Today's date:
Fall 1987

After Hegemony

Walter Russell Mead is a member of NPQ, Advisory Board and the author of Mortal Splendor. The American Empire in Transition.

In the accompanying article, Mead outlines a scenario for a stable world order after American hegemony. He argues that the great compromise between capital and labor, which made it possible for all classes to share the wealth in advanced industrial societies, must be extended to the developing nations by the developed nations.

From 1975 to 1987 more than 4 million manufacturing jobs were lost in a group of high wage countries including the US, Italy, The UK, France, Germany, Sweden and the Netherlands. During that same period, roughly the same number of manufacturing jobs were added in Hong Kong, India, South Korea, Malaysia, Japan, the Philippines and Singapore.

Moreover, a new wave of low wage manufacturing has begun, which will ultimately dwarf the effect of the Pacific Rim countries. The People's Republic of China's shift toward export-oriented growth has enormous implications for the world economy. Already, some Hong Kong producers have moved facilities onto the mainland to take advantage of lower wages there. India, too, has long term plans that involve a heavier reliance on the export of manufacturing products. The seeds of new export-oriented manufacturing economies have been planted in countries like Kenya, Malawi, Mauritius, Tanzania and Zimbabwe, all Of which showed increases of 20% or more in their still limited manufacturing employment after 1979. Textile production - fleeing quotas on the established low wage producers - has skyrocketed in countries like Bangladesh, Guatemala, Panama and the Maldives.

The world's wage differentials are huge. In 1984 the average "compensation cost" (including direct wages, benefits and payroll taxes) for industrial workers was $1.38 in Korea, $1.78 in Hong Kong and $1.27 in Brazil. By comparison, the compensation cost for an industrial worker in the United States was $13.09.

This is true, despite the fact that in the United States, real wages are down. The average weekly earnings for nonsupervisory employees in the United States peaked during 1973 at (using constant 1977 dollars) $201 per week. Since then, they have fallen 17% to $167 in May, 1987. In constant, inflation -adjusted dollars, retail sales workers in 1987 earned less than they had in any year since 1950. The living standard of the American middle class stopped rising; this was the great economic fact of the last 15 years. In Europe, while wages remained steady or rose, unemployment reached new, double digit postwar highs. According to the OECD, European unemployment can be expected to remain high at least through the end of the century.

Call it liberal capitalism, the welfare state, or modem industrial democracy; the compromise between the working classes and the ruling classes that represents the underlying facts of political and economic life in the West, and to some extent 'in Japan, has been overtaken by events.

Keynes and Henry Ford
That compromise, which in the course of the 20th Century made its appearance in virtually every advanced industrial economy of Europe and North America, balanced two interests which most social thought in the 19th Century had believed to be irreconcilable. Sooner in some countries, later in others, every major political party made its peace with the program of social compromise. "Social democratic" (in the more delicate parlance of American politics, "liberal") parties and conservative parties competed to offer the economic program that would best ensure a growing economy with higher wages for workers and higher profits for capital. What all parties had in common was the belief that the politics of social compromise could over time deliver a rising standard of living for the masses measured as some combination of rising real wages and increased security from once catastrophic events like illness, unemployment and retirement.

If Marx was the theorist of social conflict, Keynes was the theorist of social compromise. It was Keynes who - following in the footsteps of, among others, Henry Ford - demonstrated that a high standard of living for the masses was necessary to the functioning of a modern capitalist economy. If the masses could not afford the goods produced by the factories, a vicious circle would begin. Layoffs and wage cuts would reduce purchasing power more, and the economy would sink toward a new, and much less favorable, equilibrium. Programs designed to raise consumption, and to cushion the individual worker from the shock of economic change, were therefore in the interest of both capitalist and worker.

This domestic system of compromise was secured and accommodated by an analogous international system. The United States, supreme in the non-communist world after World War II, used its influence to promote a system of international compromise. The colonial and imperial rivalries of the past were replaced by a system of international free trade. Multilateral treaties and agencies provided a framework for the resolution of economic questions; multilateral security treaties ensured that military and political questions among the Western states were addressed within a common framework.

