, whichbuy from producers and then supplyretailers, added another 5 percent.Together, these sectors producedabout $1.6 trillion for the U.S. econ-omy, and their share of the total in2006 was slightly less than in 1980.

The retail sector’s makeup illus-trates the great diversity of stores inthe American economy. More than95 percent of all retailers are single-store business, the traditional “mom-and-pop” operations that populateAmerica’s Main Streets.

But revenues taken in by single-store businesses account for only halfof all retail sales. In the sprawlingmalls and shopping centers on theoutskirts of U.S. cities are the “big-box” retail stores and “super-center”warehouses that compete for con-sumers’ dollars through relentlessprice competition. The largest ofthese major retailers, Wal-Mart,seemed to be everywhere, with 4,100U.S. stores and 3,100 stores abroad.

Amazon.com, which ranked No. 32in retailing revenues in 2007, had nostores—all of its sales are made on-line. The company is by far the mostdurable survivor of the 1990s dot.comretailing boom. The shifts in rankingsof leading U.S. retailers each yearshow evidence of the constant strug-gle among large stores to win andhold the loyalty of U.S. consumers.

The Rise of Finance

The first decade of the 21st centu-ry marked the “ascendancy offinance,” in the words of Joseph E.Stiglitz, chairman of President BillClinton’s Council of Economic Advis-ers. The finance, insurance, and realestate industry category of grossdomestic product, which includesgiant securities funds, small regionalbanks, and insurance companies,contributed $2.7 trillion to the econo-my in 2006, or 21 percent of the total.Its share in 1980 was 16 percent.Between 1998 and 2006, the revenuesof U.S. finance and insurance compa-nies shot up by 71 percent, capitaliz-ing on the U.S. leadership in rapidlygrowing global financial markets.

The growth in international cred-it markets in the 2000s decade showedboth the sophistication and dyna-mism of the U.S. investment indus-try. The crash that followed in 2008revealed a lack of restraint that ledmany in the industry to assume dan-gerous risk by accumulating toomuch debt, much of it not clearly vis-ible to their shareholders.

A category of industry called “busi-ness and professional services” addedabout $1.5 trillion in output to theeconomy in 2006, or 12 percent, com-pared to 7 percent in 1980. Thisencompasses the growing economicrole played by lawyers and consul-

47

Looked at another way, govern-ments collected $2.7 trillion in taxes,roughly half of that on personal in-come and the rest on production andbusiness profits. Governments paidout $1.6 trillion in benefits, primari-ly to individuals, and $370 billion ininterest to holders of governmentdebt. (The United States places nearthe bottom of major economies in itsoverall tax burden, ranking 22nd outof 26 nations surveyed in 2006 by theOrganization for Economic Cooper-ation and Development.)

GDP sources are broken down intomajor economic sectors such as manu-facturing and retail sales. Comparingthe 2006 output of these sectors with1980 shows the magnitude of the shiftfrom goods to services over the pastquarter-century. In 2006, manufactur-ing provided 12 percent of total U.S.domestic output of goods and services.In 1980, its share was 20 percent.Finance and real estate services over-took manufacturing, contributing 21percent of the U.S. economic output in2006 versus 16 percent in 1980. Sup-pliers of professional business services,including lawyers and consultants,contributed as much value as manu-facturing—12 percent of the domesticeconomy. This figure was only 7 per-cent in 1980. Retail and wholesaletrade, at 12 percent, was slightly lowerthan in 1980. The category of healthcare and private educational serviceswas 7 percent in 2006, compared to 4percent in 1980. Government at alllevels accounted for 13 percent of thecountry’s economic output in 2006,essentially unchanged from 1980. Oiland gas production dropped to justover 1 percent of the nation’s output in2006, from 2 percent in 1980.

Excluding government’s share ofthe economy, goods-producing com-

panies made up 20 percent of totalprivate-sector output in 2006, downfrom 34 percent in 1980. The ser-vices sector climbed from 67 percentto 80 percent during that period.

Manufacturing Faces Competition

Manufacturing’s share of the U.S.economy peaked in the 1950s, whenEurope and Asia were still strugglingto recover from the devastation ofWorld War II. By 1980, Japan andWestern Europe were ready to chal-lenge U.S. industrial leadership, andin the new century they have beenjoined by China, India, and manyother nations around the globe.

American producers haveresponded to rising competition andhigher labor and benefits costs bymoving operations offshore, purchas-ing foreign parts and components,and concentrating on higher-valueproducts where innovation offers acompetitive advantage. Only 10 per-cent of the U.S. workforce holdsmanufacturing jobs today, downfrom 20 percent plus in 1980.

Even so, high U.S. worker produc-tivity and technological leadershipenabled the United States to rank asthe world’s leading manufacturer in2006, with $1.5 trillion in products in2006, or about one-quarter of totalworldwide production. “Standing byitself, U.S. manufacturing would bethe eighth largest economy in theworld,” the U.S. Manufacturing Insti-tute has said. U.S. manufacturersemploy more than 14 million work-ers, and another 6 million work inrelated industries. According to theinstitute’s 2006 report, manufactur-ing jobs pay about 25 percent morein wages and benefits than nonman-ufacturing jobs in the United States.The country’s manufacturers pro-

46

tants. The American Bar Associationreported that more than 1.1 millionlawyers were practicing in the UnitedStates in 2008, or one out every 300Americans, a far higher proportionthan in any other country.

Health care came to $900 billion,or just under 7 percent of economicoutput, reflecting the expansion ofhigh-priced health care technolo-gies and the medical needs of anaging U.S. population. In 1980,health care accounted for 4 percentof the economy.

Americans today travel more forbusiness and pleasure than a genera-tion ago, and this has fed the growthof the hotel and restaurant indus-tries, whose output totaled $350 bil-lion in 2006, or 2.7 percent of thegross domestic product. This isslightly higher than in 1980.

Where Americans Work

Details about where Americanswork provide another view of theeconomy. On a typical workday in2005, just over 141 million full- andpart-time employees went to work in

the United States. Not a single oneof them was truly an “average Amer-ican,” not in a nation of 300 millionpeople with roots in virtually everynation and culture in the world, liv-ing in huge metropolitan cities orout-of-the-way hamlets, and in everysort of community in between.

Just 1 percent of the workforcewas engaged in farming, forestry, andfishing. Construction, transportation,mining and utilities provided workfor 10 percent. Ten percent workedin manufacturing; 4 percent inwholesale trade; 11 percent in retailtrade; 12 percent in professional andbusiness services; 2 percent in infor-mation, media and software; 6 per-cent in finance, insurance and realestate; 13 percent in education andhealth care; 9 percent in arts, enter-tainment, accommodations and foodservices, and 5 percent in other ser-vices. Government employed 17 per-cent of the workforce.

In 2005, American workersreceived $7 trillion in wages orsalaries, by far the largest source ofincome for the nation’s 117 million

4948

The story of Wal-Mart’s stunning risewithin a single generation from a com-monplace, low-price variety store in

Arkansas to the world’s largest and most powerfulretailer illustrates many fundamental shifts takingplace in the U.S. economy. Wal-Mart’s fixation onbeating competitors’ prices and squeezing its oper-ating costs to the bone year after year has provedto be a potent strategy. By 2006, The Wal-MartEffect author Charles Fishman reported, more thanhalf of all Americans lived within eight kilometers ofa Wal-Mart store.

Although Wal-Mart typically sought out U.S. manufacturers to stock its shelves, as thecompany grew, Wal-Mart management accelerated their search for lower-cost productsand components in overseas markets. Today, Wal-Mart has become the most importantsingle conduit for foreign retail goods entering the U.S. economy.

Wal-Mart’s spread across the American landscape has provoked intense oppositionfrom critics, led by labor organizations fighting what they view as the company’s anti-union policies. Wal-Mart workers make half the wages of factory workers, or less, andhave sometimes had wages capped to hold down store costs. Personnel turnover is rel-atively high, but the company reports it routinely gets 10 applications for every positionwhen a new store opens. The company is using its economic clout to promote energy-efficient products, solar energy installations at its stores, and fuel conservation by itstruck fleet, and has urged employees to support its “green” strategies. Its “big box”stores, exceeding 13,000 square meters in size, have been vilified by some for over-whelming nearby small-town merchants.

However, retailing in the United States has always been intensely competitive, withlosing technologies and strategies falling by the wayside. The spread of electricity incities and the invention of the elevator in the 1880s enabled retailing magnate JohnWanamaker and imitators to create the first downtown department stores. Then Searsand other catalog stores opened a new retailing front—shopping from home. Themovement of Americans who followed the Interstate Highway System to ever more dis-tant suburbs undermined local merchants long before Wal-Mart reached its leviathansize. And Wal-Mart’s recent U.S. growth has slowed, as it and other big retailers facecompetition from Internet shopping and specialty marketers.

The older, simpler U.S. retail model of a century ago, when community-based mer-chants sold largely made-in-America products, might have provided a more stable eco-nomic base for some communities. But this static model often failed to adapt to new con-ditions generated by the nation’s dynamic economic, social, and political institutions.

Retailing’s Competitive Battlefield

Always

Low PricesAlways

Siempre precios bajos

Above: An emblem of the cost-cutting attraction of Wal-Mart.Top left: A “greeter” awaits customers entering one of the stores of the chain Wal-Mart,the largest private employer in the United States.

Courtesy of Wal-Mart

Courtesy of Wal-Mart

But apart from currency issues, arising tide of global competition,particularly from countries with lowerlabor costs, has pushed Americanmanufacturers to new competitivestrategies. A 2005 study by the U.S.Bureau of Economic Analysis discloseda trend among U.S.-headquarteredmajor multinational corporations.U.S.-based divisions cut employmentand capital investments at home butincreased jobs and investments sig-nificantly at their foreign units. Theannual output of the foreign affili-ates that year increased by more thantwice that of the parent company inthe United States. The study sug-gests that U.S. multinationals wererelying increasingly on bringing inforeign-made components, includ-ing those from their overseas affili-ates, and then including them intheir final products.

Investing in Research and Education

American investments in researchand development (R&D) and educa-tion have been a bulwark of U.S.trade competitiveness. The U.S.Manufacturing Institute has listedimportant new technologies onwhich U.S. companies rely, includingcomputer-aided design, robotics,just-in-time inventory controls, andradio frequency identification tech-nology used in tracking the flow ofgoods from factories or warehousesto stores.

The institute also reports that U.S.manufacturers are leaders in applyingthe new science of nanotechnology,which harnesses the distinctive physi-cal properties of individual moleculesto create improved products. Nano-technology is producing lighter,stronger, and more rustproof motorvehicle components. It creates stain-

proof clothing and military armor,and it greatly extends the shelf life ofbottled products.

But U.S. industry leaders warnthat the long-standing U.S. lead inR&D spending is shrinking. TotalR&D spending by China, Ireland,Israel, Singapore, South Korea, andTaiwan is expected to exceed the U.S.total before 2010. The United Statesincreased R&D investments by nearly40 percent between 1995 and 2005,but China’s investments tripled dur-ing those years, albeit from a muchsmaller base.

Support for Farmers

In the early 20th century, accord-ing to the U.S. Department of Agri-culture, more than half of the U.S.workforce was employed by the small,diversified, rural, and family-runfarms responsible for most of thenation’s foodstuffs. Today, U.S. agri-culture is concentrated on a smallnumber of very large, specializedfarms employing less than 1 percentof U.S. workers. The acreage of theaverage farm has tripled since 1940,and half of U.S. farm sales come fromthe largest 2 percent of all farm-ing operations. American farmersreceived $285 billion for their cropsand livestock, plus $12 billion in directgovernment payments in 2007. Farmimports totaled $70 billion, whileexports came to $82 billion.

Federal programs to shore upfarmers’ incomes arose in the GreatDepression of the 1930s. The goalswere to assure minimum farm pricesfor specific farm commodities and tofurther support farm prices by payingfarmers to limit production. Althoughconsumers bore the cost of the result-ing higher food prices, many consid-ered this approach reasonable when

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households. These households alsoreceived $1.5 trillion in dividendsand interest payments from theirsavings and investments, $1.3 trillionin employer benefits, and $1.5 tril-lion in government social benefits,for which they contributed $880 bil-lion in social insurance payments.

The United States has the world’smost open borders based on the vol-ume of trade that enters and leavesthe country. In 2006, the UnitedStates was the largest importer andsecond largest exporter of merchan-dise goods and led all nations in theimport and export of commercialservices. In that year, the UnitedStates exported $1.45 trillion ingoods and services, but imported$2.2 trillion, producing a recordtrade deficit of $750 billion. TheUnited States had a surplus in thetrade of commercial services such asairline travel and financial services,but it had a deficit of $838 billion intraded goods.

The strongest U.S. export goodsare manufactured capital goods,including motor vehicles, civil aircraft,semiconductors, industrial machinery,and computer accessories. Pharma-ceuticals, household goods, gem dia-monds, toys, games, and sportinggoods are the leading consumer prod-ucts exports. Chemicals and plasticproducts are the largest categories ofindustrial materials exports.

Manufactured goods make upnearly two-thirds of total exports,with agricultural products far behind,at 5 percent of all outbound ship-ments. Although traditional U.S. customers—Canada, the EuropeanUnion, and Japan—are the top recip-ients of American exports, China,India and developing countriesreceive nearly half of U.S. shipments.

Imports have risen much fasterthan exports. In 2004, for example,more than one-third of all manufac-tured products purchased by U.S.consumers were imported. In 1972,the figure was just 11 percent.

The value of the dollar comparedto other leading world currencies hasbeen a critical factor in U.S. manu-facturing competitiveness. In twoperiods—the mid-1980s and 1997-2002—the dollar’s value was high,making U.S. exports relatively moreexpensive and imports cheaper. Inboth periods, the country’s tradedeficit grew sharply. The dollar’sdecline during 2002-2008 helpedboost U.S. exports.

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require less herbicide to controlweeds. These varieties now make upmore than 70 percent of all soybeanand cotton acreage planted in theUnited States. Cotton and corn havebeen engineered to resist insects byproducing their own toxins, andthese varieties are also gaining rapidacceptance in the United States.

But genetically engineered cropsremain controversial because of critics’concerns about their environmentalimpact and some public misgivingsabout the technology generally. Theultimate response of consumers andgovernments around the world to thisscience will have major consequencesfor U.S agriculture.

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most farms were small and farmers’incomes were relatively low.

Federal policies began to changein the 1970s as foreign export mar-kets grew in importance and U.S.agriculture shifted away from pre-dominantly small farms to large fam-ily holdings and corporate farming.Federal legislation in 1996 replacedprice supports on specific commodi-ties with direct payments to farmersbased on historical production, butgave farmers flexibility on how muchof their land to farm.

Until the 1980s, half of the U.S.farm exports were major bulk com-modities such as wheat, corn, soy-beans, cotton, and tobacco. Livestockaccounted for 10 percent of exports.Horticulture products, led by fruitand vegetables, accounted for 9 per-cent. Today, livestock makes up 16percent of farm exports; horticultureproducts, 21 percent; and bulk com-modities, 36 percent.

As with manufactured goods, fluc-tuations in the dollar’s value againstother currencies produced shifts in

agricultural trade. But the changingtastes of American consumers playedan important part, too. In the early1980s, an American consumed, onaverage, 810 kilograms of food ayear, of which 72 kilograms wasimported, according to the U.S.Agriculture Department. In 2002,consumption had climbed to 900kilograms and imports per personaveraged 118 kilograms. As U.S.household wealth increased in thelate 1990s and early 2000 decade,consumers spent more on importedhigh-value farm products, from wineand beef to cut flowers. Americanwheat, corn, and other bulk exportsremained competitive because of thehigh productivity of farmland, theexpansion of large-size family andcorporate farming, and agriculturaltechnologies. Ethanol, most of itrefined from corn, made up nearly 3percent of U.S. motor fuel in 2005.

U.S. farmers have readily adopt-ed genetically altered crops sincetheir introduction in 1996. Geneti-cally altered soybeans and cotton

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Above: Corn is a major crop for human and livestock consumption domestically and for export aswell as a source of biofuel.

© Vasiliy Koval/Shutterstock

Competitionand the AmericanCulture

Competition has remaineda defining characteristic of the U.S. economygrounded in the

American Dream of owning a small business.

