The Long-Term Economic Outlook for the United States and its International Implications

The long run economic success of the United States will determine its ability to continue to provide economic and political leadership to the order it created in the aftermath of World War II. Though the U.S. economy exhibits some salient areas of strength, there are also areas of vulnerability. The future is uncertain, but how the U.S. economy evolves will certainly have implications for the rest of the world.  

A National Scorecard

The United States is potentially among the best-placed economies to benefit from the twin modern-day trends of globalization and technology. Typically ranking in the top five of the World Bank’s Doing Business Indicators and the World Economic Forum’s Global Competitiveness Index, the United States remains not only the largest economy in the world by a factor of three in current dollar terms but also among its most open, innovative, and flexible. Its high per capita income reflects high productivity—the broadest and single best measure of competitiveness. Despite being home to less than 5 percent of the world’s population, the United States accounted for 28 percent of global patent applications in 2008 and is home to nearly 40 percent of the world’s best universities. Furthermore, U.S. demographic trends are favorable compared to those in other advanced countries. Over the next twenty years, the UN expects the United States’ population to grow by 17 percent, while projecting that of the rest of the developed world will grow by only 1 percent. Part of this strength comes from high immigrant inflows and the country’s unusual ability to integrate migrants.

Nevertheless, the United States is also plagued by serious and growing weaknesses. Health care is expensive and inefficient: public and private health spending is 50 percent higher per capita than that of the next highest Organization for Economic Cooperation and Development (OECD) country, but the U.S. infant mortality rate, at 6.7 deaths per 1,000 births, is higher than in all OECD countries except Turkey and Mexico. Moreover, as the population ages, health care costs, which already account for about 17 percent of U.S. GDP, are expected to rise rapidly. Secondary education is weak, with fifteen-year-old American students ranking only 31st of 65 countries in mathematics tests and 22nd in science tests in a survey that includes many developing countries. This could mean that while future U.S. workers will lay claim to the world’s highest wages, many will bring only mediocre skills. Some also believe that the United States has a large infrastructure deficit relative to other countries, though hard evidence on this is difficult to come by.

The U.S. income distribution is considerably more unequal than other advanced countries, and that divide is growing. While incomes of the top 1 percent of Americans have soared, median household incomes have declined since 1999. Moreover, the American Dream has become a myth for many people: social mobility is lower and relative poverty rates are higher in the United States than in most other advanced countries.

Despite its high productivity and competitiveness, the U.S. cumulative current account deficit over the last thirty years is $8.5 trillion, a reflection of extremely low household savings rates and government deficits. Dysfunctional tax policies are partly to blame for the indebtedness of both households and the federal government. The U.S. tax system—complex and rife with distortions—overly encourages borrowing, including for housing. It is also an outlier among advanced countries in numerous other ways—for example, in its very low effective corporate tax rate (though high nominal rate), low effective income taxes on the richest Americans, tax breaks on large mortgages which are regressive, and low gasoline tax.

The United States retains a dominant military apparatus. For example, the United States owns 11 of the world’s 20 aircraft carriers—and Italy’s fleet of two is the second largest. But this does not come cheap. U.S. defense spending accounts for nearly 5 percent of its GDP—a share about twice that of other developed countries—and for 40 percent of global defense spending.

Last but not least, an increasingly polarized and even dysfunctional political system is contributing to the fiscal mess, as evidenced by the brinkmanship surrounding the debt ceiling and the failure of the congressional “supercommittee.” Political immobility has also often prevented the United States from leading on the big international issues—from climate change and trade negotiations to IMF replenishment, for example. The United States provides less foreign aid, proportional to its GDP, than any other advanced economy.

Some Important Trends

In Juggernaut: How Emerging Markets are Reshaping Globalization, William Shaw and I estimate that, by 2030, the rise of emerging markets will add approximately a billion people to the world middle class. These newly empowered consumers will demand education, entertainment, and products and services driven by information technology—all goods the United States excels at producing. At the same time, trade barriers—which include logistical costs—have come down in recent decades and, despite the protectionist sentiment stirred by the Great Recession, world trade continues to far outpace GDP. Moreover, as a global technological leader, the United States could in the future be propelled by innovations in medicine, biotechnology, communications, transportation, or energy. For example, developments that improve the efficiency or extraction of shale natural gas and oil—of which the United States possesses large reserves—will provide disproportionate benefits to the United States.