The Great Compromise of the 20th Century was arguably the most enlightened and far-sighted social bargain ever negotiated. Under the aegis of social democracy, the advanced Western countries enjoyed decades, in some cases generations, of rapid economic and social development. Under the Pax Americana, age-old national rivalries were sublimated into cooperative ventures and structures. Fascism and communism were united in their scorn of this system. Fascism believed that international diplomacy was an unending struggle for supremacy in which no lasting compromise was possible. Communism believed that the struggle among classes was similarly uncompromisable. Yet fascism failed to conquer and communism failed to subvert this exasperating milksop of a social system based on compromise.

Now this system is endangered - not because of the machinations of its enemies, but because of the consequences of its own successes.

International stability and economic growth were the two greatest achievements of the Great Compromise, and these are the forces which have ,begun to undermine it. Economic growth gave an impetus to the industrialization of the Third World, and the stability of the world's political and economic structure in the postwar era made the spread of industry easier than ever before.

Manufacturing was not very mobile at the dawn of the industrial age. Land transport was expensive and slow; communication over great distances was uncertain. Industry often depended on local sources of raw materials and power. Furthermore, in the early days of technology, factory operations required more skills than they do now. An old fashioned steel mill required hundreds of workers skilled in dozens of trades.

This all began to change after World War II. While population growth and the mechanization of agriculture in the Third World were creating an enormous potential work force of impoverished slum dwellers, advances in communications, transportation and management made it possible for more and more industries to relocate freely throughout the world. One country after another learned to follow the trail blazed by recovering Japan - from light industry to heavy industry to sophisticated high-tech production. The process of industrial development - from textiles to steel to automobiles to computers - that took a century of more in the West was compressed into a generation in Korea and Taiwan.

In the West industrialization went hand in hand with the development of the social compromise. Workers and capitalists learned that both parties could advance their immediate interests through intelligent compromise; productivity, wages and profits rose together. That process was never simple or smooth; every major Western country experienced its share of riots and strikes in the 19th and 20th Centuries. Even so, these societies gradually learned to settle their internal conflicts through compromise and, after World War II, to settle the international disagreements among the advanced countries in the same way.

The prospects for this kind of compromise in the newly industrializing countries are not so encouraging. The pace of industrial development has been so rapid in these countries that social institutions are lagging. Worse, any country that attempts a Western-style process of social compromise will lose its competitive labor cost advantage to other developing countries. Already some companies have moved manufacturing capability from Korea to the Philippines in search of cheaper labor.

The result on a world scale is increasing overcapacity and a constant, downward pressure on consumer demand. With prices level or falling, there is more pressure on manufacturers in high wage countries to cut labor costs by joining the movement to the Third World. This movement results in still lower consumer demand, with more intensification of competitive pressure, and more industry moving to the Third World.

Keynes warned 50 years ago that the worst of aft policies was to decrease money wages. There was no course of action more likely to bring on a depression. In Keynes' time it was still possible, although more and more difficult, to regulate wages at the national level. Today wages are set by international markets, but economies are still regulated by national authorities. The minimum wage laws and other policies of the advanced countries no longer provide an effective floor under labor prices.

Keynes' basic insights into economic processes remain valid today, but national governments, even the American government, can no longer use fiscal policy to stimulate the economy. In classical Keynesian theory, a budget deficit would generate new economic demand, stimulating more production and therefore new revenues. As Germany discovered in the 1970s, and as France and the United States confirmed in the 1980s, this relationship between stimulation and growth, while not entirely vitiated by changed conditions, is no longer as strong as it was.

For this reason, we see the leaders of the Western economics attempting to avoid the stimulative policies they would once have embraced. All countries acknowledge that an economic locomotive is required; no country will accept the sacrifice of national interest which this role involves.

Demand Is Soft
Demand, worldwide, is soft. The OPEC countries have made spectacular reductions in their imports - in the case of Saudi Arabia, imports have fallen from $41 billion in 1982 to $27 billion in 1985, and have continued to fall. Austerity programs and export drives have reduced imports in the rest of the Third World, most notably in Latin America. Yet production is up.

The resulting glut shows up in three ways: Unemployment, even during expansions, remains throughout the advanced world at levels once reached only in recessions; factory utilization similarly remains at low levels once associated with recessions; and countries in both the advanced and developing world attempt to run trade surpluses with as many of their partners as possible.