C H A P T E R

© Gary Gladstone/Corbis

“Americans…are also hustlers in the positivesense: builders, doers, go-getters, dreamers,hard workers, inventors, organizers, engineers,and a people supremely generous.”

WALTER MCDOUGALL

2004

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Joseph Schumpeter, an Austrian-born economist,coined the term “creative destruction” in 1942 to describethe turbulent forces of innovation and competition in Westerneconomies. He called it the “essential fact about capitalism.” The“incessant gales” of markets cull out failing or underperforming com-panies, clearing the way for new companies, new products, and newprocesses, as he put it.

Creative destruction was a philosophy that appealed to critics of the NewDeal social and economic intervention that took hold during the GreatDepression, and it maintains an influential following today. “I read Schum-peter in my 20s and always thought he was right,” said former FederalReserve Chairman Alan Greenspan, “and I’ve watched the process at workthrough my entire career.” Today “destructive technology” is the label forchange-forcing innovation and technology.

The juxtaposition of creation and destruction captures the ever-presenttension between gains and losses in the American market economy. Theprocess has never been without critics and political opponents. But becausethe winners have substantially outnumbered the losers, the churn of compe-tition remains a defining characteristic of the U.S. economy.

Outsiders often equate the U.S. economy with its largest corporations andwhat they make and do. They may be surprised, then, by the vital part thatsmall businesses play. Napoleon is said to have dismissed England as “anation of shopkeepers.” The phrase could also be applied in considerabledegree to the United States, whose shop owners and other small businessesaccount for over half of the private-sector U.S. workforce and economic out-put, excluding farming. (“Small” businesses, according to an official defini-tion, have fewer than 500 employees.)

A typical American town or suburb of more than 10,000 people is populat-ed with individual business owners and small firms—car dealers; accountantsand lawyers; physicians and therapists; shoe repairers and cleaning establish-ments; flower and hardware stores; plumbers, painters, and electricians; cloth-ing boutiques; computer repair shops; and restaurants of a half-dozen ethnic

Above: Some of the wealth amassed in the economy goes to good causes. Microsoftfounder and billionaire Bill Gates, shown here with a Mozambique vaccine trial patient,has made philanthropy his new job. Previous spread: Small businesses, such as thisrestaurant in Kansas, account for a vast majority of U.S. job creation.

© AP Im

ages

ple. But these vendors were blockedfrom becoming full-fledged businessowners by many hurdles, de Sotosays, including rigid class barriers,laws that discourage property owner-ship, and bureaucracies intent onpreserving the status quo. In theUnited States, change is a way of life.

The Chance to Start Again

If it is easy to launch a business inAmerica, it is also relatively simple totry again after a failed attempt. Thephilosopher Erich Fromm said thatthe “freedom to fail” was essential tooverall freedom, and the adage isoften cited as a basic tenet of Ameri-can economic life.

U.S. bankruptcy laws govern busi-ness failures. The U.S. Congress hastried to strike a balance that recoversas much of a failed company’s assetsas possible for lenders and creditors,while providing financial protectionsthat can allow some entrepreneurs togain a fresh start. The bankruptcyprocess may differ for individuals,small enterprises, and large, publiclyowned corporations.

A small business that cannot pay itsbills usually will go through what iscalled a liquidation, selling all of itsassets to pay what it can to its credi-tors. Some of the business’s debts arepaid ahead of others, and a bankrupt-cy court appoints a trustee to see thatthe process follows the rules. Banksand other “secured” lenders are highon the repayment list, as are mostemployee wages. But if there are pub-lic shareholders, these owners—whohave assumed more risk in exchangefor greater potential reward—are onthe bottom and often get nothing asthe business closes its doors.

Large companies that can’t copewith their debts may choose what iscalled a Chapter 11 bankruptcyprocess, which allows a company tostay in business while it tries to recov-er. If the company still has valuableassets or some cash coming in, and ifits crisis seems temporary, creditorsmay choose to take less than fullrepayment of their claims initially tolet the business survive and continuerepaying its creditors. In this case,too, shareholders might be wipedout, but the business can survive.

Bankruptcy law also enables indi-viduals to escape unmanageabledebts and start over, although theymay lose their homes. This escaperoute can be crucial for people wholose their jobs or for families facingheavy medical bills, for example.

The bankruptcy laws are part ofthe American cultural belief in thesecond chance. This story is wovendeeply into the national fabric ofmigration and settlement that beganwith the first boatloads of Europeanarrivals and never stopped. Frenchpolitical thinker Alexis de Tocque-ville found in the 1830s an innaterestlessness among Americans, who

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flavors. Many of the small retailerscompete with national chains boast-ing billions of dollars in revenue andthousands of employees.

Despite the odds against them,small businesses account for a vastmajority of job growth, particularly asmajor manufacturing companies trimemployment in the face of stiff globalcompetition. In 2004, for example,the number of jobs in small business-es grew by 1.9 million overall from theyear before. Larger companies with500 employees or more lost 181,000net jobs. (Economists point out thatmany small businesses provide goodsand services to large companies andthus are tied to their fortunes.)

Small Businesses at the Economy’s Core

American entrepreneurs remaineager to risk their own savings tostart small businesses despite thepotential for failure that Schum-peter’s model predicts. The widelypublished and sometimes embroi-dered story of American FoundingFather Benjamin Franklin was apotent symbol of aspiration and per-severance for generations of Ameri-

cans, “defining our image of our-selves, shaping our sense of possibili-ty,” says author Peter Baida.

The 15th child of a Boston soapand candle maker, Franklin quit schoolafter two years to work in his brother’sprinting business. He learned theprinting trade and accounting,became the American colonies’ mostnoteworthy publisher and inventor,and then played his storied role in thestruggle for national independence.Since Franklin’s time, Americans havehailed leading inventors and entrepre-neurs as icons of opportunism, fromThomas Edison to Apple’s Steve Jobs.

Millions of entrepreneurs try tocreate their own versions of success.Government data show that, in 2006,an estimated 650,000 new employer-owned businesses were started upand 565,000 went out of business,out of a total of around six millionsuch businesses nationwide. Similarratios of births and deaths amongsmall businesses are repeated yearafter year.

One obvious reason why so manyAmericans choose this path is therelative ease of starting a business.Professions such as law, medicine,and accounting have stiff licensingrequirements. But compared toother Western economies, the Unit-ed States offers an open road to awould-be business owner. The con-trast with some Third Worldeconomies is monumental. A studyby the Peruvian economist Hernan-do de Soto found that it took 289days to open a small garment work-shop in Lima, Peru. The absence of avibrant small-business class is notdue to a lack of entrepreneurs, heargued. In 1993, an estimated150,000 vendors worked the streetsof Mexico City, to cite but one exam-

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nation’s No. 1 automaker registeredwith the American mood. Congresspassed the National Traffic andMotor Vehicle Safety Act of 1966 toset automobile safety standards.

Corporations Push Back

“Ambition must counter ambi-tion,” James Madison wrote in 1788in Federalist 51, an effort to defendthe proposed U.S. Constitution hehad done so much to shape. Ameri-can businesses and their opponentsactively play the role Madison antici-pated, presenting and defendingtheir interests in Washington andstate capitals.

The word “lobbying” as a namefor these campaigns dates back atleast to 18th-century Britain. In theGilded Age of rapid U.S. economicexpansion after the Civil War, lobby-ing by railroad promoters took theform of outright bribes “where it willdo most good,” as one railroadtrustee put it, spent on congressmenwho could determine railroad routes.Today, lobbyists who contact mem-bers of Congress for their clients mustregister and publicly disclose theiractivities. Their direct contributionsof money to members of Congress arelimited and must be revealed.

Critics of lobbying say it repre-sents a corruption of the democraticprocess, giving large contributors thestrongest voice. Defenders reply thatthe lobbyist is exercising a constitu-tionally guaranteed right to petitionthe government and that lawmakerscannot properly perform their dutieswithout understanding the varioussides of controversial issues—detailsthat lobbyists are eager to provide.

In any event, lobbying is a growthindustry. In 1975, lobbyists reportedspending $100 million to make their

cases in Washington. In 2005, theU.S. Capitol had 17,000 registeredlobbyists (200 of them former mem-bers of Congress), and their spendingtotaled $2.5 billion. There is hardly acause of any size that is not part ofthis campaign, but business groupslead the list of registered lobbyists.Between 1998 and 2006, five U.S.industries reported spending a totalof $1 billion or more on lobbying.

A profound internal challenge toAmerica’s business establishment inthe past quarter-century came notfrom regulators or “gypsies of dis-sent,” but from investors. In the1980s, an industry sprang up cen-tered on Wall Street and focused ontaking over underperforming pub-licly owned corporations. In 1981,DuPont, a diversified manufacturerof chemical-based products, made abid to purchase the oil giant Conoco.A bidding frenzy followed as Cana-da’s Seagram liquor distiller andConoco rivals Texaco and Mobilsought to beat DuPont’s price. Cono-co’s $7.8 billion merger with DuPontequated to a purchase price of $98for each share of Conoco stock, twicethe share price before DuPont madeits move. The largest corporatemerger to that time, it created stun-ning financial gains not only forConoco stockholders, but also forspeculators who purchased the oilcompany’s shares and for the WallStreet investment bankers andlawyers who worked on the deal.

The Conoco acquisition opened awild new chapter in U.S. business his-tory. Bidding wars broke out to seizecontrol of companies whose low stockprices left them vulnerable. New tac-tics appeared, such as “greenmail” byinvestors and speculators who boughtsignificant shares of a company and

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were constantly changing course “forfear of missing the shortest road” tosuccess and happiness.

The historian Frederick JacksonTurner, marking the 400th anniver-sary of Columbus’s 1492 landing inthe New World, defined the Ameri-can frontier as an integral culturalcatalyst. The steadily changing fron-tier, lying ever west of existing settle-ments, was a magnet for migration,pulling footloose Americans everwestward, Turner wrote in 1893. Heattributed distinctive aspects of thepredominant American character—individualism, risk-taking, suspicionof authority, and optimism—to thisfrontier experience.

Creative Destruction at the Top of the Economy

Creative destruction is evident atthe top of the economy in the riseand decline of the largest, most pow-erful U.S. corporations.

One measure is the survey of the50 largest industrial companies pub-lished annually by Fortune magazine.In 1990, the top-50 list featuredcompanies with household namesand an international reach, manydating back to the early 20th centu-ry, including General Motors, FordMotor Company, DuPont, EastmanKodak, and the predecessors ofExxon Mobil. These businesses simi-larly reflected the heyday of U.S.manufacturing: Manufacturers held31 of the 50 places, followed by 12energy companies and seven con-sumer products suppliers.

The 2007 rankings document theconsequences of globalization, thedecline of goods production in favorof services, and the rise of healthcare as a major need for an agingpopulation. On the 2007 Fortune list,

the largest U.S. non-financial com-pany was Wal-Mart Stores. Its $351billion in revenue narrowly exceededrevenues of energy giant ExxonMobil. The number of manufactur-ers among the 50 largest industrialfirms was down to 20. Mergers hadreduced the energy companies toeight in all.

Taking the place of the displacedmanufacturing and energy firms were10 retailers, including Wal-Mart, itsrival Target, and Home Depot andLowes, the leading home improvementand construction materials retailers.Also in the top 50 were six healthindustry companies and three compa-nies focused on moving a steadilygrowing volume of food, goods, anddocuments around the country—United Parcel Service, FedEx, andSysco, the largest distributor of foodproducts. Kodak, Xerox, InternationalPaper, Goodyear Tire & Rubber, andBristol-Myers Squibb had fallen farout of the top 50 in 2007.

The global economic expansionhas profoundly altered U.S. business.But so have domestic forces ofchange. At the beginning of the 20thcentury, some of America’s dominantbusinesses were called to account byreformers crusading for better work-ing conditions and pure food. Themovement was revived in the 1960sthrough a one-man attack on thesafety of American-built automobilesby Ralph Nader, an attorney andactivist. Nader’s 1965 book, Unsafe atAny Speed, singled out the small Gen-eral Motors Corvair sedan. GM retal-iated by investigating Nader’s pri-vate life in an apparent effort todiscredit him. GM’s chairman calledNader “one of the bitter gypsies ofdissent who plague America.” ButNader’s campaign against the

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Burnham Lambert, the leading junkbond financier, admitted felony secu-rities violations in 1988, paid arecord $650 million fine, and woundup in bankruptcy court.

The corporate raiding frenzy sub-sided in the 1990s after Drexel’sdemise was followed by heavy lossesfor junk bond investors generally.The 1990s boom in technologystocks absorbed larger and largeramounts of investors’ money untilthat speculative stock surge col-lapsed in 2000. After a few years,however, a new wave of corporateacquisitions swelled up. It was led byprivate investment funds whoseclients pooled their capital and bor-rowed additional funds to purchasecompanies whose profits and stockmarket prices had slumped, creatingpossible bargains for the investors.

Unlike some takeovers by 1980sraiders, investment funds such as theBlackstone Group and the CarlyleGroup aimed not just to cut costs,but to improve the company’sresults. The private managers soughtto take a company public, sellingshares on U.S. stock markets. If thecompany was performing better thanduring its last public incarnation, theshare prices would be correspond-ingly higher and the privateinvestors would reap extraordinarygains. The list of companies acquiredby such private equity funds includ-ed the Hertz Corporation car rentalcompany, Metro-Goldwyn Mayermovie studios, Burger King,Chrysler, and TXU, the largest elec-tric utility in Texas.

In 1992, private equity invest-ments totaled just $21 billion. In2006, private equity firms boughtcontrol of 654 U.S. companies for atotal of $375 billion, evidence of the

constant turnover in American busi-ness that Schumpeter would haveinstantly recognized.

Competition and the American Culture

How did competition and disrup-tive change become accepted as partof the American economic culture?

The first European settlers in theNew World braved the perilousAtlantic crossing for varied reasons.Some sought a new land where theirreligious beliefs would escape perse-cution. Others sought gold or thefountain of youth or the passage toIndia. Many simply dreamed of a newchance in life. But most shared thereality that they would have to buildtheir new world from the bottom up.

From the first fragile settlements,Americans pushed westward, invent-ing and reinventing their society inthe face of constantly changingopportunities and hazards. HistorianWalter A. McDougall has called theUnited States “the most dynamic civ-ilization in history,” adding, “nowhereelse has more change occurred in soshort a span. America was not justborn of revolution, it is one.”

Many Americans believed thatGod, the Creator, the Almighty—whom they saw in many differentways—blessed their struggle to createa new nation. In 1630, John Winthrop,the governor of the MassachusettsBay Colony, had called his settlementa “city on a hill. The eyes of peopleare upon us.” President WoodrowWilson, in 1915, told a group of newAmerican citizens, “you have takenan oath of allegiance to a great ideal,to a great body of principles, to agreat hope of the human race.” AndWinthrop’s metaphor became afavorite of President Ronald Reagan,as the 20th century neared its close.

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then threatened a takeover unless thecompany repurchased their shares at ahigher price. Corporate “raiders” suchas T. Boone Pickens, Carl Icahn, andSir James Goldsmith became celebri-ties. Corporate leaders accused themof financial piracy. The raiders coun-tered that by purchasing shares of“mismanaged” companies, they maderightful claims on behalf of all share-holders to the companies’ true value.

Junk Bonds and Takeovers

Adding to the turmoil was anexplosive increase in leveraged buy-outs, or LBOs. The targets of thisstrategy were companies whosestock prices appeared depressedbecause of poor management orbecause of Wall Street’s misreadingof the companies’ potential. Out-side investors or a company’s topmanagers would seek to buy a com-pany from public shareholders byoffering an above-market price. Theleverage in this case was debt. Thetypical LBO was financed primarilyby loans that would be issued by thecompany once the new owners hadsucceeded in taking it over. Interestpayments on these loans were taxdeductible, lessening both the costand financial risk of the LBO andencouraging LBO organizers tooffer their bonds at relatively highyields to investors.

Traditionally, high-yielding butriskier debt securities were offered bycompanies in trouble and so wereknown as “junk bonds,” but LBOpromoters argued that these bondswere not as risky as many investorshad assumed. A 1978 change in fed-eral rules permitted regulated cor-porate pension funds to invest inLBO debt, opening a vital source offinancing to the LBO movement.

