Cold War Roots of U.S. Economic Problems

In the uncertain years immediately after the Second World War, U.S. political leaders erected a credit-financed, consumption-led economic framework. It was designed in large part to support job creation and the economic growth of its Cold War allies. The strategy succeeded. The United States and its allies won the Cold War. But the strategy put in place a set of conditions that are now the central challenge of the next U.S. presidency.

The United States became the global consumer of last resort for the export goods of first Germany and Japan — and later all the countries surrounding the USSR and China. The goal of the United States was admirable — to help redevelop the economies destroyed by the war and to keep workers in those countries from being attracted to the promises of communism.

The strategy succeeded. The Western democracies prevailed. With the fall of the Berlin Wall, the Cold War ended and democratic and market liberalism became the foundations of future global growth.

Import substitution and later export-led growth strategies were key ingredients of the economic recovery plans of World War II-scarred Japan and Germany and other Western ally countries surrounding the former USSR and China.

This is particularly clear in Asia from the 1950s into the early 1990s.

Japan, followed by the Asian Tigers and other “newly industrialized countries” in the “flying geese formation,” successively pursued national economic plans. All were focused on substituting domestic production of basic goods for imports — and then moving up the production chain to maximize growth through exports to the developed world.

The United States served initially as a capital provider and then as the linchpin importer/consumer-of-last-resort to support these recovery and development strategies. The United States — through grants, development loans and defense arrangements — met the early capital needs of its Cold War allies in the 1950s.

At the same time, the United States de-emphasized savings and encouraged consumption — even to the point of providing tax deductions for consumer credit interest expenses. This policy supported the evolving export-led growth strategies of U.S. allies. The high production, high savings strategies of the recovering and developing countries were matched by a U.S. high consumption, low savings economy.

In the early decades of the Cold War, the United States and U.S.-backed international financial institutions were net suppliers of capital to Iron Curtain allies to finance recovery and import-substitution development strategies.

As these countries stabilized and shifted to export-led growth strategies, U.S. trade deficits appeared and then deepened, and U.S. dependence on capital inflows from Cold War allies became established.

This system of export to the United States started to break down in the 1990s. Diminishing marginal returns to export-led growth set in — and a zeroing-out of the strategy occurred in the mid-1990s.

The explanations offered by the United States and other G7 governments (that the Asian downturns of the mid-1990s were mainly the result of “crony capitalism,” inadequate financial supervision and a lack of transparency) are incomplete.

The downturns were, of course, in part due to these factors, but the important question is how “Asian miracle workers” became “crony capitalists” in a matter of three or four years. Something is missing.

What is missing is a recognition that national security is the highest domestic political priority of any country. Domestic economic policies are shaped to maximize national security. The U.S. Cold War economic policies were in contrast to those the United States pursued to win World War II. To win World War II, the U.S. became a high production, high savings economy.

The United States essentially out-produced its enemies. To win the Cold War, the United States became a low-savings, high-consumption economy. It basically supported its allies in a recovery, development and growth process that out-consumed the USSR and China. The United States exhausted the USSR and forced China to change its policies on domestic investment.

The United States was able to support its allies in a recovery, development and growth process that exhausted the USSR and forced China to change its policies on inward investment.

The matching consumption-led and export-led economics pursued by the United States and its Cold War allies were optimal for addressing the priority of winning the Cold War — but not for a non-war environment.

The magnitude of the Asian adjustments following the end of the Cold War shows that Asian economic, financial and political frameworks were not workable for a post-war environment. As soon as the Western capital markets and democracies were not required to prop up those frameworks, they ceased doing so, and “Asian miracles” became “crony capitalism.”

The unsustainble U.S. federal government budget and the fragility of American household finances are expressions of the U.S. Cold War consumption-led growth policy. In the 50 years from 1947 and the enactment of the Marshall Plan to restore the economic strength of U.S. Cold War allies, to today, the U.S. budget and American households have slowly shifted from strength to weakness.

The ability of the U.S. government to pay for basic services, including the court system and the military, will be exhausted within 15 years unless Congress enacts massive tax increases, deficit increases or cuts in spending. Without these, all government revenues will be used up by Medicare, Social Security, tax expenditures and interest on the government debt.

The majority of U.S. households have gone from financial strength to weakness. Last year well over 50% of U.S. households could not maintain their living standard without going deeper into debt. These same households do not have enough ready cash to carry them through the loss of just two paychecks.

Polling indicates U.S. voters are deeply worried about their economic futures and are very suspicious of the power of “special interests.” Their worries are mirrors of the consequences of Cold War economic policies and political power of those who benefitted from them.

Presidential candidates Barack Obama and John McCain are positioning themselves as independent, “change-oriented” candidates. Neither candidate, however, has talked about “change” as meaning Americans have to shift away from the main policies of the past half century. Until they do, U.S. economics and politics will be unable to escape the grip of the past — and the risks of civil instability will deepen.

Editor’s Note: You can read Part I here and Part II here.