However, these favorable trends must be weighed against looming dangers. A fiscal disaster—caused by unchecked health care spending, unwillingness to raise taxes, and rising debt in the United States in the coming years—could lead to a sharp economic contraction and depressed demand for a prolonged period. Such a process could be accelerated by the collapse of the eurozone, which could trigger another world recession and more intense scrutiny of sovereign debt levels. The last financial crisis exposed profound institutional vulnerabilities in the U.S. financial system. But the economy’s continued “financialization” and a failure to adequately tackle the root causes of the 2008 crisis and excessive risk taking in banks may leave the United States vulnerable to another financial crisis. If left unaddressed, poverty and income inequality, both at their highest level in decades, could undermine social cohesion and further polarize national politics.

Some international trends are potentially adverse as well. While the rise of China and other emerging markets presents great opportunities, it also erodes the United States’ relative economic weight and that of its traditional allies. The ability of the United States to manage and indeed accept the rapid rise of new global economic powers—in other words, to work with the trend rather than against it—is unclear. Their rise is bound to cause numerous frictions, many of which are already visible today—from global imbalances and currencies, to aid policies, to negotiations over trade and financial regulation. How this power shift is managed is of utmost importance.

In few areas is the potential for conflict more evident than in the mitigation of climate change, where China and India and many other relatively poor and fast-growing countries are very wary of committing to emission targets that could constrain their development. Even though the worst effects of climate change are unlikely to materialize within the twenty-year horizon of the projection, its early manifestations may intensify as may awareness of its dangers. This will raise the stakes in climate change negotiations, and the United States is ill-equipped to handle them given its lack of internal consensus on the issue. 

Two Stories

In the good scenario, most of these threats are avoided. Relations with key international actors remain cautious but generally peaceful. Markets stay open and trade continues to grow rapidly. The United States addresses its fiscal deficit and succeeds in stabilizing its debt/GDP ratio over the next decade. The eurozone remains intact and no new major financial crises erupt. And the worst effects of climate change are avoided.

In this case, the U.S. economy grows steadily at about 2.7 percent a year (see Juggernaut for a more detailed discussion). This compares with 2.5 percent over the last twenty years, which includes the Great Recession. U.S. growth reflects both solid labor force growth and technological advance, while capital deepening plays a relatively small role. Average living standards continue to rise, as real U.S. per capita GDP increases by nearly 40 percent and the fruits of economic progress are more equally distributed, relieving social tensions and attenuating political divisions.

Though the relative size of the U.S. economy declines—from about a third of G20 GDP in 2010 to about a quarter in 2030 in real U.S. dollars—it remains the largest in the world at market exchange rates. In purchasing power parity (PPP) terms, however, the U.S. economy is eclipsed by China, by around 2016, and China is 70 percent larger than the United States in 2030. Trade also shifts East: the U.S. share of world trade dips from around 12 to 10 percent, while East Asia’s share is expected to double from 10 to 20 percent. Though its growth slows quite sharply by the end of the forecast horizon, China becomes the central player in world trade and the largest trading partner of most countries.  

In the bad scenario, the U.S. economy slows sharply. The breakup of the eurozone leads to a massive financial crisis in Europe, causing U.S. unemployment and fiscal deficits to rise further. With little countercyclical policy space left in the United States, a slow recovery follows after two to three years of deep recession. In the longer run, health care costs continue to rise rapidly and a failure to bridge ideological divisions over tax increases and cuts in social spending causes the debt/GDP ratio to continue its steep ascent. Investor confidence becomes severely eroded, eventually leading to a fiscal crisis and a deep recession. Meanwhile, U.S. foreign policy is handcuffed by fiscal constraints—as is already evident in the U.S. response to the Arab Spring and the eurozone crisis—and China and others are increasingly called on to help.

