LESTER
THUROW
Professor
of Management at the Massachusetts Institute of Technology
and recent dean of the MIT Sloan School of Business, Thurow
has three New York Times bestsellers to his credit.
His new work by Harper Business Books is entitled Building
Wealth: New Rules for Individuals, Companies and Countries
in a Knowledge-based Economy.
This
article is abridged from Speak Out Against the New Right
edited by Herbert F. Vetter (Boston:
Beacon Press, 1982)
President
Johnson's refusal to raise taxes to pay for the Vietnam
War is legitimately remembered as one of the key factors
leading us into our current economic mess. He wanted both
the Great Society and the war. But if he were to have both
and not wreck the economy, his only option was to raise
taxes sharply. He chose not to do so, and he wrecked the
economy.
President Reagan wants both dramatic tax cuts to encourage
investment and an even more extensive military build-up.
But he cannot have both without wrecking the economy further
unless he is willing to raise taxes dramatically on private
consumption. He has chosen not to do so. If his current
program is carried out, he too will wreck the economy.
Military spending is a form of consumption. It does not
increase our ability to produce more goods and services
in the future. While it may be necessary, it is consumption
nonetheless. And as in any private budget, if you allocate
more to one form of consumption, you must allocate less
to some other form of consumption.
This means equivalent cuts must be made in other forms of
consumption. The proposed military increase is so large
that it cannot be fully paid for with cuts in civilian expenditures
unless the president is willing to abolish major social
programs such as Social Security. If he is not willing to
do this, taxes must be raised to cut private consumption.
While President Reagan is only preparing for war and not
actively engaging in one, the economic problems of military
spending spring from the rapid production of weapons, not
from their use. The capacity to produce capital goods and
equipment, skilled manpower, and raw materials must all
be quickly redirected to military production. In shifting
both human and capital resources from civilian to military
activities tremendous strains are placed on the domestic
economy, unless measures are taken to restrain private consumption.
Without tax increases the military can get only the necessary
capital capacity, skilled manpower, and raw materials by
paying more than the civilian economy is willing to pay.
This drives up prices and creates civilian shortages.
As with President Johnson, the mistakes of President Reagan
will only become obvious long after they have been made.
By the time they are obvious, it will be too late to correct
them. If the mistakes are to be corrected and the undesirable
effects avoided, the correction must be made now—not
two to three years from now.
If the Reagan administration were to carry out its current
plans, it would have no rational alternative to a large
tax increase on private consumption. If the administration
is unwilling to raise taxes on private consumption, it will
repeat the Vietnam experience. Initially output will rise
and unemployment will fall. But eventually a sustained inflation
will result from the economy’s inability to produce
both the civilian and military goods that are being demanded
of it.
A
military build-up of the magnitude proposed by President
Reagan almost demands that the U.S. insist that its military
allies, who are also its economic competitors, engage in
a similar military build-up. From the point of view of equity,
the American taxpayer cannot be expected to accept a large
reduction in his standard of living while taxpayers abroad
continue to improve their standards of living. But even
more importantly, America cannot afford to destroy the competitive
strength of its none-too-strong domestic economy. If the
skilled workers and funds that are used for defense here
are used for civilian production abroad, it should not come
as a great surprise if we are driven out of civilian markets.
What will happen to the United States if the industries
that manufacture semiconductors, micro-processors, and computers
are forced out of business while the nation is busy rearming
itself? What good does it do us to dominate the world in
missile production if we are at the same time being defeated
in toasters? In the long run, a civilian economy that consistently
fails in competition abroad will be unable to produce missiles
for an effective military economy.
This explosion in output is predicted for an economy where
growth in productivity has been gradually slowing down since
1965 and has in fact been negative during the last three
years. The Reagan administration assumes that productivity
is going to return to a 3 percent rate of growth almost
instantly, but what will make this happen? Such an increase
in productivity has never happened before in our history,
and there are good technical reasons for believing that
it will not happen now.
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But
in planning a major military build-up, a wise economic general
does not argue about whether there will, or will not, be
a dramatic rebound in the growth of productivity. He plans
such a rapid increase on the conservative assumption that
there will not be a sharp change in productivity and hopes
to be pleasantly surprised if productivity does in fact
dramatically improve. No permanent damage occurs if he plans
for slow productivity and finds that productivity is actually
growing rapidly. He can always easily cut taxes if the economy
has extra unused productive capacity. But if he plans for
rapid growth in productivity and it does not occur, the
economic damage will be great. Taxes can be raised later
on, but as the Vietnam War demonstrated, a tax increase
in 1969 does not substitute for a tax increase that should
have occurred in 1965.
