FOUNDATIONS OF AMERICA'S ECONOMIC GREATNESS

An Analysis of Their Origin
and
An Appraisal of Their Permanence

by

Dexter Merriam Keezer
Director, Department of Economics
McGraw-Hill Publishing Company, Inc.
New York, New York

## Summary

Over the last 200 years the American economy has produced what a British historian recently called "the western miracle of combining a phenomenal increase of population with rising living standards." This has been due largely to four basic elements: (1) A wealth of natural resources; (2) a growing population with broad access to good education; (3) a continental market free of trade barriers; and (4) incentives which have encouraged hard work, saving and investment in risky enterprises.

Given escape from another world war, the prospects of continuing to produce the "western miracle" remain bright so far as the first three basic elements are concerned. There is doubt, however, about the continuing vigor of the fourth element, that of incentive. Carried beyond a certain point, the drive for stability and economic security growing out of the great depression of the 30's undercuts incentives to work hard, save, invest. So, too, does the drive for income equality first prompted by the political reaction to the great depression and inevitably reinforced by the financial necessities imposed by war and preparation for more war.

It is peculiarly difficult to appraise the strength of the economy for the longer pull because of the forced draft presently put under it by the demands of the rearmament program. Even so, the view is expressed here that the drive for income equality and stability will be stopped short of destruction of vigorous incentives to further growth and improvement of the standard of living for a growing population. A key, and perhaps decisive reason is that there is a slowly growing appreciation of the peculiar compatibility of a system of private enterprise, which complete income equality and stability would kill, and the great American ideals of personal and political freedom.

At present the American economy is surpassing its prodigious performance of the past in providing material plenty. The civilian population of the United States is enjoying the highest standard of living on record, while our economy pours approximately one-sixth of its output into war making, preparation for war and the strengthening of our allies and potential allies.

The physical prowess of our economy has been heralded so often that it is difficult to deal with its superlative performance without resorting to well worn phrases and figures. Nonetheless, it is appropriate to take some special notice of it, even at the expense of repetition.

With about 6 percent of the world's population, the economy of the United States is producing and consuming over 40 percent of the world's total output. In the food which the average American consumes there is not only half again as much nourishment as that consumed by most of the human race, but it comes in an unequalled range of flavor and variety. Of residential housing there is enough to give every man, woman and child a separate room--a luxury not even approached in any other land. All but a small fraction of our homes have telephones and radio service; and in a rush since the end of World War II over 15 million of them scattered right across the country, have been equipped with television sets.

It is possible for every man, woman and child in the United States to take an automobile ride simultaneously. The nation's 45 million serviceable passenger cars would provide more than enough accommodation and the oil industry is equipped to provide the requisite motor fuel. If everyone made an effort to drive very far or fast the world's largest traffic jam would be a foregone result. But, even so, we have over 1½ million miles of surfaced roads, on which a very large proportion of our families can and do go riding every Sunday.

There is no sovereign technical explanation of this gargantuan productive performance. But it obviously depends in major degree on the fact that we have supplemented manpower with electric horsepower equal to the power of at least one billion human workers, a total much greater than the work force of the entire human race. And once the generating capacity is installed this electric power costs not over one-five hundredths as much as human power.*

Perhaps even more notable than its magnitude is the fact that this economic performance is almost entirely the result of voluntary association, so far as the exercise of governmental authority is concerned. Within the limits of their capacities and limits imposed by police and professional regulations, workers are free to choose their occupations. The organization and direction of economic activity remains preponderantly the result of voluntary private enterprise. This is true in large measure in spite of an array of emergency government regulations currently imposed to facilitate the diversion of resources from civilian to military production.

* The most conservative ratio of manpower to horsepower which I have encountered is one to ten, the ratio used here; and I have had suggested that a ratio of one to thirty would be more nearly correct. Thus the 100 million horsepower of electricity we have the capacity to produce in the United States equals at least one billion manpower and probably more nearly three billion. It takes somewhere in the neighborhood of a cent and a half to command the use of one horsepower of electricity for an hour. An average wage of 75 cents an hour for human labor of all kinds in the United States is well on the low side, and makes the calculation that human power costs five hundred times as much as electric power, foot pound for foot pound, a conservative calculation.

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Throughout the development of the American economy there have been, to be
sure, important ranges of economic activity organized on some basis other than
that of private enterprise. Public ownership and operation has characterized
the conduct of some parts of the economy (the post office, for example)
throughout its development. And at various times and in manifold different
ways private enterprise has been tempered by public regulation and public
subsidy. However, the existence of these variants does not alter the central
fact that there has been primary reliance on individual and private initiative
to organize and direct the economy.

This freedom for private economic initiative is, of course, peculiarly
compatible with our American ideals of personal and political freedom. I be-
lieve that the security of our personal and political freedom is directly de-
pendent upon the preservation of economic freedom. In the nature of the case,
however, this is an exercise in faith. I cannot conclusively demonstrate this
dependence.

No resort to faith, however, is required to sustain the belief that an
economic system having private initiative as its principal motive power is
peculiarly congenial to a political and social system in which freedom is
assigned the highest value. Hence, to its preeminence in providing material
plenty is added the transcendent virtue of compatibility with the nation's
highest political and social ideals.

