Is the U.S. in Relative Decline? Sadly, the Answer is Yes.

 The U.K. press is currently full of reports about the visit of China's leader-designate, Xi Jinping, to Washington this week. "The princeling and the professor" was one paper's editorial take on the Xi-Obama get together. Apart from personalities, however, what has consumed British interest is the accompanying debate about whether the U.S. is in decline.  We've been there a century before, so we're agog to discuss if this signals a historic moment in the process of principal power succession from the U.S. to China.

This blog is contribution to this debate. It focuses on the issue of America's relative economic decline.  I have to say -- with regret -- that I see this as already in process: it's no longer a question of whether -- but of pace and extent. 

It may appear contentious to suggest that America's economic pre-eminence is eroding when its has approximately a 25 percent share of nominal global GDP and its own gross domestic product was roughly twice as big as its nearest single-country rival, China, in 2011. However the U.S. GDP was eight times as large as China’s as recently as 2000. In the ensuing decade China’s economy grew on annual average by 10.5 percent in real terms compared to America’s 1.6 percent. On current trends, therefore, China’s GDP will eclipse America’s on a purchasing-power parity basis in 2016 and, far more importantly, in dollar terms converted at market-exchange rates in 2018.

Any one wishing to compare China and America as economic rivals should visit The Economist chinavusa website. That must-read journal for political and intellectual elites is in no doubt that the United States is in relative decline. Signifying this, in a recent edition it began a weekly section devoted entirely to China, the first time it has singled out any nation since it began detailed coverage of the U.S. in 1942 -– symbolically the very year that Henry Luce pronounced the arrival of the American Century.

The chinavusa indices make interesting reading. The U.S. still has 133 firms in the Fortune 500 global list of top companies, twice the number China has, but it has already fallen behind China on a whole set of other economic power indicators –- steel consumption (1999), exports (2007), fixed investment (2009), energy consumption (2010) and patents granted to residents (2011). The U.S. is still ahead -– if only just -– in retail sales, stock-market capitalization, and consumer spending, but current projections suggest the lead will change hands on all these indicators in the next ten years. Finally China will outstrip the U.S. on the ultimate index of hard power –- defense spending -- in 2025.

Of course these predictions might be selective and/or wrong. It is certainly true that Americans will remain richer on a per capita basis than the Chinese for many, many years to come. Moreover, U.S. economic strength was on an upward curve of sustained pre-eminence in the twentieth century. Why should the present century be any different? The Cassandras of economic decline have always been wrong in the past -- why should now be any different? The answer is that the U.S. has to grapple with a problem of economic re-balancing that China and other emergent economic powers do not face.

For the United States, recovery from the Great Recession is not the same as renewing the foundations of its economic pre-eminence. Cyclical bounce-back will not resolve the structural weaknesses that have been slowly eroding the foundations of America’s economic strength for a quarter of a century. In essence, the United States has relied too much on internal consumption and debt, both private and public, to drive its economic growth from the 1980s through the first decade of this century. The real renewal of its economic strength requires a re-balancing of its economy to focus more on saving, investment, and exports, but this will be difficult to pull off.

The U.S. is so far showing at best mixed signs of its capacity to re-balance. Household debt, which grew from $1.4 trillion in 1980 to $13.8 trillion in 2007, is now in decline thanks to the Great Recession, with the result that household saving is at its highest level in twenty years. But recession-swollen public deficits counterbalanced this to produce a negative rate of national saving in 2009-10. Meanwhile the trade gap, having narrowed in 2009 began to grow again in 2010, when America’s bilateral deficit with China reached a historic peak ($273 billion).

The United States still leads in key economic sectors, of course, particularly knowledge-intensive capital goods, but only about 4 percent of all American firms and 15 percent of manufacturing enterprises do any exporting at all and just 1 percent of firms account for 80 percent of America’s export trade. U.S. exports of goods and services made up just 10.9 percent of GDP in 2009. For economic re-balancing to occur, a goodly number of respected economists estimate that the export share of GDP will have to double within ten years, a very tall order.