Even the feverish financial boom of the last three years - with all its overtones of the run up of stock prices in the late 1920s - can be traced to the consequences of falling money wages. When wages fall, income is transferred from workers, who spend a relatively high proportion of their income, to investors who, with larger incomes to begin with, have higher savings rates. The medium term result of a fall in money wages is an increase in investor income, and therefore in more money available for investment. The overproduction of so many basic goods makes investment in new productive capacity relatively unattractive, especially so in the high wage countries. As a result, investment in new factories remains in the Third World, while investors in the First World are increasingly attracted to speculative investments and financial instruments.

The classic case is Japan, where a shortage of rewarding domestic investments has sent capital around the world. Much of the capital gravitates to stock and bond markets rather than to investments in new productive capacity. New capacity investment, where not dictated by protectionist policies by Japan's trading partners, goes to low wage countries like Brazil, Mexico and East Asia, unless it goes to the US to stem protectionist sentiments.

Yet the health of financial investments cannot be separated from the economic health of the producers of goods. Loans to the Third World in the 1970s fueled a vast increase in the world's capacity during that decade, but falling commodity prices - and mercantilist First World trade barriers - make it impossible for these loans to be serviced. American farmers similarly borrowed to increase production in the 1970s and there, too, falling commodity prices have forced many borrowers to default.

Countries Don't Default
"Countries don't default," said Citicorp's Walter Wriston before his successor set $3 billion aside to cover Third World loans. Mr. Wriston ought to have asked himself what happened to the Allied war debts from World War I. If France, Britain, Russia and Belgium reneged on their debts, the -MBA- countries, Mexico, Brazil and Argentina, may do so as well. Most of today's Third World debt will never be paid; the question is not whether it will be repudiated, but when and how. Another question: how great will the cost be in disrupted economic relationships and political conflict before the inevitable repudiation occurs? In the 1930s, the price was high in Europe.

A rickety pyramid of debt rests on a productive economy in deep trouble. Historically, this kind of market usually ends in a crash. We have developed such effective means of preventing financial crashes through central bank interventions and deficit spending that a violent crash may never occur: The speculative boom may end in a long drawn out whimper rather than with a big bang. Even so, as long as the aggregate purchasing power of the world's workers continues to fall relative to the goods they produce, there can be no return to the rising standard of living and stable employment outlook which cemented the long social peace in the West.

The last 15 years have seen American politics increasingly dominated by the politics of industrial decline. The economy has been unable to generate the growth out of which the Democrats have, since the New Deal, satisfied their constituents with government programs. The New Deal coalition, based around Samuel Gompers' famous summary of labor's demands - "More! " - has been unable to cope with an environment that only offers less.

The Republicans for their part have also been defeated by economic reality. Their ambitious plan to restore American competitiveness through tax cuts and other 'incentives for capital formation did not result in increased investment in industrial capacity in the United States. Instead, the new capital went overseas or into dubious financial investments. While the GNP expanded under Reagan, growth was not satisfactory by historic standards - roughly comparable to the dismal performance of Brezhnev's Soviet Union.

By early 1987 the competitive weakness of the United States' economy, and the unpleasant consequences of this for the American people, had moved to the center of political debate. Yet the true seriousness of the nation's position was not yet universally realized, and the political and economic consequences of the breakdown of the old social compromise were only beginning to make themselves felt.

Work Harder, Earn Less
"Work harder and earn less." This is the discouraging message that both parties have for the American people behind the rhetoric about productivity and competitiveness. And it follows 15 years of stagnation and decline. Millions of Americans have watched their purchasing power fall, learned to live with a new insecurity about their job tenure, watched their paid medical benefits yield to more expensive and less adequate alternatives, and watched public services (mass transit, education, sanitation and police protection) decline in quality, grow more expensive or both. Neither party has yet put forward a program capable of reversing or even halting this slide; economics has once more become the "dismal science," and politics is likely in consequence to become an increasingly dismal art.

The first political victims of the crisis of liberal capitalism have been the parties that stood most obviously for the welfare state. In Britain, the United States, Germany and France the exponents of social democracy have been defeated by "conservative" forces that more or less openly disavow what Reagan Republicans like to call "the failed policies of the past." The major parties in the leading western countries have become more polarized internally. The moderate forces in each party have experienced increasing difficulty in controlling their more ideological elements - a portentous reversal of what was once a trend toward the center throughout the advanced world.