Insurance companies, mutual funds,and savings and loan banks wereother major buyers of junk bonds.

In the first half of the 1980s, LBOtransactions increased sixfold. In1988, an estimated $200 billion injunk bonds had been issued, a boomin Wall Street deal-making not seensince J.P. Morgan’s day, said BusinessWeek magazine. Shareholders bene-fited from the premium prices onLBO offers. Wall Street investmentand law firms collected handsomefees, and LBO owners stood to prof-it enormously if the plans succeeded.It was the “great, infallible money-making machine” of the decade, saidfinance professor Roy C. Smith.

The downside was the destructivehalf of Schumpeter’s creativedestruction model. To meet debtpayments, new owners often had tosell off poor-performing divisions orshrink payrolls, and then employeeslost jobs. Companies that had beenfixtures of communities for yearswere sold or dismantled. A top exec-utive of a leading U.S. automobiletire company said that the LBO was“created in hell by the devil himself.”

The LBO process depended on ahealthy economy with buyers eagerto purchase the unwanted parts ofLBO companies, on investors’ confi-dence in junk bonds, and on a per-missive regulatory climate. But theeconomy slowed at the end of the1980s, and investor confidence wasjarred by scandal. The billion-dollardeals tempted some of Wall Street’sbest-known bankers and lawyers tocheat, violating federal securitieslaws by tipping off one another onupcoming but unannounced deals,manipulating stock prices, and issu-ing fraudulently false financial state-ments. The Wall Street firm Drexel

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unlikely Revolutionary War victory,Americans increasingly viewed worknot merely as a requisite of survivalbut as the path to success.

“Significant numbers of Ameri-cans believe that anyone, high orlow, can move up the economic lad-der as long as they are talented,hardworking, entrepreneurial, andnot too unlucky,” wrote Yale Univer-sity law professor Amy Chau. Thisbelief helps explain the relativeweakness of class-based politicalmovements in the United States andthe acceptance—however grudging-ly—by most Americans of greaterdisparities in wealth than are foundin other developed nations, Chauand other commentators say.

The sociologist and political econ-omist Max Weber, writing a centuryago in his influential The ProtestantEthic and the Spirit of Capitalism,argued that Protestant religionshelped build capitalism’s foundationby endorsing hard work, honesty, andfrugality. That spirit survives, but in

changing forms, says the urban stud-ies theorist Richard Florida.

In his 2005 book, The Flight of theCreative Class, Florida argues that theprotest movements of the 1960s and1970s eventually sparked new per-ceptions of work. Increasingly notjust hard work, but fulfilling, inter-esting, fun work became the goal ofthe baby-boom generation that dom-inated the U.S. economy in the lastthird of the 20th century.

But even this cultural turn reflect-ed traditional American traits. Astreak of pragmatism, skepticism,and contrariness runs deep in theAmerican character, historians say.“The American’s attitude towardauthority, rules, and regulations wasthe despair of bureaucrats and disci-plinarians,” writes Commager.

American history suggests thatwhatever future form it takes, theindividualism and contrariness thatseem wired into the national culturewill continue to fuel Americans’ hus-tling, striving nature.

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This sense of mission fortified thewillingness of many Americans toseize the land and build a new coun-try and a strong economy. And ithelped instill in the American peo-ple a lasting streak of optimism.

“With optimism went a sense ofpower and of vast resources of ener-gy,” said the historian Henry SteeleCommager. “The American had spa-cious ideas, his imagination roameda continent, and he was impatientwith petty transactions, hesitation,and timidities. To carve out a farm ofa square mile or a ranch of a hun-dred square miles, to educate mil-lions of children, to feed the Westernworld with his wheat and his corn,did not appear to him remarkable.”

Idealism and self-interest pre-vailed alongside one another.McDougall argues that stripped toessentials, America was, andremains, a nation of hustlers. In Free-dom Just Around the Corner, McDougalldescribed his dilemma: “Shall I por-tray Americans as individualists orcommunity builders, pragmatists ordreamers, materialists or idealists,bigots or champions of tolerance,lovers of liberty and justice for all, orhistory’s most brazen hypocrites?” Infact, all of these traits have beenobvious throughout the Americanexperience, he said.

The common denominator Mc-Dougall saw was a scrappy drive tohustle, to get ahead and improveone’s circumstances. “Americans takeit for granted that ‘everyone’s got anangle,’ except maybe themselves,” hewrote. “Politicians, lawyers, bankers,merchants, and salesmen are consid-ered guilty until proven innocent.”Americans were “hustlers in thesense of self-promoters, scofflaws,occasional frauds, and peripatetic

self-reinventors,” he said. But headded, “They are also hustlers in thepositive sense: builders, doers, go-getters, dreamers, hard workers,inventors, organizers, engineers, anda people supremely generous.”

The first American settlersbrought with them the principles ofBritain’s complex, diverse, andopportunistic market economy, andapplied them on the new soil. But theBritish model was changed by theideals of liberty and democracy thatpromised opportunity. As PrincetonUniversity’s Anne-Marie Slaughterput it, “From nothing to something iswhat we mean by the AmericanDream—from rags to riches, from alog cabin to the White House, from aKansas farm to a Hollywood studio.It is a story of making and remakingourselves as far as luck and hard workwill carry us.”

Praising Work

The original contours of theAmerican economy were defined by aculture that elevated conscientiouswork into a national value. “In thebeginning America was the land andthe land was America,” wrote anthro-pologist and businessman HerbertApplebaum. Unlike Britain, the NewWorld offered the promise oflandownership to the typical settler, atleast once the Native American peo-ples had been driven off. But the landwas useless without an investment in“backbreaking and continuous work,”Applebaum added. The farmer hadto master a dozen tradesman’s skills.The tradesman had to farm. Necessi-ty bred a deep strain of individualismwithin the communal settlements thatspread across the land.

As the American colonies pros-pered and then combined in their

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Geography and

Infrastructure

Education and transportation help hold together

widely separated and distinct regions.

C H A P T E R

Courtesy of Library of Congress

“It is one of the happy incidents of the federalsystem that a single courageous state may…serve as a laboratory and try novel social andeconomic experiments…”

JUSTICE LOUIS BRANDEIS

U.S. Supreme Court1932

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As a continental nation spanning much of theterritory between two great oceans, the United States isblessed with tremendous natural resources: a treasure of forests,seacoasts, arable land, rivers, lakes, and minerals. School atlases ofNorth America once located important economic resources with sim-ple icons placed on a map: office skyscrapers marking the EasternSeaboard’s metropolitan centers; factories flanking the Great Lakesindustrial belt; stacks of wheat and grazing livestock on the GreatPlains; cotton in the Old South and eastern Texas; coal in theAppalachian Mountains of the East and on the eastern slopes of theRocky Mountains; iron ore in Minnesota’s Mesabi Range; oil wells inthe Southwest, California, and Alaska; timber and hydropower in theSoutheast and Northwest.

Of course these resources were found in many places. The area aroundPittsburgh, Pennsylvania, became a center of steelmaking because of thenearby coal deposits and its rail and river connections to the rest of the coun-try. Gary, Indiana, and Birmingham, Alabama, were big steel cities, too. JohnD. Rockefeller’s oil fortunes were made in Pennsylvania, but Texas’s plains,the coastal states along the Gulf of Mexico, southern California, and Alaskaalso sheltered large oil preserves. Even so, those old schoolbook maps cor-rectly pinpointed the different centers of America’s resource wealth fromwhich the economy grew.

A similar 21st-century economic map would look very different. Old man-ufacturing cities around the Great Lakes have lost hundreds of thousands ofproduction jobs over the past two decades. Other metropolitan areas havegrown on the strength of their technology and finance sectors. Even so, the

© Gianna Stadelmyer / Shutterstock

Above: Pittsburgh, Pennsylvania, became a steelmaking center at the confluence ofrivers, coal beds, and rail. Previous spread: The Jones & Laughlin Steel Companyplant along the Ohio River in Aliquippa, Pennsylvania, in 1938, operated near Pittsburgh.

bigger mill or factory could make agreater claim on a river’s flow than asmaller one. The factory cities thatsprung up along the rivers of thenortheastern United States owed theirexistence to shared water supplies.

The California gold rush of 1848led to an entirely different doctrine,one that met the miners’ needs andwould shape the uses of waterthroughout the West. A miner find-ing a gold seam would claim the landand water from the nearest creek towash dirt away from the preciousnuggets. The miner’s claim estab-lished a “first-in-time, first-in-use”priority allowing him to take as muchwater as he required.

After the gold rush ended, theminers’ approach to water rightsbecame an established custom. Unlikethe principle of shared resources inthe East, the miners’ “prior appropri-ation” doctrine, as it became called inthe West, allowed pioneering develop-ers to claim vast amounts of water tosupport the expansion of cities in aridSouthern California and other south-western states and to help westernfarmers grow crops on dry land bytapping immense underground wateraquifers without limitations. LosAngeles and Las Vegas exist as metro-politan cities today because of thewestern water rights doctrine.

The example of water rights illus-trates the variety of regional policies,laws, and practices that emerged with-in a diverse Union. U.S. SupremeCourt Justice Louis D. Brandeisframed the case for the diversity ofstate policies in a widely noted dis-senting opinion on a 1932 case beforethe court: “It is one of the happy inci-dents of the federal system that a sin-gle courageous state may, if its citizenschoose, serve as a laboratory, and try

novel social and economic experi-ments without risk to the rest of thecountry.” States remain laboratories ofpolicy innovation in education, energysupply, and public transportation.

Unifying Forces

The landscape of U.S. history iscovered with travelers’ paths. Theeconomic blight throughout theSouth after the U.S. Civil War sentthousands of Scotch-Irish immi-grants and their children driftingwestward to find open farms in Texasand native American Indian territo-ry. “When conditions became intol-erable, they exercised their ultimateright as Americans—the right tomove on,” Dan Morgan wrote. Theychalked “GTT” on abandoned frontdoors and departed. Their neigh-bors knew the initials meant “Goneto Texas.”

The Great Depression and duststorms of the 1930s forced the great-est migration in the nation’s history, as300,000 people from Oklahoma,Texas, Missouri, and Arkansas headedfor California’s fertile central valley.Fearful California authorities raised asign in Tulsa, Oklahoma, warning,“No Jobs in California. If you are outof work keep out!” But the Okies, asthey were called, went anyway.

The movement of people wastriggered by both opportunity andnecessity. A long-running migrationof African Americans out of theSouth continued throughout the20th century as farm mechanizationdisplaced hand labor. The greatesttransition began during World WarII, when northern steel and auto fac-tories offered jobs to African Ameri-cans to fill wartime vacancies. Eco-nomic necessity prevailed overtraditions of racial bias.

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American economy retains its strong-ly regional character.

A Nation of Regions

Distinct regions emerged inAmerica’s first century as immigrantsfrom different lands moved to partsof the country where their skillsmight best be suited and their fami-lies welcomed. Scandinavian farmerslanded in Minnesota; Jewish immi-grant tradesmen from Europe’s citiessettled in New York and other majornorthern cities; Mexican farm work-ers beat a path to California’sorchards and fields.

Settlers followed kinsmen, creat-ing clusters of common customs thattook root in each region. JournalistDan Morgan has observed that order-ly New England “Yankees” movingfrom their homes in the northeasternUnited States to Ohio laid out plansfor future towns with schools andcourthouses “before the first harvestwas in.” German immigrants erectedsturdy dairy barns in Pennsylvania,built to last, and they did, as one gen-eration followed another. Farmersand townspeople in the East soughtland or fortune on western frontiers,braving life-threatening challenges.Those who made it implanted astrong individualistic strain that stillcharacterizes the western outlook.

This clustering of people, skills,and resources fostered the emer-gence of distinct regional identitiesand personalities. Journalist JoelGarreau, in his book The Nine Nationsof North America, suggests that theUnited States, Canada, Mexico, andthe Caribbean contain separateNorth American regions with differ-ent, defining characteristics. TheU.S. regions are New England; theold industrial states around the Great

Lakes; the South with its historicallegacies and new economicdynamism; the breadbasket of farm-lands from the Midwest to the GreatPlains; the thinly settled wildernessand desert regions along the RockyMountains; the center of Latino pres-ence in Texas and the Southwest; thenucleus of environmental activismalong the Pacific Coast; and the tip ofFlorida with its ties to the Caribbean.

“Some are close to being rawfrontiers; others have four centuriesof history. Each has a peculiar econ-omy; each commands a certain emo-tional allegiance from its citizens.These nations look different, feel dif-ferent, and sound different fromeach other,” Garreau wrote. “Someare clearly divided topographicallyby mountains, deserts, and rivers.Others are separated by architecture,music, language, and ways of makinga living. Most importantly, eachnation has a distinct prism throughwhich it views the world.”

Differences in character affectedhow each region developed. An exam-ple is water. The first settlers reachingAmerica from Britain brought withthem the traditions of English com-mon law. Owners of “riparian” prop-erty—on the banks of lakes andrivers—had the right to claim use ofthe “natural flow” of water past theirlands. But this principle was tested byeconomic competition. Mill owners,key players in the northern colonies’economy, could claim competingrights to the same river.

To settle these disputes, Americancourts created the doctrine of “reason-able use.” It is, in effect, a requirementthat users fairly share water resources.What was reasonable in these disputesvaried from state to state and regionto region, but it often meant that a

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gained 352,000 people a year onaverage. In the West, Pacific Coaststates lost an average 75,500 resi-dents a year, but the Rocky Mountainstates gained an average 130,000.

Unifying Forces and Infrastructure

Even as immigration, resources,and culture helped define regionaldifferences, other economic and cul-tural forces worked to break downregional barriers and integrate moreclosely the nation’s regionaleconomies. These included a com-mon currency, a legal system thatrecognized the rights of propertyownership, and federal laws creatinguniform policies for commerceamong the states. A crucial linkagewas the development of the country’stransportation infrastructure, whichsmoothed the flow of goods amongall the regions.

The need for transportation net-works was clear from the start. It wasGeorge Washington’s dream to con-nect Virginia and other eastern statesto the Ohio Valley—then the nation’sfrontier—through a canal from Wash-ington, D.C., across the AppalachianMountains to Ohio. But money wasscarce, and construction did notbegin until 1828. Before the canal’scompletion in 1850, hundreds ofsteamboats were working the Missis-sippi River and regional railroadscrisscrossed the populated easternstates. Rail and steam had made thecanal obsolete before its completion.

Samuel F.B. Morse’s developmentof the telegraph received crucialfunding from the federal govern-ment: a $30,000 grant enabled him torun a telegraph line from Baltimore,Maryland, to Washington, D.C., in1844. The determined inventor tri-umphed when the line instantly and

magically transmitted to Washingtonthe results of the presidential nomi-nating conventions held in Baltimore,using the dot-and-dash letter codeMorse had created.

Morse’s telegraph was an earlydemonstration of the key role that theU.S. government would play in pro-moting science and commerce, a rolethat has continued to the presentthrough the funding of the U.S. spaceprogram, cancer research, andadvanced energy systems. Morsebelieved that the government, havingbankrolled the project, should buildand run a nationwide telegraph net-work, just as it delivered the mails.But Washington officials were notinterested, and Morse and his part-ners formed a private company torun telegraph wires between Wash-ington and New York. Five years later,19,000 kilometers of lines had beenstrung. That number was doubled byarmies during the Civil War. BeforeMorse’s death in 1872, telegraphlines extended 400,000 kilometers,opening a coast-to-coast communica-tions capability that was indispensableto the economy’s growth.

The federal government alonehad the authority and capital tolaunch the 19th century’s greatestinfrastructure project—the transcon-tinental railroad. President AbrahamLincoln signed the legislation creat-ing a nationally chartered corporationto undertake the immense project.Two companies got the task of build-ing the lines, one starting in Omaha,Nebraska, the other in Sacramento,California. The hazardous project,which had to cross deserts and over-come western mountain ranges,employed 10,000 workers, includingEuropean settlers, freed slaves, andChinese immigrants.

