Special report

Imperial overstretch?

More a question of psychology than economics

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PAUL KENNEDY, a British historian based at Yale, made himself notorious in 1988 by suggesting in his magisterial book, “The Rise and Fall of the Great Powers”, that dominant powers had in the past fallen because of “imperial overstretch” and that the same might well happen to the United States. His judgment soon looked premature: the next year the Berlin wall's fall reduced the stretch with a twang, and the next decade America's economy became a world-beater. But that does not mean he will be wrong for ever.

Admittedly, the prospect still looks far-fetched. The burdens of America's world role are large and expanding, but not overwhelming. The resources produced by America's economy are vast, and the country recovered quickly from last year's brief and mild recession. Even so, the stretch is going to increase during the next few years. The real question is not whether America can afford its global burdens, it is whether it is going to want to afford them. Or, to put it another way, whether the effort required to afford them could have economic and political consequences.

On the face of it, the past offers some comfort. In the 1960s, at the height of the cold war and Vietnam, defence spending exceeded 9% of GDP in some years. In the 1980s, during Ronald Reagan's defence build-up, it reached 6%. In 2000 it was a mere 3% of what was by then a much larger GDP. And even the White House's proposal to increase spending next year by $48 billion to $379 billion, amid promises for more after that, would still leave it below 4% of probable GDP. That spending will exceed the military budgets of the next 14 biggest defence spenders combined, but will still be readily affordable.

America's military chiefs do not, though, think that next year's enlarged budget is anywhere near large enough. They argue that the increase has done no more than to repair damage done to reliability and readiness by previous trimming. The budget did little to transform the armed forces in ways that are often debated but hard to implement, such as turning army divisions into lighter, more mobile units; shifting the air force away from fighters and further towards bombers; and transferring resources from peaceful areas such as Europe towards hotter spots. The missile-defence scheme remains in its infancy, and is likely to cost more than current plans envisage. Following the war in Afghanistan, there will be pressure to spend even more on unmanned aircraft and precision-guided munitions. And the current strain on manpower is likely to persist for a long time, given the probable invasion of Iraq, continued fighting in Afghanistan, the desire to maintain bases in Central Asia, and subsequent peacekeeping and training roles in Afghanistan, Iraq and elsewhere.

The services already have trouble recruiting enough men and women for what is a 1.4m-strong force, and there has been no rush to volunteer since September 11th. The cost of recruiting each extra soldier is said to average $15,000. More will be needed, and restoring conscription is for the moment a political non-starter. Nor can America afford to rely upon increased spending and capabilities among its allies, both because they have proved poor at spending and because even the NATO countries are so far behind technologically that it is getting ever harder to fight alongside them.

Reagan politics, Reagan economics

Defence spending is thus likely to rise quite sharply for several years, as will the much smaller budgets for the new Department of Homeland Security and overseas aid. At this point, however, the past begins to look a bit less comforting.

High levels of defence spending for Vietnam in the late 1960s and the Reagan build-up in the 1980s both contributed to the emergence of big federal budget deficits. In the first case, the deficit helped stoke inflation, with later reinforcement from an Arab oil embargo in 1973; in the second, the deficit meant that short-term interest rates had to be high to curb inflation and that long-term interest rates—the main determinant of corporate borrowing costs—stayed high for longer than they would otherwise have done.

If defence spending does soar during this decade, the consequence is likely to be a moderated version of the Reagan era. As then, the White House has committed itself to cut taxes at the same time as raising spending, so unless a lot of money can be cut from other programmes a large federal deficit is a likely outcome. Inflation may not jump as a result, because the Federal Reserve can be relied upon to raise interest rates if necessary. But that will make economic growth a bit slower, especially if extra federal borrowing again raises long-term rates. And there is a considerable risk that America's deficit on the current account of its balance of payments, already more than 4% of GDP, could help bring about a sharp fall in the dollar. That will be helpful for exporters, but could force interest rates to rise further.

Thus, the picture starts to look rather like the one that led Professor Kennedy to make his premature judgment: twin budget and current-account deficits raising the cost of money and making the dollar volatile, while politicians and voters start to wonder whether they have taken on too much. Three years after Professor Kennedy's book, America took on the Gulf war—but made its allies, especially Japan and Germany, pay the bills.

There is, of course, a crucial difference. The Gulf war in 1991 came after a decade in which the American economy had performed poorly, at least in comparison with its apparent new rival, Japan. A study at the Massachusetts Institute of Technology, culminating in a 1989 book called “Made in America”, shocked readers by showing how badly American firms lagged in what were thought of as the key industries and technologies of the time. By contrast, the September 11th attacks came after a ten-year economic expansion, in which annual productivity growth had jumped, unemployment had plummeted and American firms seemed to be leading in all the key industries and technologies.

