Down and Out in the United States?

J. Bradford DeLong

For most of the past decade the world has been lectured to by Americans who proclaimed the perfection of the US economy: its focus on competition, loose labor regulation, and a modest social safety net, all of which supposedly delivered dynamism and high growth rates.

Continental Europeans were told to follow the US model and liberalize their labor markets, so that businesses that want to hire can do so without losing money and so that unemployed workers who find new jobs won't see their wages offset by cuts in welfare-state benefits. Japanese were told to socialize the losses their banking system incurred when Japan's bubble burst, then re-privatize those parts of it that could still succeed as going concerns and liquidate the rest. East Asia's Tigers were told to abandon the German-Japanese financial system based on universal banking and adopt the Anglo-American model based on liquid financial markets. They were also admonished to do a better job at regulating their financial system.

Other developing countries were told that their trade barriers, their love of inflationary finance, their failure to curb tax evasion, and their lack of governments strong enough to enforce property and contract rights against local notables, organized bandits, and - most important - their own functionaries were keeping them from participating in the new globalized economic cornucopia.

Now it's "pay back" time, when the world lectures America about how to fix its no-longer-perfect economy. But can this criticism be constructive, not a bout (pleasurable, of course) of Schadenfreude ?

The most obvious piece of advice is that America's financial system should follow more faithfully the advice its advocates dispensed to others. In some countries, corporate managers are disciplined by the representatives of large universal banks who sit on corporate boards and vote large blocks of shares. In many countries, managers' leashes are also held by families of plutocrats who exercise control through pyramids of companies and special classes of stock. America's model of corporate governance was supposed to rely on the following set of factors:

· managerial failures were supposed to trigger hostile takeovers;

· even before a takeover occurs, managers were supposed to be disciplined by fears of a revolt by their boards of directors, especially when the directors think that the company might be become a target of a hostile takeover;

· managers were to pursue good performance at all costs, because their stock options and other performance-related compensation made their own fortunes tied to that of shareholders and the corporation.

Within those constraints, American managers were supposed to exercise considerably more discretion than their foreign counterparts, so that they could use their business judgment without being shackled and second-guessed.

Combined, all of this was supposed to deliver dynamism. But for this system to work solid information about under-performing companies must be available to investors and the link between the pay of top managers and company performance must be real.

Instead, what evolved was a lax accounting system and a "heads you win, tails your options will be re-priced and you still win" method of managerial compensation. No surprise, then, that bosses who couldn't legitimately show the market strong profits cooked the books, often with the help of their supposedly independent accountants.

As things stand, it is in no one's short-term interest, certainly not in the short-run interest of accounting firms that make more money from consulting contracts than from doing a company's books, to allow accurate information - if it is bad - to leak into the market. Other countries must then tell America that the state can't stand back and let the market do this job: accurate business information is a governmental responsibility. Moreover, the greed of bosses cannot be the sole determinant of managerial remuneration.

Unfortunately, America now has an administration keen to downplay the importance of timely reporting of insider stock sales (the President himself failed to do that when he was in business), the timely reporting of changes in the accounting treatment of a company's unrealized revenues (something that did happen at Halliburton when it was run by Vice President Cheney), and of executives' duty to know about the fraud committed by their subordinates (unlike what happened when current Army Secretary White was running Enron's energy trading operations).

Outsiders should also remind America that its population is aging and that big savings will be needed to pay for the looming retirement of the baby boomers. Two years ago "Save Social Security" (America's state pension system) was a political mantra. The huge federal budget surplus was supposed to provide the means to do that. President Bush's tax cut, however, squandered the surplus. Huge deficits reappeared. Outsiders must remind America that its pension system is a ticking time bomb that must be defused.

Third and last, the past two decades saw America change from a largely middle-class society of the same genus as Europe's social democracies into a creature with extremes of wealth unseen since before World War I. One driving force behind this is America's retreat from its unique emphasis on education.

Declining public school quality, downward pressure on funding for public higher education, and a failure of political will to make higher education affordable for everyone has produced a growing education gap among those who can and cannot afford quality education. So while the economic case for greater private and public investment in education is stronger than ever, most individuals can't save enough to pay for it, and education - despite all the talk of politicians - is not the federal priority it should be.

After lording it over the world for so long, Americans should accept today's rebukes with grace. But if the rest of the world really wants to help, it should lecture America along the lines I suggest. Some of us might listen.