How to Remain the Number One Economy as China Ascends to Number Two
The news that China’s GDP will surpass Japan’s this year, making China the world’s number two economy, raises important issues for the United States.  There’s no prospect of China taking over the number one slot anytime soon: Even in our present shape, the United States will produce at least $14.3 trillion in goods and services this year, compared to China’s $5.3 trillion. But the Sino-Japanese shakeup in global economic rankings is a sign that America has to raise its game.
The real lesson here comes less from China’s ascendance than from Japan’s decline. Twenty years ago, Japan had racked up 30 years of extraordinarily rapid growth – just as China has today – and scaremongers predicted that Japan soon would overtake us. Yet Japan’s good times ended abruptly in 1991, ushering in two decades of economic stagnation. And the origins of that long downward slide should seem all too familiar to Americans, since it began with the sudden collapse of a huge real estate and stock market bubble, which then triggered a banking crisis and deep recession.
Sweden had a financial meltdown the same year as Japan; yet Sweden put together a new policy consensus around economic liberalization and the economy came roaring back within three years. On the other side of the world, Japan suffered through year-after-year of policy mistakes and paralysis by its long-ruling Liberal Democratic Party, producing two decades of economic languish. The particulars of Japan’s decline should make our public officials squirm: Hemmed in by powerful interests and an irresponsible opposition, the LDP couldn’t bring itself to clean up the country’s banks or fix the housing market, much less undertake deeper economic reforms to prepare Japanese businesses and workers for globalization and its intense competition.  So, Japan was left instead with years of financial-sector weakness that limited business investment – sound familiar? – especially for the new enterprises that drive technological innovation and job creation.
As Japan continued to falter economically, the LDP sank trillions of yen in new public projects – and almost nothing to reform their economic policies or upgrade the skills of Japanese workers, especially millions of women consigned to positions that have no future in a modern, idea-based economy. The result has been prolonged economic stagnation, and faltering competitiveness even for its global companies. From 1990 to 2005, for example, Japan’s share of the world market for producing high-tech goods collapsed from 24 percent to less than 15 percent.
The question for us is whether our own political system has the capacity to address challenges here that echo Japan a generation ago. We may not face the prospect of a national economic reversal as severe as Japan’s, and our world-class corporations should continue to prosper. Yet, we face serious challenges of our own which, if left unaddressed by Washington, could leave a majority of ordinary Americans facing economic stagnation for a generation.
At the top of this catalog of challenges are jobs, because the storied capacity of America’s companies to create new jobs has eroded badly. In the Bush expansion of 2002-2007, our private sector generated less than half as many net new jobs, relative to growth, as we did in the Clinton expansion of the 1990s, the Reagan expansion of the 1980s, and even the Carter expansion of the mid-to-late-1970s. The best policy response is to reduce the cost to businesses of creating those new jobs. We also know just how to do that – cut the employer’s payroll tax burden for net new hires, and slow future increases in the health care costs which they have to pay.
The outstanding question, however, is whether Washington can raise its game and enact these reforms. Let’s frame the political challenge in the terms that dogged economic reform in Japan for a generation. So, can congressional Republicans accept a tax increase, even one designed to fund a corresponding payroll tax cut? Optimally, the tax increase could contribute something on its own – for example, a carbon fee that also would help address our energy security and climate change.  For the other side of the aisle, can Democrats find a way to support a tax cut for business, even if it’s the most effective way to spur job creation?  Similarly, can Republicans swallow hard and support more regulation of our broken health care market, in order to reduce costs for business – and are Democrats prepared to trim federal outlays for powerful health-care interests if doing so will ultimately help create jobs and raise wages?
Here’s another challenge we will have to meet to avoid a version of the Japanese disease: Restore higher levels of domestic savings to support and promote higher levels of both private investment and public investments, especially in education and training, and in 21st century infrastructure including universal broadband and a modern electricity grid. We now know, after two generations of trying, that tax breaks aren’t enough to convince most Americans to save more. Since the 1990s, we’ve provided generous tax breaks in various forms that cover 80 percent of all personal saving, all to no avail. The only certain way to raise national savings, it appears, is to reduce public dissaving, through lower budget deficits.
Facing an economic slowdown that could go on for a long time, can Republicans accept cuts in defense spending – even with Secretary Robert Gates’ blessing – and measures to expand revenues? Ronald Reagan, of course, did take the same two difficult steps; but he was more willing to compromise, it seems, than some of his current-day followers. Across the aisle, will Democrats vote for measures that expand revenues from those they don’t call “rich,†even gradually, along with measures to trim future Medicare and Medicaid costs, even if it requires trimming benefits?
Stating the challenges so concretely exposes the political difficulties. But we also know what can happen eventually when a wealthy country – one like Japan – loses the political will to raise its’ game.