Far from deepening America's recession, as many economists immediately feared, the terrorist attacks turn out to have coincided with the beginnings of a recovery. Cuts in interest rates and in taxes, both before the attacks and after, seem to have helped maintain growth in consumer spending by ramping up house prices and making employees confident that even if they lost their jobs they would quickly find new ones. It would be premature, though, to declare that the first decade of the 21st century is therefore bound to be as buoyant for America's economy as was the final decade of the 20th.

Once again, America needs to be compared with Japan, but in a rather different way. Like Japan in the 1980s, America in the late 1990s was given an exaggerated sense of its economic strength by a huge speculative bubble in the country's stockmarkets. To alter the metaphor, it was rather like an Olympic athlete on steroids: basically impressive, but made to look even more so by the artificial stimulus of a financial-asset boom. Now the steroids have been withdrawn, America's economy remains impressive, but they are likely to leave side-effects.

Share prices crashed most spectacularly in the Nasdaq high-tech market in 2000-01, but the more conventional Dow Jones Industrial Average also slumped. In history, such crashes have always produced economic traumas of some kind, generally a combination of banking collapses, corporate bankruptcies, accounting scandals and waning confidence among consumers and investors. Bit by bit, these elements are emerging. Scandals at Enron, Global Crossing, WorldCom, Tyco and others are spreading disillusionment about the integrity and honesty of corporate managers; revelations about conflicts of interest and favouritism at investment banks are spreading a similar disillusionment about Wall Street.

The effects of such disillusionment on the wider economy are likely to be indirect: it will probably sap consumer confidence, and lead households to save more of their incomes for fear that their pension investments might be worth less than they once thought; companies will find it harder to raise new capital, and so will become more cautious about how much debt it is safe to carry and thus about capital investment.

In the immediate future, this probable economic bumpiness will be more important for domestic American politics than for international affairs. The determination to fight against al-Qaeda terrorists and, in due course, against Saddam Hussein, will surely not be affected. Economic weakness, especially if it is expressed in rising unemployment, will, however, make the Bush administration even keener to pander to domestic lobbies for trade protection, as it already has for steel and farms. Again, this will be a repeat of the Reagan era, when free-trade rhetoric was contradicted by measures to restrict imports from Japan.

The virtues of flexibility

Even so, there remain good reasons to feel confident about America's longer-term prospects; scholars should not be following Edward Gibbon by writing “The Decline and Fall of the American Empire” just yet. Where Japan suffered following its crash in 1990 from a rigid economy and political paralysis about what to do about it, America may suffer from some political paralysis but its economy is flexible enough to sort itself out, in time, cleaning up messes and reallocating resources rapidly. Gibbon, remember, was writing about the trials and tribulations of Rome's empire—but it was an empire that endured for hundreds of years.

Entrepreneurship looks strong and management capable—if overpaid. The greater intensity of competition in the American market than in either Western Europe or Japan continues to force firms to keep changing and innovating, and restrains their ability to raise prices. In information technology, American-based firms still lead the world. And venture capital has been flowing rapidly into the newer industries of fuel cells, genetics and medical technologies.

There are, though, two small clouds on this otherwise sunny horizon that could be worth attending to. The first is that, despite the technical prowess of its universities, fewer Americans are taking undergraduate degrees in natural sciences and engineering than students in almost any other rich country. As chart 8 shows, only 6% of American 24-year-olds have first degrees in those subjects, a lower figure even than in Europe and far lower than in the stars on this measure, Finland and (surprisingly) Britain. America's universities lead the world in all the sciences, but many of their students, especially postgraduates, are foreign rather than American.

According to Paul Romer, an economics professor at Stanford University noted for his work on the links between technology and growth, the reason for this is likely to be that science courses are costly to provide, so colleges make them hard to pass. While English, history and economics faculties give high grades to 75% or more of their students, computer-science and chemistry faculties give A or B grades only to around 60%. The fault may be grade inflation in the arts courses, but the result is that fewer Americans want to take science.

Does that matter? It is a splendid thing that foreign students come to Stanford, MIT and elsewhere to study science; some of them stay and found companies or work in existing ones, while others return home and (it is hoped) speak warmly of their American experiences. Mr Romer does not want to discourage them. But he and others argue that the longer Americans continue to shun science courses, the more it will make America vulnerable—to a change in the wish of trained foreigners to work there, say, or just to a weakening knowledge of technical subjects in the workforce as a whole. He advocates subsidies to alter the incentives faced by both professors and American students.

The second small cloud looms over the new industry of biotechnology. It is the result of political opposition to the use of stem cells and other material from human fetuses in genetic research, which is a side-effect of the fierce battle that has long raged in American politics over abortion. What the ban on this and on all cloning means is that the pioneering research in this new and evolving field will take place elsewhere, in countries that do permit it. If the resulting industry turns out not to amount to much, this may not matter; for the time being, America remains the hottest place to do other sorts of medical research. But if it fulfils the dreams of its advocates, America will have sacrificed its domestic hopes in one of tomorrow's industries.

This article appeared in the Special report section of the print edition under the headline "Imperial overstretch?"

America's role in the world

From the June 29th 2002 edition

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