Two years ago, in autumn 1998, the international economy appeared to be in profound difficulty. The crisis that had broken out in East Asia in summer 1997 was in the process of engulfing the rest of the world. Stock markets and currencies had crashed outside the capitalist core. Russia had declared bankruptcy. Brazil was falling into depression. The Japanese economy had slipped back into recession. The American economy was not immune. In response to falling profits during the first half of 1998, especially in the still pivotal manufacturing sector, equity prices fell alarmingly from July through September. By October, a severe liquidity crunch threatened to plunge the US—and thereby world—economy into the danger zone. At that point, however, the Federal Reserve intervened. It bailed out the huge Long Term Capital Management hedge fund, on the grounds that, had it been allowed to fail, the international economy risked financial collapse; and lowered interest rates on three successive occasions, not only to counter the credit squeeze, but also to make crystal clear that it wanted equity prices to rise, to subsidize the consumption needed to keep the international economy turning over.
The upshot has been contradictory in the extreme. A US cyclical expansion that, up through 1995, had been even less vigorous than those of the 1970s and 1980s suddenly gathered steam. Since then it has delivered five years’ rapid growth of GDP, labour productivity and even real wages, while reducing unemployment and inflation quite near to the levels of the long postwar expansion. Investment has boomed impressively. Although wildly over-hyped in the business press, US economic performance during the past half-decade has been superior to that of any comparable period since the early 1970s. On the other hand, the same period has witnessed the swelling of the greatest financial bubble in American history. Equity prices have taken leave of any connexion to underlying corporate profits. Household, corporate and financial debt have all reached record levels as a percentage of GDP, making possible an historic explosion of consumption growth. The resulting acceleration of imports has brought trade and current-account deficits to all-time highs. The result has been an unprecedented increase in the acquisition of US assets by the rest of the world, especially short-term holdings, which leaves the American economy theoretically vulnerable to the same sort of flight of capital, asset depreciation and downward pressure on the currency that wrecked East Asia.
The Boom opened the way to the Bubble, but the Bubble has blown up the Boom a good deal more. The problem, therefore, is to disentangle the one from the other. Only by determining the forces underlying each will it be possible to grasp the overall trajectory of the US economy, and gain some idea of where it is going. Have the tensions that nearly brought down the world economy just two short years ago been transcended? Will the current cyclical upturn broaden and deepen? Lurking behind these questions lies a bigger one. Is the American economy finally pulling out of the long downturn that overtook it around 1973, and on the verge of a new long upswing, like that of the 1950s and 1960s? Or, alternatively, does it face the sort of large-scale correction and reaction that ultimately overtook the Japanese bubble of the 1980s, in which the return to earth of over-priced equities and real estate set off a deep and extended recession?
The roots of manufacturing revival in the US go back to the recession of 1979–82, when the record-high real interest rates which accompanied Volcker’s turn to monetarism set off an extended process of industrial rationalization. Massive means of production and labour were eliminated in an explosion of bankruptcies not witnessed since the shedding of suddenly unprofitable plant and equipment during the Great Depression of the 1930s. The crisis of manufacturing was rendered deeper by the huge rise in the dollar which followed the major increase in real interest rates of these years. An acceleration of productivity growth in manufacturing was one palpable result. Another, however, was a series of record-breaking current-account deficits, as the runaway dollar sharply reduced US competitiveness. Between 1980 and 1985, manufacturing import penetration rose by one third. These trends could not be sustained, and soon issued in an abrupt and epoch-making reversal of policy.
The turning point—a watershed for the world economy as a whole—came with the Plaza Accord of September 1985, when the G5 powers agreed to take joint action to reduce the exchange rate of the dollar, to rescue a US manufacturing sector threatened with decimation. The Plaza Accord set off ten years of more or less continuous devaluation of the dollar against the yen and the Deutschmark, accompanied by a decade-long freeze on real-wage growth. It thereby opened the way for the competitive recovery of US manufactures, a secular crisis of German and Japanese industry, and an unprecedented explosion of export-based manufacturing development throughout East Asia, where currencies were for the most part tied to the declining dollar. Between 1985 and 1995, the dollar fell by about 40 per cent against the Deutschmark and 60 per cent versus the yen. In the same period, real wages in US manufacturing increased at an average annual rate of 0.5 per cent, compared to 3 per cent in Germany and 2.9 per cent in Japan. Meanwhile, the long-term shake-out of high-cost/low-profit means of production in the US economy was given a further major kick by the recession of 1990–91 and the subsequent extended ‘jobless recovery’.
The combination of dollar devaluation, wage repression and industrial shake-out—and the increased investment that finally ensued after about 1993—detonated a fundamental shift in the modus operandi of US manufacturing towards overseas markets. From 1985 to 1997 exports increased at an average annual rate of 9.3 per cent, more than 40 per cent faster than between 1950 and 1970. Little by little, exports pushed the manufacturing sector forward, and thereby the whole economy. This restoration of international competitiveness made possible what turned out to be a major recovery of pre-tax profitability in manufacturing. As late as 1986, despite vigorous growth of productivity and stagnation of real wages, the rate of profit in manufacturing still remained more than 20 per cent below its level of 1978, and 50 per cent below its level of 1965. But from 1986 onwards manufacturing profitability increased rapidly. Its ascent was interrupted by the recession of 1990–91 and its aftermath but, by 1995, the pre-tax profitability of US manufacturing had risen by 65 per cent above its level of 1986 and was, for the first time in a quarter of a century, above that of 1973—although still a good third below its high tide in 1965.
It has become standard to downplay the importance of the manufacturing sector, by pointing to its shrinking share of total employment and GDP. But during the 1990s, the US corporate manufacturing sector still accounted for 46 per cent of total profits accruing to the non-financial corporate sector; in 1998 (the latest year for which there is data), it took 42.5 per cent of that total. It was the fall of profitability in the international manufacturing sector, beginning between 1965 and 1973, not only in the US but across the world economy, that was primarily responsible for the long downturn—the extended period from the early 1970s through the early 1990s marked by slow growth of output, investment and productivity, high unemployment and deeper and longer cyclical recessions.footnote1 By the same token, the recovery of pre-tax profitability in US manufacturing was the source of the rise in pre-tax profitability in the non-financial private economy, which climbed by 15.6 per cent between 1986 and 1995, approaching its levels at the end of the 1960s. This is clear from the fact that the pre-tax rate of profit in the non-financial economy outside of manufacturing remained roughly flat for this whole decade—even falling slightly.