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New England’s textile industryover the past century graduallymoved to the South, where land wascheaper and labor unions weaker. Inrecent decades, foreign auto andtruck companies have set up facto-ries across the South, welcomed bygrowth-minded business and civicleaders. Today, once-empty towns inWyoming are filling up with new-comers taking jobs in the state’sexpanding coal industry.

The mobility of American work-ers is well documented. One study inthe past decade reported that, onaverage, U.S. college graduateswould work for 11 employers beforeretirement. The U.S. Bureau of LaborStatistics calculated that collegegraduates would hold 13 differentjob positions, counting promotionsand changes of employers, beforereaching 38 years of age.

The willingness of Americans to“get up and go” is recorded by thenational census taken every 10 years.The 1990 U.S. census found that just60 percent of the country’s peoplewere living in the same state wherethey were born. And that averageconcealed considerable variationsamong the states. Eighty percent ofPennsylvanians surveyed in that cen-sus, and more than 70 percent of res-idents of other states, including Iowa,Louisiana, Michigan, Minnesota, andMississippi, were living in their birthstate. But only 30 percent of Florida’sresidents could say the same.

Migration continued in the begin-ning of the 21st century. From 2000to 2004, the northeastern UnitedStates lost a net average of 246,000residents a year, and the Midwest’spopulation declined by an average161,000 people a year. But the South

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Above: The 1930s Great Depression and dust storms led 300,000 people from the plains states tomigrate to California looking for work on farms.

Courtesy of Library of Congress

influential automobile and oil indus-tries, the government-funded high-way network was under constructionby 1956. Its initial route plan wascompleted in 1992 at a cost of $114billion—10 times the projected bud-get—and paid for almost entirely bytaxes on gasoline sales and otheruser fees.

By 2004, the road network cov-ered 75,408 kilometers. It accelerat-ed the movement of city dwellers tosuburbs, encouraged the spread ofindustry from older commercial cen-ters in the North into the South andWest, and established the truckingindustry as a rival for railroads inshipping freight. It also put moreAmericans on the road, and theresulting increases in their already-expanding demands for oil-basedmotor fuels would dominate thecountry’s energy policy debates.

Creating a National Audience

The United States is often consid-ered a comparatively decentralizedcountry, one with a federal govern-ment, and yet one in which individ-ual citizens identify strongly withtheir regions, states, and municipali-ties. To some extent this was a func-tion of the country’s great size, andof technological limits. Nineteenth-century advances such as the tele-graph and the transcontinental rail-road helped to bridge this distance.

But it was broadcasting—radio,then television—that helped to createtruly nationwide audiences, a morecommon culture, and a truly nationaleconomic market. Americans livingthousands of miles apart could expe-rience domestic and global eventssimultaneously. Radio news broad-casts from the 1920s on deliveredmomentous news happenings, Presi-

dent Franklin D. Roosevelt’s “firesidechats,” and popular sporting events.

Broadcasting in America mostlyhas evolved along a privately owned,publicly regulated model. While radioand television stations are licensed bythe federal government and arerequired to serve the public interest,most also are run to generate profitsfor their private-sector owners, whoachieve this by selling advertisingtime. These product pitches primethe pump of consumer spending.The country’s top advertisers spent$150 billion promoting their wares in2006, with 44 percent of that going totelevision, 40 percent to newspapersand magazine, 7 percent to radio,and nearly 7 percent more to fast-growing Internet advertising.

Advertising is the informationsource that underpins competitionand promotes the consumer choiceessential for a mass-market economy.Critics also charge that advertisingpromotes excessive materialism andunwise spending impulses.

The Power of Education

Benjamin Rush, a Philadelphiaphysician and signer of the Declara-tion of Independence, told all whowould listen that winning the war ofindependence from England hadbeen hard enough. Still harder wouldbe the challenge of making democra-cy work. To fulfill that task, the newself-governing nation had to create abroad system of free public education.

“The form of government wehave assumed has created a new classof duties to every American,” Rushsaid in 1783. Believing thathumankind was “improvable,” Rushand other founders wanted educa-tion to be useful. But it also had acentral political purpose: Education

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The railroad united the nationfrom coast to coast. Grain, coal tomake steel and illuminating gas, cop-per, iron ore, petroleum, timber,clothing to supply new city depart-ment stores and consumer catalogbusinesses, foodstuffs—even fruit innewly created refrigerator cars—allcould cross the country in search ofmarkets. A trip from New York toChina, which had taken 100 daysaround South America’s forbiddingCape Horn, now could be completedin 30 days thanks to the continent-spanning railroad.

In 1912, the automobile was still atoy of the wealthy. But industrialistCarl G. Fisher, whose company madeautomobile headlights, saw the possi-bilities of a coast-to-coast highwayand organized a campaign to create itwith public contributions. The 5,456-

kilometer route was called the Lin-coln Highway, and by 1925 it ranfrom New York to San Francisco. Atthe project’s start, improved high-ways covered less than half of theroute. Sections of the route followedhistoric pathways blazed by NativeAmericans, colonial settlers, CivilWar armies, and the Pony Expressmail service. Called “America’s MainStreet,” it forged the first connectionbetween commerce and the automo-bile and inspired the construction ofthe Interstate Highway System begin-ning in the 1950s.

President Dwight D. Eisenhowerhad made the arduous cross-countrytrip by truck as a young Army officerin 1919 and conceived of a modernlimited-access highway system thatwould buttress America’s internaldefenses. Strongly promoted by the

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Above: The Interstate Highway System of limited-access roads like these in Los Angeles bolsteredsuburbs, drove shifts of manufacturing to different states, and promoted the trucking industry forshipping goods.

© iofoto / Shutterstock

veterans attend college, and the per-centage of men attending collegesclimbed rapidly. The percentage ofwomen over age 25 who had attend-ed college did not increase signifi-cantly until after 1980. But by 2005,the percentage of women over 25with some college education exceed-ed the percentage for men, reflectingthe impact of the women’s move-ment and the desire of, or need for,women to join the workforce.

As international competition andforeign trade became larger factorsin the U.S. economy during the firstdecade of the 21st century, a shift ofjobs away from the older centers offactory production accelerated. Theregions gaining jobs have beenregional centers where technologyand finance are strongest, as shownby government data on job gains andlosses for major U.S. cities from 2000to 2007.

While job growth throughout theUnited States averaged less than 1percent a year during those sevenyears, Huntsville, Alabama, a center ofU.S. space technology, had a 42 per-cent increase in “professional, scientif-ic, and technical” jobs. Austin, Texas,where semiconductor production hasa strong footing, had a 22 percentgain in the same category of technol-ogy jobs. In Northern Virginia, whoseeconomy is built on the presence ofmajor contractors who work on thefederal government’s technologymissions, jobs in the professional andscientific category expanded by 31percent from 2000 to 2007, and com-

puter system design jobs grew by thesame percentage.

In contrast, Chicago, America’s“second city” and the centerpiece ofthe old manufacturing Midwest, lost19 percent of its goods-producing jobsover those seven years. South Bend,Indiana, another old factory city, lost18 percent of its goods-producingjobs. Detroit, Michigan, home of theU.S. car industry, suffered a 35 per-cent drop in goods-producing jobs.

Well before the start of the 21stcentury, many had concluded thatAmerica’s economy could no longerprosper simply by employing Yankeeingenuity to convert its wealth of nat-ural resources into products for saleat home and abroad. Nor could itrely on older industries that hadbeen centerpieces of state andregional economies to hold theirplaces in competitive markets.

Since the 1980s, many local offi-cials have tried to stimulate theireconomies by investing in theirregion’s education and technologyresources. Some governors have cre-ated technology “greenhouses”—giving space in research facilities tohelp entrepreneurs develop newproducts and processes. Universitieshave developed courses to equip sci-entists and engineers with specificskills needed by local companies.

Such regional strategies lostmomentum in the 2000s decade asthe economy grew and unemploy-ment shrank. But the steep recessionthat began in 2008 was expected torenew interest in these policies.

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was essential to equip citizens to usethe power of the ballot wisely.

The question was how, and at firstalso who. In the nation’s early decades,states followed many paths in expand-ing public education, at least to thesons of white Americans. Native Amer-icans were excluded. African-Ameri-can children in the North had separateschools; the children of slaves receivedno schooling. Young girls were typical-ly taught homemaking skills.

The reforms that would makeAmerican education a model for theworld got their strongest initial pushfrom Horace Mann, who served assecretary of the Massachusetts StateBoard of Education beginning in1837. He grew up in poor circum-stances and could attend school onlypart time, but, with help from tutors,he attended college and then spentthe rest of his life promoting a then-revolutionary educational philosophy.

Mann campaigned for free, tax-payer-supported public schools thatboth rich and poor children wouldattend together. While these publicschools would be managed locally,Mann advocated an encompassingsystem of educational improvementto apply best-teaching methods andto assess schools’ performance.Mann’s preferred curriculum wouldseek to instill general Protestantmoral, as opposed to religious, pre-cepts, and it would aim to foster anonpartisan patriotism. Beyond that,Mann argued that schools must strivefor the highest scholarship, teachingstudents to educate themselves forroles in the economy and society.

States across the country gradual-ly adopted Mann’s ideas, thus raisingthe quality of broadly available pub-lic education. Schools in poor areasand the racially segregated parts of

the South received substantiallyfewer resources than other schoolsystems, a gap that has narrowed butnot been fully eliminated since thestart of federal antipoverty and edu-cational programs in the 1960s.

While debates about educationmethods have persisted at least sinceHorace Mann’s day, one precept wide-ly shared by most Americans is that anation’s wealth includes not just its cit-izens’ private property, but also thosecitizens’ capacity to better themselves,says historian Lawrence A. Cremin.“Granting its flaws, its imperfections,and even its several tragic shortcom-ings,” Cremin says, the U.S. educationsystem stands “among the two orthree most significant contributionsthe United States has made to theadvancement of world civilization.”

By the end of the 19th century, awide range of colleges and universi-ties had been opened. They includedelite private universities, a group ofcolleges opened for African Ameri-cans, and a system of land-grant uni-versities established by Congress toprovide education in “agricultureand mechanical arts.” The land-grant schools have evolved todayinto state universities with tens ofthousands of students.

Education was a cornerstone ofU.S. economic success. The 1940federal census reported that one-quarter of Americans over the age of25 had attended high school and 4.6percent had graduated from college.A 2007 census survey found 44 per-cent of Americans over age 25 hadgraduated from high school, 17 per-cent had attended college but notearned a degree, and 27 percentwere college graduates.

At the end of World War II, Con-gress funded scholarships to help

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Governmentand the Economy

Much of America’s history has focused on the debate over the government’s role in the economy.

C H A P T E R

© Lance Nelson/Corbis

“Then a strange blight crept over the area and everything began tochange....There was a strange stillness....The few birds seen any-where were moribund; they trembled violently and could not fly. It was a spring without voices. On the mornings that had oncethrobbed with the dawn chorus of scores of bird voices there was nowno sound; only silence lay over the fields and woods and marsh.”

RACHEL CARSON

Silent Spring1962

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The United States was established on the mutuallyreinforcing principles of individual enterprise and limitedgovernmental influence. The rage of the American colonists overa range of taxes imposed by the British Crown helped trigger theRevolutionary War in 1775. “Taxation Without Representation” was abattle cry. The new republic’s first secretary of the Treasury, AlexanderHamilton, succeeded in establishing a national bank but lost his cam-paign for a federal industrial policy in which government would pro-mote strategically important industries to strengthen the nation’seconomy and its military defense.

But this predisposition toward free enterprise was not absolute. From thebeginning, the country’s governments—federal, state, and local—have pro-tected, regulated, and channeled the economy. Governments have inter-vened to aid the interests of regions, individuals, and particular industries.Just how far the government should go in doing this always has been a cen-tral political issue.

The legal justification for economic regulation rests on a few sections ofArticle I of the U.S. Constitution. These give Congress authority to collecttaxes and duties, borrow on the credit of the nation, pay the federal govern-ment’s debts, create and regulate the value of U.S. currency, and establishnational laws governing bankruptcies and the naturalization of immigrants.States were barred from taxing trade with other states. The Constitution’sauthors recognized that the young country had far to go to match Europeanscientific and industrial leadership; in part for this reason, they empoweredCongress to give authors and inventors exclusive rights to profit from theircreations for a limited period.

The most general—and controversial—constitutional language on theeconomy lies in the 16 words of Article I, Section 8, which authorize Con-gress to “regulate commerce” with foreign nations, with the native AmericanIndian tribes, and among the states. This application of the commerce

© Underwood & Underwood/Corbis

Above: Rachel Carson, a government scientist, raised concerns about pesticide usethat led to government environmental regulation. Previous spread: In 2009 the FederalReserve was poised to gain even more power for regulating financial institutions.

wrongful conduct. In one exception-al case, a former sales manager of aleading U.S. drug company received$45 million in 2008 as his share ofthe payment by the company thatsettled a federal investigation intoalleged improper marketing ofdrugs widely used in the govern-ment’s Medicaid program for low-income patients.

For more than a century, Ameri-cans have debated how far the feder-al government should go to preventdominant companies from under-mining economic competition. Regu-lation of businesses has usually beenof one or two types. Economic regula-tions have tried to combat abuses bymonopolies and, at times, establish“fair” prices for specific commodities.Social regulations aim to protect thepublic from unsafe food or drugs, forexample, or to improve the safety ofmotorists in their cars.

Federal regulation arrived withthe railroad age in the 19th century.The power of railroad owners to setinterstate shipping rates to theiradvantage led to widespread com-plaints and protests about discrimi-natory treatment that favored somecustomers and penalized others. Inresponse, the Interstate CommerceCommission, the United States’ firsteconomic regulatory agency, was cre-ated in 1887. Congress gave it theauthority to determine “reasonable”maximum rates and require thatrates be published to prevent secretrate agreements.

The ICC set a pattern that wouldbe followed by other federal regula-tory agencies. Its commissioners werefull-time regulators, expected tomake independent, fact-based deci-sions, and it played an influential rolefor nearly a century before its powers

were reduced in the movementtoward government deregulation.The agency was abolished in 1995.

Another early regulatory agencywas the Federal Trade Commission,established in 1914. It sharedantitrust responsibility with the U.S.Justice Department for preventingabuses by powerful companies thatcould dominate their industrieseither singly or acting with othercompanies. By the end of the 19thcentury, the concerns about econom-ic power had focused on a series ofdominant monopolies that con-trolled commerce in industries asdiverse as oil, steel, and tobacco, andwhose operations were often cloakedin secrecy because of hidden owner-ship interests. The monopolies typi-cally took the form of “trusts,” withshareholders giving control of theircompanies to a board of trustees inreturn for a share of the profits in theform of dividends.

More than 2,000 mergers weremade between 1897 and 1901, whenTheodore Roosevelt became presi-dent and began his campaign oftrust-busting against the “malefac-tors of great wealth,” as he called thebusiness tycoons he targeted. UnderRoosevelt and his successor, Presi-dent William Howard Taft, the feder-al government won antitrust lawsuitsagainst most of the major monopo-lies, breaking up more than 100,including John D. Rockefeller’s Stan-dard Oil trust; J.P. Morgan’s North-ern Securities Company, which dom-inated the railroad business in theNorthwest; and James B. Duke’sAmerican Tobacco trust.

Congress in 1898 gave workersthe right to organize labor unionsand authorized government media-tion of conflicts between labor and

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clause to the states has been usedduring the past century to justify far-reaching government programs onissues the Founding Fathers couldnever have imagined.

Interpretation of the commerceclause divides Americans who wantan activist federal government fromthose who advocate a more limitedcentral authority. The U.S. SupremeCourt has often been called on toresolve disputes over the reach of thecommerce clause. Some of theimportant 19th-century decisionsinterpreted the clause narrowly, find-ing that, while shipments of goodsalong rivers that passed several stateswere covered by the commerceclause, manufacturing was a localactivity and not covered.

But the court’s decisions grewmore expansive in the 20th century,upholding important New Deal pro-grams affecting employment andagriculture. In the 1960s, the judicia-ry broadly interpreted the term“interstate commerce,” as it held thatCongress did possess the power topass the landmark civil rights lawsthat forbade private businesses fromengaging in racial discrimination. Inthese cases the courts carefully scruti-nized the evidentiary record for tiesto interstate commerce, in oneinstance finding it in the wheat usedin the hot dog rolls served by a “pri-vate” club that practiced discrimina-tion in membership. Beginning inthe 1990s, a number of SupremeCourt rulings sought to narrow thoseearlier decisions by focusing the com-merce clause on controversies direct-ly centered on economic activities.