Economic re-balancing also requires the state to play a constructive role in the process. In part this will be through greater public investment in all levels of education, in worker training, environmental safeguards, and infrastructure improvement to enhance competitiveness and productivity. Most significantly, economic re-balancing requires the national government to put its finances on a sustainable basis for the medium to long term so that credit is freed up for productive investment in the private sector.

A fiscal course correction will have to await stronger economic recovery lest it flatten the current expansion, of course. Sometime in the middle of this decade, however, the United States will have to begin taking action to control entitlement spending on Social Security, Medicare and Medicaid and to boost revenues through tax hikes. Without such a course correction, the Congressional Budget Office estimates that the U.S. public debt ratio to GDP will in 2023 surpass its previous peak of 109 percent, reached in 1946 when America was paying for WWII borrowing, and will hit 185 percent GDP around 2035. In those circumstances, legally required entitlement spending and interest repayment would increasingly squeeze out the availability of tax revenue for other programs. This would leave the U.S. government reliant on borrowing to fund defense, education, and infrastructure, but interest rates (long and short term) would become sky-high because of investor concern about the sustainability of the public debt, with severe consequences for economic growth.

The current state of intense political polarization inhibits America’s capacity to address its fiscal problems. Republicans insist on spending retrenchment on entitlements and domestic programs is the only route to fiscal salvation, while the Democrats want revenue enhancement to be part of the mix. Both are essential to achievement of fiscal sustainability. The Republican notion that tax increases for the rich will inhibit growth is not supported by the historical evidence from the 1990s (when economic growth and taxes rose) and the Bush era (when low taxes did not work any economic magic). Moreover, the current tax system underwrites the extreme inequality of income that is retarding America’s capacity to move from consumption and borrowing to savings and investment. In 1976 the richest 1 percent of households owned 9 percent of the nation's pre-tax income; in 2007 its share was 24 percent, with the richest 0.1 percent accounting for 12 percent. In essence, this income inequality leaves the rich with so much money that they binge on bubble-creating stock-market and real-estate speculation (and SuperPAC contributions), and leaves the middle classes without enough money to buy the things they think they deserve, which leads them to borrow and go into debt.

Without a fiscal course correction, America will not have the public investment funds to spend on programs that will keep it competitive in the future. Big education spending on schools and colleges is needed to upgrade the qualifications and skills of the immigrant population that is essential to America’s vibrancy. The states patently cannot sustain the public university system. California, which once had the greatest public universities in the world, is moving towards semi-privatisation through charging high fees that discourage low-income and lower-middle income applicants. As a result, a recent reported concluded, the Golden State will have a one-million graduate shortage by 2025 that will seriously threaten its knowledge-intensive industries.

Is America in relative economic decline? The simple answer is yes. Can it sustain the Number One spot? This is possible, but highly unlikely. But its strategy for doing so would be mistaken if this involved trying to block China’s rise, which benefits the global economy and that of the United States. Setting aside issues of national prestige, Americans might consider asking themselves whether it is better to be a vibrant and prosperous Number Two in a revitalized global economy rather than top dog in a stagnant Number One. As Britain found out, being economic Number One is a finite rather than infinite resource; however, America is highly unlikely to experience a twenty-first century decline of comparable dimensions to the Britain's in the second half of the twentieth century because it has too many advantages and assets -- but it still needs to safeguard its capacity to exploit these to best effect through taking prudent and timely fiscal actions.

To what extent relative economic decline translates into geopolitical decline is another matter. It is difficult to see China matching U.S. military power and global reach for many years to come, even if it does overtake the U.S. in defense spending in the 2020s. Nevertheless there is a link between economic power and geopolitical power. U.S. hegemony can no longer be relied on to keep the global peace and in regional terms China 's influence can only grow in Asia, arguably the continent that faces the greatest strategic challenges of anywhere in the world (such as a divided Korea, a disputed Taiwan Straits, and India-Pakistan nuclear rivalry). As such, the international community has to hope that the U.S. and China enter a debate about the type of international order that will emerge in the twenty-first century.