Since the immediate consequence has been the weakening of the social democratic and labor-oriented parties, it is easy to miss the significance of the shift to a politics of class conflict. But assuming that no economic solution can be found to the decline of the middle class, the long term political beneficiaries of the decline of middle class will not be the parties of the democratic right.

Political landscapes can change with breathtaking speed. In 1929 the international horizon was peaceful; in America, the Republican laissez-faire philosophy of the "New Era" was beyond all serious challenge. Few anticipated the upheavals that lay, in Hoover's famous phrase, "Just around the comer."

A Global New Deal
For any lasting improvement in the world economy to come about, wages and social spending in the Third World must rise. The Great Compromise of liberal capitalism must take hold in the Third World, or it will fall apart in the First. Without some form of minimum wage in the Third World, jobs will continue to move to low wage havens, and demand will continue to leak out of the economy.

Raising wages in the Third World will require the active involvement of First World governments and multilateral institutions. A combination of carrots and sticks would close markets to products made without such minimum wages and provide financing and free trade to countries and firms that complied with international guidelines. Essentially, wages must be tied to productivity world wide which is not the same as saying that wages must be equal around the world.

According to figures collected by the World Bank, manufacturing employees in Third World and newly industrializing countries receive about 2 5 % of the value added in manufacturing as wages and salaries, while workers in the Western countries receive from 40% to 50%. Increases of about 30% in annual pay - preferably accompanied by a reduction in hours worked - would bring most Third World manufacturing incomes into a more stable relationship with First World conditions provided that the social wage was proportionately raised. Hourly wages would rise by about $1.00 in most countries.

To accomplish the same goal by the alternative method of lowering wages in the First World would be far more disruptive. There, hourly wages would have to fall $6.00 or more to reach wage/productivity parity, a decline whose political and economic consequences would be impossible to predict or contain.

By maintaining a relationship between productivity and pay, we can ensure that the consumers of every country could purchase goods more nearly equal to their own production. Under current conditions, world trade depends on imbalances. Third World countries must run huge export surpluses because they lack internal markets. In self defense the advanced countries are forced into competition themselves to increase their own exports. Any action taken to reduce this basic imbalance will greatly improve the climate for international economic cooperation.

Moving toward equal pay for equal productivity will not only put the world economy on a sounder footing; as a policy it has the kind of general appeal around which a political consensus can form in the United States and the other advanced countries. As a "feel good" issue, raising the wages of the super-exploited labor of the Third World gives a coherent and progressive framework for American foreign policy. As a "bread and butter" issue, defending the living standards of the American people can win solid support from organized labor. Farmers and miners will support the effect of this policy on commodity prices; manufacturers will welcome an approach to foreign competition which protects them from low wage labor without setting off trade wars among the world's advanced economics. Banks with large loans to developing countries will appreciate a policy that offers concrete support and guarantees for credit to overseas borrowers. By including the I social wage" in international labor standards, we will also find a framework to discuss a critical international issue which, so far, has escaped the full attention it merits: environmental protection.

The fears expressed by Jacques Attali [p. 4], that Keynesian stimulation of world markets would simply shore up an obsolescent technology, may be somewhat exaggerated. It was Keynesian stimulus, after all, which enabled the United States to make the transition to the new products and new technologies of the mid-20th Century. New products and new technologies benefit disproportionately from programs that raise economic demand at the margin. If demand stimulation in die Third World succeeds in opening substantial new markets, then there will be demand for new and presumably more efficient facilities to make these goods at the lowest cost available. Raising the cost of labor relative to the cost of capital will also encourage technological innovation. Historically new consumer goods arise from technical innovations in the field of production. Presumably the investment called forth by the new markets will call forth new, more productive techniques of production and these techniques in rum will serve as the basis for new consumption products.

In any case, our major trading partners among the advanced countries will find it easier and more rational to work together on an approach of this kind than to continue the drift toward trade wars that help no one. Politicians in these countries are also concerned about protecting the wages of their constituents.

Linking access to international markets to international standards for wages and working conditions is a policy that can avert a depression, protect the living standard of the American middle class, give coherence to American foreign policy, and promote economic cooperation among the advanced industrial democracies. Democrats and others looking for "new ideas" for 1988 and beyond will be well advised to consider policies along these lines. For those who believe in economic growth, social harmony and international cooperation, there are not many alternatives.

back to index