Although economic regulation hasdiminished since the 1970s, its protec-tions still play an essential role, affect-ing the health of workers; the safety of

medicines and consumer products;protection of motorists and airlinepassengers, bank depositors and secu-rities investors; and the impact of busi-ness operations on the environment.

The Reach of Economic Regulation

In the life cycle of an Americanbusiness, the first step is the leastregulated of all. An entrepreneurseeking to form a new business needonly register the company andrecord it with state tax authorities.Those entering specific occupationsmay require licenses or certifications,but no permission is required to cre-ate a company.

Another set of laws and rules gov-ern the balance of the rights ofemployees to keep their jobs and therights of employers to fire workerswho aren’t performing acceptably.The rules favor the employer. Inmost U.S. states, people are consid-ered “at will” employees, meaningthey can be discharged whenever theemployer chooses, except undersome specific situations where theworkers’ rights are protected. Peoplemay not be fired because of theirrace, religion, gender, age, or sexualpreference, although terminatedemployees will need to show thatthey were wrongfully discharged ifthey want to recover their jobs. Thefederal Equal Employment Oppor-tunity Commission, created in 1961,can sue employers to defend workersagainst unjust firing.

A federal whistle-blower law pro-tects employees who disclose theiremployers’ illegal activities. If anemployer has cheated the federalgovernment, a whistle blower mayreceive between 15 and 30 percent ofthe money recovered by the govern-ment because of the company’s

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When President Woodrow Wilson traveled to the 1919 Paris PeaceConference at the end of World War I, the U.S. delegation he assembled includ-ed Samuel Gompers, the slight, 69-year-old son of poor Jewish immigrants from

Holland by way of Britain. Gompers had risen from an apprentice cigar maker in New YorkCity to become president of the American Federation of Labor, the country’s largest unionorganization.

Gompers’s leadership of the AFL during the turbulent birth of the union movement definedthe unique role of labor organizations in the United States. For most of the century that fol-lowed, despite periods of violent conflicts with company managements, U.S. labor leadershipnever frontally attacked the capitalist market structure of the nation’s economy. Its goal wasa greater portion of the economy’s fruits for its members. “We shall never cease to demandmore until we have received the results of our labor,” Gompers often said. But he also held that“the worst crime against working people is a company which fails to operate at a profit.”

Although these goals sound today to be within the boundaries of mainstream politicaldebate, labor’s efforts to organize railroad, mine, and factory workers a century ago pro-duced constant confrontations, many of them violent and some deadly. The strike by steel-workers at Andrew Carnegie’s Homestead, Pennsylvania, plant in 1892 caused a bloody fightpitting workers and their families and friends against company-hired guards, and ultimatelystate militia. The core of the dispute was a power struggle between workers and managementover work rules governing the plant’s operations. Although Carnegie said he favored unions,he backed the goal of his deputy, Henry Clay Frick, of regaining unchallenged control overthe plant. After a series of assaults, gunfights, and an attempted assassination of Frick, thestrike was broken. Gompers’s AFL would not take the strikers’ side, and the plant remainednon-union for 40 years.

But over the following decades, labor’s demand for a larger share of the economic pieand relief from often brutal working conditions were adopted increasingly by politicalreformers and then national political candidates. Even in the darkest years of the GreatDepression, when a quarter of the nation’s workforce was unemployed, American laborunions mostly concentrated on securing higher wages and better working conditions and noton assuming traditional management prerogatives to make fundamental business decisions.Nor did U.S. labor unions follow the example of European unions by embracing radical pol-itics or forming their own political party. American labor instead typically used its financialand organizational clout, greatest in the industrial states of the Northeast and the Midwest,to back pro-labor political candidates.

The legitimacy of organized labor was guaranteed by the National Labor Relations Actof 1935, commonly known as the Wagner Act. Part of President Franklin D. Roosevelt’s NewDeal, the law established the rules under which workers could form unions and employerswould be required to bargain with them, and also established a National Labor RelationsBoard to enforce those rules.

During the prosperous years following World War II, U.S. labor unions enjoyed theirgreatest success. Automobile manufacturers, to cite one example, found it preferable to nego-tiate generous wages and benefits, passing through the costs to American consumers.

But global and domestic developments gradually changed the economic climate in waysunfavorable to industrial unions. Many U.S. manufacturers expanded or shifted operationsto southern states, where labor unions were less prevalent. Beginning in the 1980s, manu-facturers turned increasingly to foreign sources of products and components. When steel andother manufacturing plants closed down across the northeastern and midwestern states, peo-

The Changing Union Movement

ple started calling the region the Rust Bowl, an echo of the devastating 1930s’ Dust Bowlerosion of midwestern farmland. In the southern Sun Belt, much domestic industrial jobgrowth focused on new, nonunion factories established by foreign manufacturers, Japaneseand German carmakers prominent among them.

One symbolic moment in the relative decline of organized labor occurred early in the firstadministration of President Ronald Reagan (1981–1989). Ironically, Reagan came from aunion background; a successful actor, he rose to head the Screen Actors Guild, where he leda campaign to block communist efforts to infiltrate the union. In 1981, Reagan confronteda strike by the Professional Air Traffic Controllers Organization. The strike was illegal, asfederal employees were by law permitted in many cases to unionize but prohibited from strik-ing “against the public interest,” as the commonly used phrase went. Reagan gave the con-trollers 48 hours to return to their jobs, then fired the 11,000-plus who refused to return,replacing them with new workers and breaking the union.

The outcome reflected the American public’s lack of sympathy for public employeestrikes, and it also reflected waning union membership. At the end of World War II, one-third of the workforce belonged to unions. By 1983, it was 20 percent, and by 2007, the fig-ure had dropped to 12 percent

One bright spot for organized labor was growth in the services sector, particularly amongpublic service employees such as teachers, police officers, and firefighters, whose jobs couldnot easily be outsourced. This trend is illustrated by the growth of the Service EmployeesInternational Union, whose ranks nearly doubled between 1995 and 2005 to reach 1.9 mil-lion members at a time when industrial union rolls were shrinking. The SEIU representsworkers at the bottom of the income scale, including janitors, nurses, custodial workers, andhome-care providers. Many of their jobs lack health insurance and other benefits that comewith high-paid work. Another major union, the National Education Association, representsmore than 3 million public school teachers and employees.

Labor organizations such as the AFL-CIO (an umbrella organization of many unions),SEIU, and NEA assisted President Barack Obama’s successful 2008 election, helping staffhis voter registration and turnout drives. The unions hoped that the incoming Obama admin-istration would advance new legislation strengthening their efforts to organize workplaces.

Above: Organizers for the Office Workers Union stage a rally on Wall Street in New York City in 1936.

© Time & Life Pictures/Getty Images

nant firms, not their size and poweralone; Theodore Roosevelt famouslyobserved that there were both “goodtrusts” and “bad trusts.”

In 1911, the Supreme Court setdown its “rule of reason” in antitrustdisputes, holding that only unreason-able restraints of trade—those thathad no clear economic purpose—were illegal under the Sherman Act.A company that gained a monopolyby producing better products or fol-lowing a better strategy would not bevulnerable to antitrust action. But theuse of antitrust law to deal with dom-inant companies remained an unset-tled issue. Federal judges hearingcases over the decades have tendedto respect long-standing legal prece-dents, a principle known by its Latinname, stare decisis.

Court rulings at times havereflected changes in philosophy ordoctrine as new judges were appoint-ed by new presidents to replace retir-ing or deceased judges. And thejudiciary tends also to reflect thetemperament of its times. In 1936,during the New Deal era, Congresspassed a new antitrust law, theRobinson-Patman Act, “to protectthe independent merchant and themanufacturer from whom he buys,”according to Representative WrightPatman, who co-authored the bill. Inthis view, the goal of antitrust law wasto maintain a balance between largenational manufacturing and retail-ing companies on one side, and thesmall businesses that then formedthe economic center of most com-munities on the other.

This idea—that the law shouldpreserve a competitive balance inthe nation’s commerce by restrain-ing dominant firms regardless oftheir conduct—was reinforced by

court decisions into the 1970s. Atthe peak of this trend, the U.S. gov-ernment was pursuing antitrustcases against IBM Corporation, thelargest computer manufacturer, andAT&T Corporation, the nationaltelephone monopoly.

Protecting Competition, Not Competitors

In the 1980s, the Reagan admin-istration adopted a different philoso-phy, one advocated by academics atthe University of Chicago. The“Chicago school” economists arguedthat antitrust law should, above all,protect competition by putting con-sumers’ interests first: A single pow-erful firm that lowers product pricesmay hurt competitors, but it benefitsconsumers and therefore should notrun afoul of the antitrust law.

Robert H. Bork, an antitrustauthority and federal appeals courtjudge, argued that “it would be hardto demonstrate that the independentdruggist or the grocery man is anymore solid and virtuous a citizenthan the local manager of a chainoperation.” The argument that smallbusinesses deserved special protec-tion from chain stores “is an uglydemand for class privileges.”

This shift in policy was reflectedin a climactic antitrust case againstthe Microsoft Corporation. PresidentBill Clinton’s Justice Departmentfiled an antitrust suit in 1998 againstMicrosoft, which controlled 90 per-cent of the market for personal com-puter operating systems software.Microsoft allegedly had used its mar-ket power to dominate a crucial newapplication for computers—thebrowser software that links users tothe Internet.

A federal judge ruled againstMicrosoft, but his decision was over-

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management. During the New Deal,Congress enacted the National LaborRelations Act of 1935 (usually calledthe Wagner Act after one of its spon-sors), which legalized the rights ofmost private-sector workers to formlabor unions, to bargain with man-agement over wages and workingconditions, and to strike to obtaintheir demands. A federal agency, theNational Labor Relations Board, wasestablished to oversee union elec-tions and address unfair labor com-plaints. The Fair Labor Standards Actwas passed in 1938, establishing anational minimum wage, forbidding“oppressive” child labor, and provid-ing for overtime pay in designatedoccupations. It declared the goal ofassuring “a minimum standard of liv-ing necessary for the health, efficiency,and general well-being of workers.”But it also allowed employers toreplace striking workers.

In the 1930s and the decades thatfollowed, Congress created a host ofspecialized regulatory agencies. TheFederal Power Commission (laterrenamed the Federal Energy Regula-tory Commission) was created in 1930as an independent regulatory agencywhich would oversee wholesale elec-tricity sales. The Federal Communica-tions Commission was established in1934 to regulate the telephone andbroadcast industries. The Securitiesand Exchange Commission in 1934was given responsibility for oversee-ing securities markets. These were fol-lowed by the National Labor RelationsBoard in 1935, the Civil AeronauticsBoard in 1940, and the ConsumerProduct Safety Commission in 1975.Commissioners of these agencieswere appointed by the president.They had to come from both majorpolitical parties and had staggered

terms that began in different years,limiting the executive branch’s abili-ty to replace all the commissionersat once and hence its influence overthe regulators.

The Antitrust Laws

The government’s antitrustauthority came from two laws, theSherman Antitrust Act of 1890 andthe Clayton Act of 1914. These laws,based on common law sanctionsagainst monopolies dating fromRoman times, had different goals.The Sherman Act attacked conspira-cies among companies to fix pricesand restrain trade, and it empoweredthe federal government to break upmonopolies into smaller companies.The Clayton Act was directed againstspecific anticompetitive actions, andit gave the government the right toreview large mergers of companiesthat could undermine competition.

Although antitrust prosecutionsare rare, anticompetitive schemeshave not disappeared, as economistJoseph Stiglitz says. He cites effortsby the Archer Daniels Midland com-pany in the 1990s in cooperationwith several Asian partners tomonopolize the sale of several feedproducts and additives. ADM, one ofthe largest agribusiness firms in theworld, was fined $100 million, andseveral executives went to prison.

But the use of antitrust laws out-side the criminal realm has beenanything but simple. How far shouldgovernment go to protect competi-tion, and what does competitionreally mean? Thinkers of differentideological temperaments have con-tested this, with courts, particularlythe Supreme Court, playing the piv-otal role. From the start, there wasclear focus on the conduct of domi-

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environmental gain. Academic andbusiness critics of Rachel Carson, forexample, argued that eliminatingDDT removed the most effectivepesticide in the fight against mosqui-toes that spread malaria. In her time,Carson—who urged that DDT becontrolled, not eliminated—tippedthe public debate in favor of precau-tionary government regulation thatcould address serious threats, eventhough some scientific or economicissues were still being debated. Thecurrent debate over climate changehas reached a similar point.

As historians have observed, U.S.government priorities on economicand social issues have seldom taken astraight, unbroken path, but insteadhave followed the swings of publicopinion between a desire for moreregulation and one for unfetteredeconomic growth. In the 1960s, aperiod when Americans challengedthe status quo on a number of fronts,many were willing to discount theindustry viewpoint in the debate overpesticide regulation and to supportfederal intervention to protect theenvironment. In the 1980s, opinionreversed direction again.

The Tide Turns Against Regulation

Historian Daniel Yergin sees aturning point in public support forregulation in America’s economicstagnation of the 1970s, when oil pricesand inflation soared, and employ-ment and stock markets slumped.Critics of regulatory activism had longcharged that regulation stifled eco-nomic growth, and they challengedgovernment economic interventionsas unwise and unfair.

With the economic malaise of the1970s and early 1980s, more Ameri-cans and their political representa-

tives were willing to give business afreer hand in order to enhance eco-nomic growth. “With time,” wroteYergin and Joseph Stanislaw in TheCommanding Heights, “competitionincreasingly came to be seen aspreferable to regulation.” StephenBreyer, an important U.S. Senatestaff member in the 1970s, put itsimply: “Why regulate something ifit can be done better by the market?”

Breyer, later a U.S. Supreme Courtjustice, was targeting the regulation ofcommercial airline service by the fed-eral Civil Aeronautics Board. The CABset prices for air travel on all domes-tic routes and decided which airlineswould serve the cities around thecountry. It was a regulatory tradeoff:In return for providing unprofitableair service to smaller cities, airlineswere rewarded with high prices andprofits on busy routes between largecities. By the 1970s, this seemed likean inefficient, costly approach. Com-petition could do better, Congressconcluded, and in 1978, airlinederegulation was enacted. The CABwas closed down in 1985.

Although the costs and benefits ofairline deregulation continue to beargued, competition dramaticallychanged the industry. Prices did fallon heavily traveled air routes. Newairlines sprang up to challenge theindustry leaders. The new airlinespaid lower wages to pilots, mechan-ics, and flight attendants and couldcharge less money for tickets. Theolder airlines lost ground, fallinginto damaging quarrels with theirunionized pilots and other employ-ees. Many failed. Others mergedtogether to try to stay competitive.The number of people flying ondomestic U.S. flights soared from240 million in 1977 to 665 million in

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ruled by a higher appeals court judge.A key factor in the latter decision wasthat Microsoft offered its browser soft-ware for free. While that hurt its muchsmaller competitors, consumers bene-fited, and maximizing consumerinterests served the larger interests ofthe economy, the court ruled. Compe-tition and innovation would keepcompetition healthy, according to thistheory. President George W. Bushdecided not to continue the JusticeDepartment’s case against Microsoft.

The Birth of Environmental Regulation

Widespread social regulationbegan with the New Deal employ-ment and labor laws but expanded inthe 1960s and 1970s. Both Democra-tic and Republican presidents joinedwith Congress to act on a wide rangeof social concerns.

Perhaps the most striking exam-ple of how public opinion affectsU.S. government processes was thesudden growth of the environmentalmovement as a powerful politicalforce in that period. Conservation ofnatural resources had motivatedpolitical activists since the late 19thcentury, when California preserva-tionist John Muir led campaigns toprotect wilderness areas and found-ed the Sierra Club as a grassrootslobbying organization for his cause.