Although there is great occasion for satisfaction with the performance of
our economy, relatively few people are sharing in that satisfaction. On the
contrary, the dominant lines of economic reflection run in terms of worry--about
the stability of our economy, about its capacity to grow or about the tugging
and pulling between various special interests which, long sustained, it is
feared would pull the economy apart at the seams. We worry desperately about
the consequences of re-arming and we worry about the consequences of stopping
the re-arming. Indeed it seems doubtful if so much worry about its durability
has ever gone along with such brilliant performance by an economy. Questions
such as these are urgently asked by many:

"Is the rearmament program the principal support of our prosperity?
Would a sharp reduction in the program mean depression?"

"Are we bleeding ourselves white in sending economic aid abroad?"

"Is continuing inflation going to eat away the foundations of our society?"

"Is ever higher federal taxation of those who work, and social security for
those who don't, killing the incentive to work?"

"Is the widespread reliance on government as the primary source of welfare
benefits destroying the confidence in private enterprise essential to its con-
tinued success?"

The urgency with which questions such as these are being asked grows primarily
out of two quite recent developments in our national history. One is the great
depression of the '30's. The other is World War II and its aftermath of conflict
with Communist Russia, war in Korea and the attendant rearmament program.

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The depression of the '30's and the political reaction to it resulted in a major realignment of social and economic forces in the United States, broad extension of social services by the various governments with increases in taxes, a great increase in the pre-occupation of the people with economic security and a deep undermining of confidence in business enterprise as a method of directing economic activity. The demands imposed by World War II led to an enormous expansion of the economy as a whole, but in the process also greatly expanded the burden of taxation, and continued a process of income levelling which the great depression had precipitated. The rush to be ready for World War III, if it comes, further increases the burden of taxation and enlarges the federal government's control over the economy in many other ways.

While recent developments prompt most of the worries about the future of our economy, exclusive concentration on these developments provides a too limited perspective in which to gauge the validity of the worries. Our economy has successfully surmounted severe crises in the past. Hence, to make a balanced assessment of its present prospects it is necessary to take a longer view of the development of the economy and the elements which have given it its peculiar strengths and weaknesses.

Over the full two centuries of which we are taking anniversary account, the shape, size and substance of our economy have been so completely transformed that direct "then and now" comparisons are apt to be more entertaining than illuminating. For example the population - about 1,250,000 when the mutual insurance business was established--has increased over 100 times and spread out over a continental area about nine times as large as that occupied in 1752. From being 90 percent rural and agricultural it has become preponderantly urban and industrial, with less than 8 percent of the population being concerned directly with agriculture.

One thread, however, runs through the whole development. It is that of a rising standard of living for a rapidly increasing population. The notable element here, of course, is the element of growth, reflected in the broad diffusion of an improved standard of living. It is one thing to provide a high standard of living for the few; it is quite another and more imposing performance to provide a rising standard of living for the great mass of people. Throughout recorded history a few have always enjoyed high standards of living. It has been remarked that electric lights would have been of little use to Louis XIV; he had enough candles and retainers to tend them to get the same effect. So, too, in the middle of the 18th century on this continent a few enjoyed what even today would be counted a high standard of living. To be sure, they knew nothing of modern speed and convenience of travel; and, as a glance at George Washington's tortuous denture on display at Mount Vernon attests, poor teeth and other physical ailments were often far more afflicting than they are today. But the basic elements of a high standard of living -- food, clothing and shelter of fine quality and servants to make them pleasantly accessible -- were enjoyed by a few Americans two hundred years ago. The accomplishment of the American economy lies only in part in increasing these standards; it lies largely in extending the rising standards on a mass basis, in producing what a British historian recently called "The Western miracle of combining a phenomenal increase of population with rising standards of living." *

* "Wealth of Colonies," W. K. Hancock, Univ. Pres., Cambridge, 1950, p.34
Cited by Joseph S. Davis in a Stanford University Research paper on "Our Changed Population Outlook and its Significance."

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The unique success of our economy in raising the American standard of living has, I believe, (in company with many others) been compounded largely of four basic elements. They are:

1. A wealth of natural resources.

2. A growing population with broad access to educational opportunities.

3. A geographically large and populous market area free from trade barriers such as protective tariffs.

4. Incentives which have successfully encouraged (a) most individuals to work hard, (b) the saving of a substantial share of current income for investment in capital equipment, and (c) the widespread pursuit of venturesome enterprise in the hope that the rewards would justify the risks taken.

The contributions of these four basic elements to the success of the American economy is, I believe, generally enough appreciated so that it needs little laboring. Obviously the fact that our country has been very bountifully blessed both with agricultural resources and the resources required for modern industrialism has contributed decisively to our success in providing and multiplying a high standard of living. We have had a substantial share of the World total of fine arable land, spread through a broad band of climatic zones to make for a great diversity of crops. Beneath the soil we have had almost half of the world's known resources of coal and, located in convenient proximity to some of them, a large share of the known world supply of high grade iron ore. And so it goes through much of the catalog of the basic materials of modern industrialism.