There is, however, one major economic problem with the proposed
cuts in expenditures. Most of the cuts focus on the working
poor—essentially the group that is above the poverty
line but within $3,000 of it. This group is going to be
faced with a choice. The Reagan administration assumes that
a cut in the social welfare benefits for the working poor
will force them to work more. It is more likely that it
will encourage them to work less to regain eligibility for
the programs that they have just lost.
Suppose you are one of the working poor and have a sick
child. One choice is to work harder—perhaps by taking
a second job—in order to pay the necessary medical
bills. Another is to quit working to make yourself eligible
for Medicaid. To pose the choices is to give the likely
answer. If the second choice prevails, the remaining social
welfare programs will have to expand and will cost more
than expected. The cuts in the civilian budget will therefore
be smaller than the ones now projected. The result will
be that the grave strains imposed on the economy by Reagan's
military build-up will become graver still. The dangers
of this budget are such that I can think of no priority
higher for the nation's economic welfare than close and
skeptical scrutiny of all new military expenditures to determine
whether they are really needed.
Market
Crash Born of Greed
LESTER
THUROW
From the Boston Globe, April 17, 2001
Every
economic system comes with its own genetic characteristics.
Stock market crashes, booms and busts, inflation and deflation
are all genetically part of capitalism. There are other
social economic systems that come without these intrinsic
instabilities. In communism there is no stock market to
crash and central planning prevents ups and downs in either
prices or output.
While these alternatives—socialism, cooperatives, kibbutzes—do
not have capitalism's "bad" genes, they also do
not have its "good" genes.
Capitalism has come to dominate the world's economies since
no other system has been able to generate long-term economic
growth in the two hundred years since the onset of the industrial
revolution. Many others have been tried, but they have all
failed.
Capitalism's bad genes cannot be separated from its good
genes since both flow from the fact that capitalism taps
into the greed that seems to be built into human beings.
The desire to have "more," however much one already
has, is the human desire that makes capitalism work. It
leads us to acquire the skills that will earn us the most
money, to work long hours, and to be ruthless profit maximizers.
The alternatives to capitalism all tried to tap into altruism.
It is more important to help one's neighbor or the society
in general than it is to help one's self. This is a much
nicer ethical principle than the greed that underlies capitalism,
but it unfortunately does not seem to be congruent with
the way human beings are constructed. No one has been able
to construct a society where communal altruism dominates
individual need.
But it is also greed that leads to stock market crashes.
Go back to the first capitalist stock market crash—tulip
mania in Holland in the 1800s. At the peak of the boom four
black tulip bulbs bought one of those nice row houses along
the canals in Amsterdam. At the time everyone knew that
was crazy. In the long run, the price of a tulip bulb cannot
be higher than the cost of growing a tulip bulb. But there
was a time when eight tulip bulbs bought a house. If an
investor got out of the market when it was eight to one,
when it was going to peak at four to one, he or she missed
an opportunity to multiply their wealth by a factor of two.
Who would want to pass up such an opportunity?
What was true in the 17th century is equally true in the
21st century. The high tech stock market crash now underway
is not hard to explain. What were obviously overpriced high
tech stocks had to come down to reality. What has to be
explained is not the fall in prices but how the stock market
prices of companies with no revenues, no profits, and no
business model could have been so high a year ago. And the
answer is greed. We all knew that these stocks were overpriced,
but we all wanted to get wealthy. We knew that prices would
eventually fall, but we believed that we could get out before
the declines began. But as a group we cannot all get out
of the market at the same time. Someone has to be left holding
the bag. Greed overwhelmed rationality.
If greed is the primary factor leading to stock market crashes,
there is also a secondary set of genetic characteristics
that makes the crashes much bigger than what greed alone
would do. This is the "herd" mentality. When a
few of us start to run for the exits, we all start to run.
We don't think, we run. And when we all run, prices don't
return back to normal. They crash right through normal to
abnormally low levels. Stocks with good revenues, profits
and business models crash right along with those that have
none of these characteristics.
We run as a herd because we have been genetically selected
to do so. If a herd of antelope sees a lion, thousands run,
even though only one of them will be eaten. No one wants
to sacrifice itself and be that one antelope that will be
eaten. If there were such an animal, the rest of us would
not have to run. Antelope also run if they see the grass
waving in the wind or if they see other antelope running.
There may be a lion. One can always come back to eat the
grass if the lion isn't really there. The one who waits
to see if the lion really is there gets eaten. Over millions
of years we have been genetically programmed to run as a
herd. It is always rational to run.
Just as eventually a herd of antelope will settle down to
eating grass, so eventually the stock market will return
to normal. The prices of good companies will recover and
bad companies will go out of business. All the investor
has to do is to decide which are the good companies and
which are the bad companies. Two or three of those dot.coms
are going to be the Walmarts, General Electrics, and Merrill
Lynches of tomorrow. If you buy those few, you really are
going to get rich.
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