The movement surged in newdirections in the 1960s followingpublication of a best-selling book,Silent Spring, written by governmentbiologist Rachel Carson. She warnedthat the growing use of chemical pes-ticides was causing far-reachingdamage to birds, other species, andthe natural environment. They couldthreaten human health as well, shesaid. The chemical industry attackedCarson as an alarmist and disputed

her claims. But her warnings, ampli-fied by media coverage, won power-ful support from citizens and theU.S. government. The movementled to a ban on the widely used pes-ticide DDT and the formation of theU.S. Environmental ProtectionAgency in 1970 to enforce federalenvironmental regulation.

Unlike the independent agenciescreated in the 1930s, the EPA wasmade a part of the executive branch,subject to the president’s direction.This approach was followed later withother new agencies, such as the Occu-pational Safety and Health Adminis-tration (OSHA) in 1970 to preventworkplace accidents and illnesses, andthe Consumer Product Safety Com-mission in 1972 to regulate unsafeproducts. Because of the increasedpresidential control, these agencies’regulatory policies often change withthe arrival of a new president.

Federal regulations have had pro-found impacts in reducing healthrisks facing industrial and shipyardworkers; improving the safety ofmedicines, children’s toys, and motorvehicles; and improving the cleanli-ness and quality of lakes, rivers, andthe air. OSHA, for example, requiresemployers to create a workplace thatis “free from recognized hazards”that cause or could cause death orserious harm. The OSHA legislationhas been used by the government,often following demands by laborunions, to control workers’ exposureto a range of industrial chemicalsthat cause or may cause cancer.

Debate about such regulation hasoften centered on whether there isadequate scientific evidence to justifygovernment action and whethercompliance costs paid by businessesand their consumers are worth the

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other states. Many states also protect-ed small community banks with rulesrestricting the number of branchoffices that big banks could openinside the state. Almost all of theseregulations were removed after 1980,leaving a banking industry that wasmore competitive, more concentrat-ed, more freewheeling and morerisk-taking—and more vulnerable tocatastrophic failures.

As banks expanded geographical-ly, they sought also to enter newfinancial arenas, including ones for-bidden to them by New Deal-era leg-islation that separated parts of thecommercial banking and securitiesindustries. Banks were permitted toreenter the securities business in1999, and many major banks subse-quently created unregulated divi-sions, called special investment vehi-cles, in order to invest in speculativemortgage-backed securities andother housing-related investments.

Congressional advocates of a loos-er regulatory regime argued thatgreater bank freedom would producemore modern, efficient, and innova-tive markets. For a time, it arguablydid. The U.S. financial sector led theway during a period of unprecedent-ed international expansion of bank-ing and securities transactions.

A McKinsey Global Institute studyreported that from 2000 to 2008, thesum of all financial assets—bank

deposits, stocks, and private and gov-ernment bonds—soared from $92trillion to $167 trillion, an averageannual gain of 9 percent and one thatfar exceeded the growth in world eco-nomic output. Alan Greenspan, chair-man of the Federal Reserve Boardduring most of that period, said thatglobal financial markets had growntoo large and complex for regulatorsadequately to oversee them. It was forCongress, he argued, to pass new lawsshould it wish closer oversight. But aseconomist Mark Zandi, author ofFinancial Shock, a book about the2008 crash, says, “Legislators and theWhite House were looking for lessoversight, not more.”

At this writing, the 2008 financialcrisis appears to have reversed thephilosophical trend toward greaterreliance on markets and the assump-tions about financial deregulationthat had increasingly held sway inthe United States since the end ofthe 1970s. A public backlash againstmulti-million dollar bonuses and lav-ish lifestyles enjoyed by leaders offailed Wall Street firms fed demandsfor tighter regulation. Greenspanhimself, who retired in 2006, told acongressional committee two yearslater that “those of us who havelooked to the self-interest of lendinginstitutions to protect shareholders’equity, myself especially, are in astate of shocked disbelief.”

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2000. On the other hand, flightsbecame more crowded, delays andlost luggage problems grew, andmore questions surfaced about theairlines’ safety and maintenancepractices. But the restructuring ofthe airline industry marked a clearturning point toward a reliance onmarkets, not government, to makethe economy work for the public.

The Regulation of Banking

Since the first years of the Ameri-can republic, federal and state law-makers and government officialshave struggled to determine theright level of regulation and govern-ment control over the banking sys-tem. When banks can respond tomarket forces, innovation and com-petitive services multiply. But compe-tition’s downside has been a succes-sion of banking crises and financialpanics. Overly aggressive lendingand speculative risk-taking that led tothese crises have, in turn, led to polit-ical demands for tighter controls overinterest rates and banking practices.A new chapter in this debate began inresponse to the 2008 financial crisis.

The U.S. banking and financeindustries have been remade over thepast quarter-century by globalization,deregulation, and technology. Con-sumers can draw cash from automat-ed teller machines, pay bills andswitch funds between checking andsavings accounts over the Internet,and shop online for home loans. Asservices have expanded, the numberof banks has contracted dramatically.Between 1984 and 2003, the numberof independent banks and savingsassociations shrunk by half, accord-ing to one study. In 1984, a relativehandful of large banks, with assets of$10 billion or more, held 42 percent

of all U.S. banking assets. By 2003,that figure was 73 percent.

New computer systems to managebanking operations gave an advan-tage to large banks that could affordthem. The dramatic expansion ofworld trade and cross-border finan-cial transactions led the largest banksto seek a global presence. New mar-kets arose in Asia and other regionsas banking and investment transac-tions flowed instantly across oceans.These trends called for and werefueled by a steady deregulation ofU.S. banking and finance rules.

Historically, the banking industryhas been split between smaller, state-chartered banks that claimed close tiesto their communities, and largernational banks whose leaders soughtto expand by opening multistatebranch offices, saying their size madethem more secure and efficient. Thissplit echoes in some ways the debatesin America’s early days betweenAlexander Hamilton and Thomas Jef-ferson over urban and rural interests.

Community banks prevailed earlyin the 20th century, but were devas-tated by the 1930s banking crisis;their limited assets left them particu-larly vulnerable. The country’surbanization after World War IIreduced the political power of rurallegislators, undermining their abilityto defend smaller banks, and in 1980banking deregulation got under way.

Until the 1980s, U.S. commercialbanks faced limits on the levels ofinterest rates they could charge bor-rowers or pay to customers whodeposited money. They could nottake part in the securities or insur-ance businesses. And their size wasrestricted as well. All states protectedbanks within their borders by forbid-ding entry by banks headquartered in

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Above: Workers assemble a Boeing 787 Dreamliner at the company’s Everett, Washington, plantin January 2009.

Opposite page—clockwise from top: Hills of corn in Kansas are reminders that agricultureremains an important part of the U.S. economy; Federal Express, which delivers goods here in San Francisco and a lot of other places around the world, started out as a small business;workers at a New Balance factory in Skowhegan, Maine, survive the brutal competition of thefootwear industry; construction workers such as this one in New York prospered during the realestate boom early in the 21st century and suffered during the following bust.

Below: Chassis for Ford Motor Company autos roll down the assembly line at the company’sChicago assembly plant in June 2007, before the U.S. auto industry suffered its great contraction.

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Above: Mario Escobar processes orders at this small draperies business in Calabasas, California.

Opposite page—clockwise from top: A Shell Oil Company refinery in Deer Park, Texas, producessome of the tens of millions of barrels of oil consumed in the United States every day; PresidentObama aims to encourage alternative energy sources, such as this wind power utility near PalmSprings, California; the 2008 global recession slowed down shipping at U.S. ports such as thisone in Elizabeth, New Jersey.

Below: Coal mines, such as this one in Coulterville, Illinois, might supply even a bigger share ofU.S. energy needs if clean-coal technology can be made to work efficiently.

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Above: Andronico’s Market in San Franciscorepresents retail sales, one of the serviceindustries that account for the largest share ofeconomic output.

Right: The New York Stock Exchange repre-sents financial services, a sector of the ser-vice economy that was reeling in the globalfinancial crisis that emerged in 2008.

Below: Another representative of retail isLowe’s, which sells hardware to builders andthe millions of Americans who perform littlejobs around the house.

Above: Entertainers Amy Adams, left, Meryl Streep, center,and Viola Davis represent an important U.S. services indus-try that accounts for a significant share of U.S. exports.

Left: Barbie, who reached age 50 in 2009, has become one of toy manufacturing’s all-time hits.

Below: Tourists, such as these at the South Rim of theGrand Canyon in Arizona, contribute a significant share of the U.S. economy.

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Above: Health care represents a growing share of U.S. economic output and a growing costburden for American government and business.

Opposite page—from top: Holiday shopping at the end of the year can mean success or failurefor retailers; U.S. exports to China include McDonalds restaurants.

Below: Education is viewed as one way to reverse a trend of income disparity in the United States.

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A U.S. Economy Linked

to the World

Despite political divisions,the United States shows

no sign of retreat from global engagement in trade and investment.

C H A P T E R

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Open trade “dovetailed with peace; hightariffs, trade barriers, and unfair economiccompetition, with war.…”

Secretary Cordell HullU.S. Department of State

1948

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Trade ties the United States’ economy inextricablyto the markets and economies of the rest of the world. In2007, the U.S. gross domestic product—the output of U.S.-basedworkers and property—totaled nearly $14 trillion. One out of everyeight dollars, or $1.6 trillion, came from exports to foreign destina-tions. Imports into the United States were significantly higher, total-ing $2.3 trillion.

In addition to traded goods and services, huge tides of financial transac-tions flow across global borders. U.S. companies and individuals directlyinvest more than $2 trillion abroad annually, making the United States theworld’s largest direct investor in foreign economies. It also receives moreinvestment from outside its borders than any other nation. As a world finan-cial capital, New York is the center of an international hedge fund industry ofprivate investors that amassed nearly $1.5 trillion in assets at the end of 2006.

While U.S. exports add to the nation’s gross domestic product, the largervolume of imports reduces it. The trade imbalance over the past decade hascreated a politically sensitive tradeoff: The surplus of imports tended tolower prices paid by American consumers, but it also depressed wages forsome workers in industries facing foreign competition. The U.S. tradedeficits have also undermined the value of the U.S. dollar compared to othermajor currencies, increasing concerns about the stability of the world’s finan-cial markets, as described in chapter 8.

What does the United States export? The largest single category in 2006was motor vehicles and their parts and engines, totaling $107 billion. Semi-conductors ($52 billion), civilian aircraft ($41 billion), computer accessories($36 billion), pharmaceuticals ($31 billion), telecommunications equipment($28 billion), chemicals ($27 billion), plastic materials ($25 billion), andmedicinal equipment ($22 billion) followed on the list of major export indus-try categories.

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Above: Rising imports from Asia such as these cargo containers unloaded in Tacoma,Washington, created political tension in the United States. Previous spread: The for-eign exchange value of the U.S. dollar alternatively plunged and soared in the globalfinancial crisis that began in 2008.

oversee member nations’ compli-ance with trade agreements. TheGATT process has successfully low-ered tariffs on most manufactureditems, stimulating a vast increase inworld commerce far beyond thevision of the Bretton Woods organiz-ers. The exception has been agricul-tural tariffs, which have remainedrelatively high because of the politi-cal strength of the farming sector inboth wealthy and developing nationsand the desire to safeguard essentialfood production.

Government subsidies and tariffson farm products have long beenpolitically controversial. Americanfarmers received $16 billion in vari-ous federal subsidies in 2004. U.S.agricultural tariff rates average 12percent, raising the price of foreignfarm products by that amount overall.In the U.S. Congress, representativesfrom urban areas tend to criticize thetariffs as an unjust tax on consumersthat isn’t necessary to support Ameri-can farmers. Representatives fromfarm states counter that U.S. tariffsare far lower than average farm tariffsin Europe (30 percent), Japan (50percent), and India (114 percent).

Subsidies affect farmers’ decisionsabout which crops to plant. U.S.wheat production has fallen, forexample, as many farmers haveswitched production to corn used inthe manufacture of ethanol as amotor fuel. The U.S. governmentprovides a cash subsidy to ethanolblenders, which, in turn, increasesthe price farmers receive for supply-ing corn. Farm subsidies are a con-frontational issue with developingnations, which have resisted pres-sures to open their markets furtheruntil the United States agrees tolower its support for its farmers.

The theoretical argument for freetrade, made more than two centuriesago by Scottish economist AdamSmith in The Wealth of Nations, holdsthat all nations prosper if each con-centrates on manufacturing andtrading goods where it has a particu-lar advantage: France its wine,Britain its woolens. On the flip side,for Britain to put a high tariff onFrench wines raises the price of allwines for British consumers.

But theory and politics began tocollide in the 1960s and early 1970swhen the rising manufacturingprowess of Japan and Germanybegan seriously to erode U.S. produc-tion in many industries, includingsteel, automobiles, shoes, and textiles.The advantages of expanded tradewould be enjoyed across the entirepopulation, as foreign productsafford consumers new choices and,often, lower prices. The costs of tradehit much more narrowly on particularindustries and their employees whosebusinesses slumped or failed.

The AFL-CIO, America’s largestand most influential labor organiza-tion, had initially supported the post-war consensus on trade expansion.But it changed direction in 1970. Thethreat to its union members from thespread of technology, the escalatingflow of U.S. investments into foreignbusinesses, and unfair trade practicesby foreign governments could nolonger be ignored, said its chief lob-byist, Andrew Biemiller.

The greatest challenge to the Unit-ed States in trade in the 1980s andearly 1990s came from Japan. As theJapanese rebuilt from World War II,they steadily created an array ofexport-focused industries with world-class technologies and efficiencies. Insteel, automobiles, consumer elec-

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U.S. oil and gas imports totaled$330 billion in 2006. Americansimported $257 billion worth of motorvehicles, engines, and parts that year,along with $100 billion in computersand computer accessories, $91 billionin various kinds of apparel and tex-tiles, $64 billion in pharmaceuticals,$36 billion in televisions and VCRs,and $29 billion worth of toys andgames. The variety of traded itemsspans virtually everything Americansmake, wear, use, or consume.

The United States is the world’slargest agricultural exporter, withone out of every three acres plantedfor export, according to U.S. govern-ment surveys. The value of U.S.exports of farm products, animalfeeds, and beverages came to $66billion in 2006. Imports were higher,at $74 billion. The total volume ofU.S. farm exports rose by 17 percentbetween 1997 and 2007, and in thatperiod American farmers exported45 percent of their wheat, 33 percentof their soybean production, and 60percent of their sunflower oil crops.

As economist Paul M. Romer hasobserved, imports rose from 12 per-cent of the U.S. gross domestic prod-uct in 1995 to about 17 percent adecade later. Foreign money pro-vides about one-third of U.S. domes-tic investment, up from 7 percent in1995. In other words, Romer says,“The U.S. is more open to the glob-al economy than ever before, and thelinks run in both directions.”

A commitment to expand globaltrade has been a cornerstone of U.S.policy since the final years of WorldWar II, when the United States andother victorious nations adopted aseries of international compacts topromote economic stability andgrowth. Trade restrictions and cur-

rency devaluations were widely con-sidered to have worsened the 1930sGreat Depression by stifling interna-tional commerce.

Through the formation of theUnited Nations and the agreementson international economic policiesreached at the 1944 Bretton WoodsConference in the United States, theallied powers hoped to replace themilitant nationalism that led to thewar with cooperative economic poli-cies. During the Cold War betweenthe Soviet bloc and the West, tradeliberalization with Europe and Asiabecame an instrument of U.S. for-eign policy and a way to promotemarket capitalism in emergingnation economies.

Open Trade and Foreign Policy

U.S. Secretary of State CordellHull said in 1948 that open trade“dovetailed with peace; high tariffs,trade barriers, and unfair economiccompetition, with war.… If we couldget a freer flow of trade…freer in thesense of fewer discriminations andobstructions…so that one countrywould not be deadly jealous ofanother and the living standards ofall countries might rise, therebyeliminating the economic dissatisfac-tion that breeds war, we might have areasonable chance of lasting peace.”

In 1948, the United States and 22other nations signed the GeneralAgreement on Tariffs and Trade, aset of international rules that signifi-cantly reduced tariffs and other bar-riers to the international flow ofgoods. Seven other rounds of tradenegotiations followed as the GATTmembership expanded, leading in1995 to the creation of the WorldTrade Organization in Geneva,Switzerland, with the authority to

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and other nations that U.S. business-es and labor unions attacked asunfair. The policy arguments oftenbroke down on ideological lines, withliberal Democratic legislators callingfor more intervention and Republi-cans protesting that the governmentwould fail if it tried to pick winnersamong industries and interests.