Concerns about its waning influence deter the United States from reducing its defense spending, causing defense spending to accelerate in China and, in response, among its Asian rivals. U.S. and foreign companies shun the fiscally and growth-challenged United States as an investment destination. Outsourcing intensifies and good jobs in the United States are scarce; social cohesion is undermined by rising inequality and downward pressure on government spending on education, infrastructure, and social services.

Distracted by its domestic problems and internal divisions, a paralyzed United States accelerates its withdrawal from the international stage. The multilateral trading system is stalled, and trading partners eschew bilateral negotiations with the United States as they cannot rely on it to deliver on the deals it negotiates. The United States’ influence in the IMF, World Bank, and WTO declines in proportion to its economic and financial weight.

In this bad story, growth in the United States slows to a snail’s pace: an average of 1.5 percent a year through 2030. Weaker international trade and finance arrangements, as well as spillovers from U.S. and European domestic crises, will slow growth in other countries by about 0.5 percent a year. Slower growth holds down U.S. living standards: U.S. per capita GDP rises by only 18 percent over twenty years, half as much as forecast in our baseline. The U.S. role is considerably diminished internationally—the U.S. share of G20 GDP (measured in real dollars) falls to just under 25 percent by 2030, while China’s economy passes that of the United States in dollar terms and is 85 percent larger in PPP terms. Seen as a country on a downslide, the United States is both incapable of leading and disinclined to lead, and other countries look to align themselves with ascendant powers.

Global Implications

Even in the good scenario, the United States will be a less dominant economic player on the international stage. That scenario, however, is unambiguously better not only for Washington but also for the international community, which the United States continues to lead on the strength of its institutions and values. A reinvigorated United States participates in the conclusion of a watered-down Doha Round and then leads a process of WTO reform that streamlines new negotiations and strengthens the rules governing the international trading system. An ambitious Trans-Pacific Partnership including Japan and China is concluded, as is an important bilateral agreement on reducing behind-the-border barriers with the European Union. IMF resources are greatly expanded. As it rebalances its own books, the United States steps up its contributions to the World Bank and embarks on an ambitious development initiative in support of a more democratic Middle East. Working closely with China and India and leading by example, the United States guides the G20 as it tackles the most difficult challenges, from climate change through agricultural and energy subsidies to financial regulations. 

In the bad scenario, the eurozone unravels. The European Union still exists, but as an empty shell around a fragmented continent mired in a prolonged depression. Suffering from another global crisis, Japan remains ensnared in its decades-long slump. With the United States increasingly withdrawn, and few countries willing to follow an authoritarian and mercantilist China (assuming it does not adapt quickly to playing a more prominent global role), a large and dangerous global power vacuum is created. There is also a dearth of values and ideas, as the Washington Consensus becomes discredited and the world’s most successful economy, China, is built on a one-party, state-driven system.

Progress on climate change, trade reform, financial and monetary system reform, and global governance grinds to a halt, and the trading system may be thrown into reverse by a revival of protectionism. A weaker and less secure international community reduces its aid effort, leaving impoverished or crisis-stricken countries to fend for themselves and, therefore, multiplying the chances of grievance and peripheral conflicts. The United States loses its proportionally greatest influence to regional hegemons—China in Asia and Russia in Eastern Europe and Central Asia—while Western Europe would remain divided and rudderless. The Middle East finds itself riven by numerous rivalries that occasionally erupt into open conflict and oil price shocks. More generally, the absence of leadership and confusion on values makes the reconciliation of disputes more difficult and tempts the strongest to take risks they would not otherwise take.

Conclusion

Which of the stories is more likely to be realized? I believe the good scenario is the more likely, though many would disagree. What is clear is that the outcome will depend crucially on today’s decisions, and, if mistakes are made, the bad scenario may well materialize. The overriding lesson of these two futures is that there is more at stake in current economic policy debates in Washington and Brussels than most people realize. A return of the United States and European economies to health over a reasonable time frame is vital for preserving the current international order and reestablishing a sound base for continued prosperity and peace.

This article was originally presented at a workshop entitled “The United States and the Global Future” hosted by the Atlantic Council’s Strategic Foresight Initiative and the U.S. National Intelligence Council on December 2, 2011.