In some sectors, notably steel pro-duction, U.S. firms faced foreigncompetitors that were owned or con-trolled by their governments. Theseforeign firms were expected to keepexpanding steel production in orderto build economic capacity and pro-vide jobs—regardless of whether thesteel industry’s customers neededmore output.

As a signatory to the WTO agree-ment, the United States seeks to re-solve such trade disputes through thatorganization’s multilateral process.

But U.S. law permits unilateral ac-tions against countries that are foundto violate U.S. trade law—althoughsuch actions could expose the UnitedStates to retaliation by these coun-tries. The 1974 Trade Act authorizesthe U.S. trade representative—apresidentially appointed official—toinvestigate complaints of unfairtrade practices and to impose penal-ties or sanctions against foreign com-panies that violate American law. In1984, the act was amended to definefailure to protect intellectual proper-ty as an unfair trade practice.

Threatened U.S. industries havelobbied Congress for protective quo-tas and tariffs and for relief from whatthey saw as unfair trade practices.

U.S. companies also bring com-plaints to the U.S. InternationalTrade Commission, an independentU.S. government agency authorizedto impose trade restrictions on for-

eign suppliers that violate fair tradelaws. U.S. textile, shoe, specialty steel,consumer electronics, and color tele-vision manufacturers all demandedprotection from import competition.

But U.S. foreign policy prioritiesoften entered the picture. Ratherthan jeopardize relations with itsallies, the United States under severalpresidential administrations soughtvoluntary agreements to limit importsof steel, for example, rather than uni-laterally imposing sanctions.

A Boost for Trade Expansion

The case for trade expansionreceived a major, if unexpected,boost in the 1990s from the adminis-tration of President Bill Clinton.Clinton’s predecessor, George H.W.Bush, had made a North AmericanFree Trade Agreement a centerpieceof his economic program, and itawaited congressional action as the1992 presidential campaign arrived.Some of Clinton’s advisers urgedhim to back NAFTA to demonstratehis credentials as a “new Democrat”—one who embraced trade and tech-nology and was not beholden to thelabor leaders who adamantlyopposed the agreement. Otherswarned Clinton that supportingNAFTA could cost him precious elec-toral votes in a campaign that fea-tured the independent candidacy ofsoftware billionaire H. Ross Perot,who predicted that NAFTA wouldsend jobs flying to Mexico with a“giant sucking sound.”

Stanley Greenberg, Clinton’s poll-ster, argued that backing NAFTAmight afford important politicalgains. Even though many voters wereuneasy about the Mexican tradeissue, they were not against tradeitself, Greenberg said. Voters in “new

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tronics, and semiconductors, Japan’ssuccesses were built on a cohesive cul-tural commitment to quality. ButJapan’s critics argued that its growingtrade advantage also rested on unfairtrade practices that restricted compet-ing imports from the United Statesand other rivals, giving Japanesefirms a safe haven in which to grow.

Responses to Foreign Competition

Competition from Japaneseautomakers, whose costs were lowerand automation more advanced,pushed the American carmakerChrysler Corporation to the edge ofbankruptcy in 1979. Chrysler was thethird largest U.S. auto manufacturer.Its collapse would have cost hundredsof thousands of jobs at its plants andthose of its suppliers. It was saved bya $3.5 billion “bailout” by the U.S.government, a flood of orders fromthe U.S. military, and the exuberantsalesmanship of its chief executive,Lee A. Iacocca. Two decades later,Chrysler was purchased by Germany’s

Daimler-Benz and then sold to a private-equity company. In 2009,Chrysler went through a bankruptcyreorganization, supported by federalfinancial assistance, and sold its assetsto a new ownership group includingthe United Auto Workers retireehealthcare trust and Italy’s Fiatautomaker. The U.S. government hada temporary minority share.

Chrysler’s 1979 crisis opened along debate over how the UnitedStates should advance its global trad-ing interests. During the administra-tions of Presidents Ronald Reaganand George H. W. Bush, politicians,economists, business leaders, andlabor leaders advanced differentstrategies for strengthening Ameri-ca’s international competitiveness.Some urged new initiatives, such asgovernment-business partnerships totarget research efforts at technologi-cal breakthroughs in leading-edgeindustries such as semiconductors.Others demanded stronger defensesagainst trading practices by Japan

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The U.S. steel industry has faceda series of crises since the mid-1970s,when steel producers engaged in a glob-

al battle for market share, profitability, and sur-vival. The industry’s struggles graphically illus-trate the impact—both positive and negative—ofcreative destruction on American manufacturing.

Benefits have accrued to the nation as awhole. The U.S. steel industry and its workers are

three times more productive today than in the 1970s. American steel companies have invest-ed in advanced processes that have dramatically boosted energy efficiency while reducing pol-lution and health threats to steelworkers. The sharp rise in coal and other energy prices since2000 has helped U.S. steel producers that own their own raw materials.

On the ledger’s other side, steel industry employment plunged from 531,000 in 1970 to150,000 in 2008. Steelmaking cities in the American industrial heartland were batteredover these decades. In a 2006 interview, Nobel Prize-winning economist Joseph Stiglitzrecounted the impact of the industry’s fall on his hometown of Gary, Indiana, a city foundedby U.S. Steel Corporation a century ago. The city “reflects the history of industrial Ameri-ca. It rose with the U.S. steel industry, reached a peak in the mid-’50s when I was growingup, and then declined very rapidly, and today is but a shell of what it was.”

In Europe and Asia, governments have directly intervened for more than a quarter-centuryto help fund a massive expansion of steelmaking capacity. They have supported both officialand unofficial import barriers and turned a blind eye on secret market-sharing agreements,according to evidence before the U.S. International Trade Commission and the EuropeanUnion’s competition authorities.

While the United States has sporadically restricted imports, it has never developed along-term policy to bolster the American steel industry’s competitiveness.

International trade rules permit countries to defend domestic industries against the“dumping” of imports in their home markets at “less than normal” prices. When recessionsand financial crises left world markets filled with surplus steel, the U.S. industry soughtdumping penalties to combat low-priced imports. In response, U.S. presidents tended toimpose temporary limits on imported steel, or arrange voluntary restraints, to ease the dam-age to American steel firms. But the U.S. steel industry rarely got the sustained protectionit sought. For a range of political and economic reasons, U.S. policy has tended to resisttough trade sanctions. Cheaper steel imports benefited the auto industry and other steel usersand helped restrain inflation. And Washington has been sensitive to the outcry from foreigngovernments against proposed U.S. trade penalties.

The result is a U.S. steel market that is more open to foreign ownership and imports thanare any of its major rivals. In 2007, more than 30 percent of U.S. steel consumption wasimported, a far higher import share than one finds in the markets of major U.S. steel com-petitors Japan, Russia, China, and Brazil.

U.S. Steel Corporation, the company that J.P. Morgan founded in 1901, remains thecountry’s largest steel manufacturer and is ranked 10th in the world based on 2007 output.Nucor, the upstart U.S. producer that challenged “Big Steel” by fabricating new steel fromscrap melted in high-efficiency furnaces, is third in the United States and 12th in the world.

The other major U.S. steel concern is a collection of commonly owned historic compa-nies headed by the former Bethlehem Steel, a major producer that sank into bankruptcy inthe late 1990s. They were bought at severely discounted prices by an American investor,

A Lesson in Creative Destruction

Wilbur L. Ross, a specialist in distressed asset acquisitions. Ross says his approach to buy-ing failing companies and reclaiming the salvageable parts is “a Darwinian thing.” He toldFortune magazine in 2003, “The weaker parts get eliminated, and the stronger ones comeout stronger. Our trick is to figure out which is which, try to climb on to the ones that can bemade into the stronger ones, and then try to facilitate the demise of the weaker ones.”

In 2004, Ross sold the U.S. plants to India’s Lakshmi Mittal and his Mittal Steel com-pany, which then became part of the world’s largest steel producer in 2006 when Mittalmerged with Europe’s leading steelmaker, Arcelor. Today, U.S. Steel, Arcelor Mittal, andNucor control more than half of U.S. production. Ten percent is owned by Russian steel inter-ests, another beneficiary of the relatively open U.S. steel market.

Following the late 1990s’ financial crises, when low-cost foreign steel flooded the U.S.market, more than 40 steelmakers, distributors, and fabricators filed for bankruptcy. At thattime, the U.S. steel industry owed more than $11 billion in “unfunded” pension obligationsto a growing population of retirees, debts that it could not pay. Bankruptcy was a way out.

U.S. bankruptcy law allows companies to revoke certain contracts, including pensioncommitments, which can then be passed on to the Pension Benefit Guaranty Corporation, afederal agency that insures certain pension plans and pays promised benefits upon a compa-ny’s failure. Steelworkers retired from the insolvent companies held on to most of their pen-sion benefits thanks to the PBGC, but they lost the retiree health insurance coverage alsopromised by their former employees.

Trade restrictions imposed by former President George W. Bush, coupled with relief fromsome industry retiree health care commitments, helped the U.S. steel industry recover dur-ing the economic boom of the early 2000s. But the recession that began in 2008 has revivedfears of steel surpluses, particularly with the growth of state-supported steelworks in Brazil,India, and China. Steelmaking capacity in those three countries now equals one-third of theworld’s total, and the debate over fair trade in steel is back on the world’s agenda.

Above: In February 2008 thousands of steelworkers rallied near the White House demanding protective tariffs and othermeasures to help their newly again troubled industry.Opposite top left: The U.S. steel industry survives in a reduced size, continuing research and development as at thisfacility in Monroeville, Pennsylvania.

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© AP Images

nations and negotiated bilateralagreements with Israel, Jordan,Chile, and Singapore. But opposi-tion grew in the House of Represen-tatives as imports cut more deeplyinto U.S. manufacturing employ-ment. Earlier trade agreements hadsucceeded in Congress largelybecause they could be handledunder special fast-track parliamen-tary rules that specified firm dead-lines and forbade amendments. U.S.officials said the rules preventingmajor congressional amendmentswere essential since they locked inthe terms reached by negotiators atthe bargaining table. Congress couldapprove or reject the pacts, but notchange them. However, a renewal ofthe fast-track authority in 2002passed by just three votes in theHouse, and the authority was notrenewed when it expired in 2007.

When President George W. Bushin 2008 sought congressionalapproval of a pending trade agree-ment with Colombia, House SpeakerNancy Pelosi, a Democrat, blocked it,asserting the House would first haveto consider measures to deal with theU.S. economy’s slowdown and to“address the economic insecurity ofAmerica’s working families.”

Patents, Copyright, Trademarks

The innovation- and technology-driven information age has pushedthe question of intellectual propertyto the top of the world’s trade agen-da. It is an issue with a long pedigree.Strict laws protected the trade secretsof medieval crafts guilds but facilitat-ed knowledge sharing among guildmembers. By the 15th century, Euro-pean rulers were granting patents toinventors and to foreigners willing tointroduce new technologies.

Since those early times, the linesof debate have been clearly drawn:Invention of products is bolsteredwhen inventors have a legal right toexploit their discoveries by gaining amonopoly on their use. But if theprotection extends too long, compe-tition suffers and improvements areheld back. The question is how tostrike the balance. The inventor canseek protection by securing a patentfrom the federal government, but heor she is required to describe theinvention in detail. The patent hold-er must be prepared to enforce it, incourt if necessary, by compellingthose who use the invention either tocease or else pay for their use. Insome cases, inventors prefer to keepa process or formula secret and notdisclose it by seeking a patent. Per-haps the most famous example is theformula for the ingredients of Coca-Cola, which has remained a businesssecret and is kept in the vault of anAtlanta, Georgia, bank.

Recognizing the importance ofprotecting inventions and encourag-ing innovation, the authors of theU.S. Constitution granted Congresssole authority to create patent andtrademark laws. As PresidentGeorge Washington’s first secretaryof state, Thomas Jefferson, who hadexperimented with new designs forplows, reviewed the country’s firstpatents until his diplomatic dutiesbecame too great. U.S. patent andtrademark policies have evolvedsteadily since then.

To receive a patent, an inventormust satisfy basic requirements: Theinvention must be of a kind that canbe patented, such as a machine or amanufacturing process; it must havea useful purpose, and it must mark asignificant advance over earlier prod-

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economy” states such as California,he asserted, wanted an international-ist president. Clinton agreed, declar-ing he would seek to improve theagreement and then support its pas-sage. He went on to defeat Bush inthe 1992 election. Perot received 19percent of the popular vote, a high-water mark for no-compromiseopponents of trade expansion in anational election.

After becoming president, Clin-ton made congressional approval ofthe NAFTA agreement one of hisadministration’s top priorities, gath-ering a coalition of Republicans andpro-trade Democrats in both theHouse of Representatives and theSenate to support it. An intensenationwide debate followed, withAmerican labor unions warning thatU.S. workers would lose jobs to Mex-ico, and with U.S. business leadersurging approval of the trade pact asa way of stimulating exports.

To win support from moreDemocrats, Clinton’s negotiatorspushed Mexico and Canada to accepttwo additions to the agreement de-signed to improve workers’ rightsand environmental protection inMexico. These, it was thought, wouldhelp protect American labor by pre-venting Mexican producers from cut-ting their costs at the expense oflabor and environmental standards.Congress approved the pact in 1993.

The debate about NAFTA’s eco-nomic impact continues. During the2008 Democratic presidential prima-ry campaign in Ohio—a state thathas lost 400,000 manufacturing jobsthis decade—leading contendersBarack Obama and Hillary Clintoneach said they favored amendingNAFTA to make it fairer to workers.But they did not call for its repeal.

Following NAFTA’s approval, theUnited States sought regional tradeagreements with Central American

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Above left: Democratic presidential candidates Hillary Clinton, left, and Barack Obama, right,both campaigned in 2008 to make trade agreements fairer for U.S. workers but not to repeal any agreements.

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cheap to borrow money and remark-ably profitable to run a corpora-tion…The more China was willing tolend to the United States, the moreAmericans were willing to borrow.”

Then the debt bubble burst in2008, creating a financial crisis that isstirring the debate among Americansabout the benefits of globalization andtrade. A consensus favoring opentrade has prevailed in the UnitedStates for more than half a century,buttressed by the belief that America’screative, entrepreneurial economy hasmuch more to gain than lose througheconomic engagement with the world.

But these values are hardest to pre-serve during economic hard times,when foreign competitors becomenatural targets for the frustrations of acountry’s unemployed and foreign

practices that appear unfair feed pro-tectionist feelings.

America’s continued political sup-port for a free flow of trade andfinance and its openness to the worldmay depend on a continued prosperi-ty for the large majority of its citizens,many experts say. Federal ReserveChairman Ben Bernanke said in2007, “if we did not place some limitson the downside risks to individualsaffected by economic change, thepublic at large might become less will-ing to accept the dynamism that is soessential to economic progress.” ButAmerica could not turn its back on therest of the world’s economy, even if itsomehow chose to, and as the controlof the U.S. government changedhands in 2009, there was no sign of aretreat from global engagement.

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ucts or processes. The maximumlength of patent protection is 20years from the date of filing. Half ofall U.S. patents are issued to foreigninventors. The United States appearsby far more open to foreign inven-tions than its major trading partners:The Japanese Patent Office issued 90percent of patents to Japanese inven-tors in 2002, for example.

The earliest intellectual propertyrights agreements were the 1883 ParisConvention on Patents and the 1886Berne Convention, which coveredartistic and written works. The PatentCooperation Treaty of 1970, amend-ed several times since then, creates astandard process for patent applica-tions among more than 100 countries.

The most important recent agree-ment is the 1994 Trade RelatedAspects of Intellectual PropertyRights, or TRIPS, which sets out aminimum list of protections that sig-natories must provide and requiresthat whenever a signatory nationgrants its own citizens any intellectu-al rights, it must extend the samerights to inventors from other signa-tory nations. “The problem of inter-national [copyright] piracy hasbecome more acute in the digitalage,” public policy scholar SuzanneScotchmer says. Modern copyrightpiracy involves software, music,movies, even textbooks.

The theft of trademarks, the ille-gal copying of products, and the pira-cy of books, software, and recordedentertainment remain a serious andprovocative issue for the UnitedStates, particularly in its trade rela-tions with China. Nine of every 10U.S.-content DVDs sold in China arepirated, the Motion Picture Associa-tion of America complained to Con-gress in 2007. Companies in China

allegedly produce counterfeit autoparts and other products that are soldabroad under the name of well-known U.S. manufacturers, accordingto the U.S. Motor Equipment andManufacturers Association. Similarprotests have been made by U.S.pharmaceutical companies, who warnthat counterfeit Chinese medicinespose potential serious health threatsto unsuspecting purchasers.

Dan Glickman, a former U.S. con-gressman who heads the Motion Pic-ture Association of America, toldCongress that, at the national level,Chinese officials express concern andwill take limited actions, but theseactions don’t extend to effective con-trols within China’s provinces. Over-all, trade violation enforcement is“selective, it’s arbitrary, it’s intention-ally vague in some cases. And insome cases, it’s just not very welldeveloped,” Glickman testified to acongressional committee.

When the United States supportedChina’s membership in the WTO, theexpectation was that the latter’s tradepolicies would converge with interna-tional rules. From a U.S. perspective,the need to make the expectation areality remains a major trade issue.

The economic interdependence ofChina and the United States symbol-izes the sweeping growth of trade andcross-border financial flows as the newcentury began. Historian Niall Fergu-son describes a symbiotic relationshipbetween the two states he whimsicallycombined as “Chimerica.” InexpensiveChinese imports helped keep inflationlow in the United States and helpedput downward pressure on U.S. wages.China reinvested dollars received forits goods in the United States to fundU.S. deficits, helping keep U.S. interestrates low. “As a result, it was remarkably

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A New Chapter

in America’s EconomicStory

The United States, in its democratic way,faces up to immense economic challenges.

C H A P T E R

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At this writing (March 2009), the United Statesand much of the world were enmeshed in a financial crisisand economic downturn considered by many to be the worstsince the Great Depression of the 1930s. The need for an immediateresponse has ushered in a burst of government intervention, moststrikingly in the United States but also throughout the industrializedworld. By spring 2009, it appeared that the gravest fears of a com-plete financial meltdown had been averted and world stock marketsrecovered part of their devastating losses over the previous half year.But the United States and other industrial nations still faced risingunemployment and a vulnerable economic future.

Several conclusions seemed inescapable. Economic globalization, whichhas linked banking and trade on every continent, enabled the financial mar-ket contagion to spread worldwide. Leaders of the United States and othermajor economies agreed that a new system of financial market supervisionand regulation would have to be created to restore investors’ battered confi-dence in markets and revive investment. The reforms should seek to set newbanking and investment standards for all advanced economies, and the Unit-ed States would have to play a leading role in their creation by reforming itsown complex system of banking and securities regulation.

Former Federal Reserve Chairman Paul Volcker introduced a blueprint forsuch reforms early in 2009 on behalf of a group of prominent internationalfinancial officials and academics called The Group of 30. The organization’sreport sought to “restore strong, competitive, innovative financial markets tosupport global economic growth without once again risking a breakdown inmarket functioning so severe as to put the world economy at risk,” said Vol-cker, who also led President Barack Obama’s Economic Advisory Board, asthe new administration took office.

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“Starting today,…we must pick ourselves up,dust ourselves off, and begin again the work ofremaking America.”

PRESIDENT BARACK OBAMA

United States of America2009

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ages

Above: President Barack Obama, shown with former Federal Reserve Chairman PaulVolcker, faces the greatest economic challenges in a generation while working with aCongress that is sharply divided politically. Previous spread: The numbers for the U.S.economy started turning down even before the 2008 global crisis.

money into the banking system andnew spending programs in themonths that followed. As WorldBank President Robert Zoellick toldthe New York Times late in 2008,America’s “ability to turn aroundproblems is really unmatched histor-ically.” Economist Brad Setser notedthat in 2008 the United States sold astunning $1.7 trillion in Treasurysecurities without triggering a jumpin market interest rates.

The second challenge—confront-ing the growing federal budgetdeficit—would likely be much hard-er. As President Obama and otherpolitical leaders observed, the Amer-ican public and their political repre-sentatives could not postpone indef-initely hard decisions about thescope and breadth of government’srole in the U.S. economy and thebest means of funding those commit-ments. Foreigners ask, Zoellick said,“will the United States get at some ofthe root causes that could determineits real strength over the next 10 or20 or 30 years?”

The government’s longstandingcommitments to America’s elderly

were a big part of the challenge. Cur-rent projections suggest that, absentfundamental reform, Social Security(retirement income), Medicare (med-ical care for the elderly) and Medicaid(medical care for low-income families)programs will swamp all other claimson the federal budget within a fewdecades. They take 44 percent of allcurrent federal spending, excludinginterest paid on the U.S. national debt.

In 2011, the first of the 78 million-strong baby-boom generation willbecome eligible for Social Securityand Medicare benefits. The U.S.Treasury estimates that by 2030, thethree major “entitlement” programswill absorb two-thirds of the federalbudget, assuming that federal taxescontinue at current levels. If nochanges are made in spending or taxlaw, government revenues in that yearwould cover only half of the expectedexpenditures, according to the 2008Financial Report of the United States.

Because the government mustborrow to pay for expenditures thatexceed revenues (the federal deficit),the unchecked rise of entitlementspending would also swell the U.S.

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The group called for tighterrestrictions on banks to preventreckless lending by them; moreeffective accounting standards thatcould help identify potentially dan-gerous investing trends; rules com-pelling the largest private hedgefunds and other pools of privateinvestment capital to disclose resultsand levels of borrowing, and regula-tion of over-the-counter derivativessuch as the complex, credit defaultinsurance investments that becamean unseen virus in the global bank-ing system collapse.

An effective worldwide consensuson a new financial regime was adaunting goal, given the spectrum ofeconomies and political systemsamong the major nations. But thechallenge was no less formidable inthe United States itself.

As other chapters have described,economic governance in Americahas evolved unevenly, responding tothe major currents of change in theeconomy itself. From the writing ofthe Constitution onward, Americanshave debated government’s properrole in the economy: Did society’sneeds require a strong governmenthand, or would government stifleinnovation and enterprise that dri-ves economic advancement? Howshould government authority bedivided among the federal govern-ment and the states?

The U.S. financial regulatory sys-tem, thus, is a patchwork of manystate and federal agencies with over-lapping missions, and some majorgaps in oversight lying in between.Some reformers have said the finan-cial crisis calls for creation of a single,powerful financial market oversightagency. The Federal Reserve wasseen as the most likely candidate for

that role in the United States. Butsuch a role would stir concernsamong many Americans about cen-tralizing too much power in a singlegovernment agency—an issue thatseparated the followers of Jeffersonand Hamilton at the country’s birthand remains very much alive today.

Soaring Deficit

One consequence of the emer-gency measures taken to stimulate theeconomy and shore up threatenedfinancial institutions is a drasticincrease in the federal budget deficit.That figure, which represents the dif-ference between federal spending andrevenue, was headed over $1 trillionin 2009, nearly three times the previ-ous year’s figure. President Obama’s2009 stimulus package of new govern-ment spending and tax cuts wouldbring the deficit, as measured in pro-portion to the entire economy, to alevel not seen since the end of WorldWar II.

While Americans differed over thedetails of the stimulus plan, a broadconsensus emerged that swift actionwas necessary. Most economistsagreed that a rapid and massive fiscalstimulus of federal spending wasessential to spur job creation andreverse the economic contraction.They also agreed that once the econ-omy had stabilized, the United Stateswould have to turn to the much hard-er task of deficit reduction by betteraligning the government’s spendingcommitments with its revenues.

The U.S. government was able toreact on a massive scale as the crisiserupted late in 2008. The financialstrength of the Federal Reserve andthe ability of the U.S. government toborrow abroad helped Washingtonpour unprecedented amounts of

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As noted in chapter 1, the foreignresponse to the global financial crisiswas a rush to purchase U.S. Treasurysecurities because America’s eco-nomic size and political stabilitymade the dollar the safest refuge.But a growing U.S. indebtednesscould press foreign investors to sub-stitute a basket of currencies includ-ing the euro and the Chinese yuanfor the dollar in international trans-actions and to reduce the amount ofdollars held in government accounts.

“The next crisis will be related toour own federal government’s daunt-ing fiscal challenges,” wrote economistMark Zandi in 2008. “Global investorsare already growing disaffected withU.S. debt, and even the Treasury willhave a difficult time finding buyers forall the bonds it will be trying to sell ifnothing changes soon.”

In the aftermath of the globalfinancial crisis, the United States alsowill be challenged to repair the credi-bility of its financial sector. TheObama administration has pledged to

support international efforts tostrengthen banking reserves andinvestment regulation and place limitson market risk-taking without stiflingthe flow of capital to fund growth.

Obama’s Plan

Immediately following his electionto the presidency, Obama began toshape a large-scale federal responseto the emergency. The massive eco-nomic stimulus plan passed by theU.S. Congress early in his administra-tion distributed federal funding,loans, and tax cuts throughout the fal-tering economy. It also sought to usefederal dollars to fuel a rapid expan-sion of new, technology-advancedenergy and environmental initiatives.These developments, it was hoped,would create new markets at homeand overseas for American companiesand millions of jobs for workers acrossa wide range of skill levels.

Many of the energy and environ-mental opportunities presented acommonsense appeal. Investments innew energy controls and weatheriza-tion could help homes and businessesbetter conserve energy used for heat-ing, cooling, and lighting. A fastertransition to hybrid gas-electric vehi-cles, or eventually “plug-in” electriccars, could cut America’s dependenceon foreign oil shipments from politi-cally volatile regions.

Expansion of the nation’s electricpower transmission grid could allowmore renewable energy from windand solar power to move from theSun Belt in the South and the Mid-west’s windy Great Plains to thenation’s urban centers. Perhaps in adecade, electric cars could beplugged into the grid when not onthe road, recharging themselves atnight when electricity is cheapest.

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national debt (the amount borrowedby the government from lenders inAmerica and abroad). If currentspending and taxing trends contin-ue, the U.S. debt in 2032 wouldequal the nation’s annual economicoutput of goods and services.

The trends are unsustainable, theTreasury says, and would steadilyundermine confidence in America’seconomy and in the dollar. FormerFederal Reserve Chairman AlanGreenspan has called the outlook a“pending tsunami.” As Obama saidshortly after his election in 2008, ifthe financial challenges are hard,“the politics are even harder.” Olderpeople may have to postpone retire-ment. Health care and Social Securi-ty benefits may have to be limitedfor the wealthiest Americans, ortaxes on working American mayhave to rise—choices that will testsociety’s cohesiveness. “You have tohave a president who is willing tospend some political capital onthis,” Obama said, “and I intend tospend some.”

Income Disparity

A growing disparity in the distrib-ution of the economy’s rewards raisedeven higher the political hurdles toachieving both domestic economicreform and international economiccooperation. Scholars have identifieda number of possible factors that,taken together, have increasinglyconcentrated income and wealthgains among a small minority of theU.S. population. Among them: thedecline in higher-paid manufactur-ing jobs and a shift toward lower-scale service employment, the grow-ing employment disadvantages ofless-educated workers in a highlytechnical economy, and the burden

of rising medical care costs for Amer-ica’s lower- and middle-income fami-lies. Because of these and other fac-tors, the average wage of U.S.non-farm workers has not increasedappreciably since 1980, after takinginflation into account.

Harvard University economistBenjamin M. Friedman observed,“The central question for the UnitedStates at the outset of the 21st centu-ry is whether the nation in the gener-ation ahead will again achieveincreasing prosperity, as in thedecades immediately following WorldWar II, or lapse back into the stagna-tion of living standards for the major-ity of our citizens that persisted fromthe early 1970s until the early 1990s.”

The government’s long-term fis-cal plight also carries internationalpolitical complications. As the 2000sdecade proceeded, foreign investorsfinanced an increasing share of U.S. government debt. In mid-2000,this debt totaled $1 trillion. Eightyears later, the total was $2.7 trillion,with government-owned banks or“sovereign” investment funds hold-ing the fastest-growing share. Theyused the U.S. dollars flowing over-seas that bought manufacturedgoods and oil to purchase U.S. Trea-sury securities and other U.S. gov-ernment debt. America, in essence,was borrowing from the future tofinance current consumption.

A 2008 report by the Council onForeign Relations emphasized thepolitical ramifications of this finan-cial dependence: “Without financingfrom China, Russia, and the Gulfstates, the dollar would fall sharply,U.S. interest rates would rise, andthe U.S government would find it farmore difficult to sustain its globalrole at an acceptable domestic cost.”

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will be a great test for the current gen-eration of Americans. As Kent H.Hughes of the Woodrow Wilson Inter-national Center for Scholars writes,“It is hard to see how the UnitedStates will win the contest of ideas inthe 21st century without continuedeconomic growth, technological inno-vation, improved education, andbroad-based equality of opportunity.”

In 2009, the United States is strug-gling to recover from a harsh recessionthat has challenged the public’s faithin national economic policies, opentrade, financial markets, and businessgovernance. Hughes adds that “thecountry will need to take steps torestore national trust in key institu-tions, rediscover a sense of nationalpurpose, restore its commitment toshared gains and shared sacrifices, andrenew its sense of American identity.”But it also is true that Americans havefaced and surmounted such challengesin the past, and few doubt but thatthey will do so again.

Barack Obama’s candidacy forpresident was historically unique inmany ways, but his economic plat-form was rooted deeply in America’spolitical history. Many observers saw

in his victory a swing of the politicalpendulum from Reagan-era limitedgovernment and light regulation ofmarkets back toward Franklin D.Roosevelt’s New Deal era of greatergovernment economic intervention.

How much of a shift occursremains to be seen. But in the 2008election the American people optedfor activism, and in his inauguraladdress President Obama sought torespond. “Starting today,” he said,“we must pick ourselves up, dust our-selves off, and begin again the workof remaking America.” Even with theDemocratic Party majorities in theHouse and Senate, finding solutionsto intractable economic and energyproblems would require effective col-laboration between the presidentand members of both parties at atime when political divisions aresharp. But that has been the situa-tion throughout America’s history,with few exceptions. In other timesof crisis, the country found a way for-ward despite the fractious aspects ofdemocracy. The start of Obama’spresidency marked the opportunityto write a new chapter of the nation’seconomic story, with much at stake.

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Federal initiatives could seed new,globally competitive industries andsecure U.S. leadership in worldwideefforts to restrain carbon-based cli-mate change. For example, the useof wind or nuclear power to makeelectricity, and of biofuels to drivecars, could reduce greenhouse gasemissions. One day, the carbon emis-sions from coal-fired power plantscould be confined and stored perma-nently underground.

Some Americans posed philo-sophical and political challenges tothis vision. Longstanding quarrelsover the desirability of “big” govern-ment continued. So did clashes ofregional interests. Lawmakers fromstates where wind energy is generatedsought to strengthen the nationwidetransmission system, but their coun-terparts in states with strong coalindustries resisted mandates to usemore wind power. Sector-leading util-ity and energy companies perceivedthreats to their established businessmodels, particularly in the proposalsto cap carbon emissions from coaland oil operations and for expandeduse of solar power in homes and

offices. And regardless of the pre-ferred strategy, the financial crisis hadundermined the capacity of Americanindustry and investment firms to fundsuch an energy transformation.

More optimistic observers notedthat America still could bring impor-tant resources to bear on the chal-lenge of devising new energy strate-gies, among them its entrepreneurialculture, the depth and breadth of itseducational system, and the free-dom it afforded capital to seek thehighest returns. Singapore’s minis-ter of education, Tharman Shanmu-garatnam, commented in 2006about an essential aspect of U.S.education. “We know how to trainpeople to take exams. You know howto use people’s talents to the fullest.Both are important, but there aresome parts of the intellect that weare not able to test well—like creativ-ity, curiosity, a sense of adventure,ambition. Most of all, America has aculture of learning that challengesconventional wisdom, even if itmeans challenging authority.”

Applying these real strengths tothe nation’s equally real challenges

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