Of itself, a large and rapidly growing population is not necessarily an economic asset. To be potentially an economic asset a growing population must have access to good resources and the capacity to exploit them intelligently. In the Far East, where these conditions have not been present, increasing population has simply laid a heavier hand of poverty on the land. In the United States, however, the population has not merely grown in numbers. It has also had access to more than proportionately increased educational opportunities. For example, in 1950 about 94% of all children between the ages of 5 and 17 were in school, as opposed to 79% a half century earlier. And even when adjusted for the declining value of the dollar, the expenditures per pupil had increased six fold over this half century, the only period for which even tolerably good statistics are available.

The availability of a great free trading area has conferred upon the American economy two advantages of transcendent importance. With customers lined up in continental array, producers have been able to exploit in unique degree both the economies of specialization and those arising from large-scale operations.

It was one of the great turns of good economic fortune for the United States that during a decisively formative period the damage to be done by dismembering the American market by tariff barriers was dramatically demonstrated. The American colonies had won their war for independence against Great Britain. Thereupon,

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Of itself, of course, sturdy protection of property does not necessarily create the incentive to do what is needed to acquire it. To have that incentive there must also be opportunity. This, however, was so broadly available that the widespread complaint that the federal Constitution was essentially a device to protect those with comfortable property holdings was soon submerged by a general bestirring of the populace to become similarly endowed. To be sure, until the Civil War the slaves of the Southern states remained property rather than being accorded an opportunity to acquire it, and indentured servants were numerous elsewhere until the forepart of the nineteenth century. But it remained true that both for most artisans and farmers there was abundant economic opportunity to advance into the substantial property holding class.

Although it slights what are surely many vicissitudes, the following description of the process of becoming a prosperous farmer in western Connecticut in about 1780 by a traveller from France reflects the abundant opportunities available. "Any man who is able to procure a capital of five or six hundred livres of our money, or about twenty-five pounds sterling, and who has a strength and inclination to work, may go into the woods and purchase a portion of one hundred and fifty to two hundred acres of land, which seldom costs him more than a dollar or four shillings and six pence an acre, only a small part of which he pays in ready money. There he conducts a cow, some pigs, or a full sow, and two indifferent horses which do not cost him more than four guineas each. To these precautions he adds that of having a provision of flour and cider. Provided with this first capital the ground is cleared; the air and the sun begin to operate upon that earth which is wholly formed of rotten vegetables, and teems with the latent principles of production. The grass grows rapidly; there is pasturage for the cattle the very first year, after which they are left to increase, or fresh ones are bought; and they are employed in tilling a piece of ground which yields the enormous increase of twenty or thirty fold. The next year the same course is repeated; when, at the end of two years, the planter has wherewithal to subsist, and even to send some articles to market; at the end of four or five years he completes the payment of his land, and finds himself a comfortable planter."*

In large part because of the availability of opportunities such as this in the North and West and the perpetuation of the plantation economy manned by slaves in the South, agriculture and the business of opening an ever-expanding frontier remained the dominant concern of the economy prior to the Civil War. Along with a thriving volume of commerce, there were widespread beginnings of a factory system, but they remained relatively small beginnings. Although there are no statistics, reliable or otherwise, covering the situation, the Federal Census Bureau has remarked that, "It seems probable that until the year 1850 the bulk of general manufacturing was carried out in the shop and the household by the labor of the family or individual proprietors, with separate assistants."**

After the Civil War, however, opportunities for large scale manufacturing operations developed rapidly and touched off a sweep of modern industrialism which still surges forward. New markets were rapidly opened up west of the

* "Opportunity in a New Land," Francois Jean Chastellux. From a description of Western Connecticut, 1780, in Travels in North America in the years 1780, 1781 and 1782, New York, 1827.

** The Bureau confirms the accuracy of the observation but cannot locate the publication quoted.

human, plant and animal health, preference in state excise taxes for products made of home-grown materials and reductions in highway use taxes for haulers of home products are among the manifold devices which have been used. In the aggregate, however, they are minor aggravations to the free flow of trade through the length and breadth of the land.

Any attempt to appraise the present and prospective vigor of the incentives which have provided the driving force of the American economy inevitably moves onto slippery and uncertain ground. These incentives are the result of extremely complicated compounds of calculations of economic gain and loss and feelings such as those of pride, envy, hope and fear which to date defy anything approaching exact measurement. How the compounds are made varies from individual to individual, and from time to time. Indeed, the considerations involved include not only almost everything on earth, but even expectations of what is going to happen in heaven. For some, the hope of heavenly reward provides an incentive to hard and faithful work far more compelling than any gain to be made on earth.

In the United States it seems clear that one of the strongest incentives to vigorous economic activity has consistently been the existence of a fluid social structure. The standard dictum on this point has been that "any boy can become president," with the presidency of the United States in mind. But the fact that the presidencies of great financial and industrial organizations have been and continue to be even more accessible is obviously a great stimulus to economic ambition. Also it gives reliance upon private enterprise a justification which it does not have in countries where economic advance is often blocked by powerful class barriers. But how the power of incentive of this type compares with that of monetary gain no one knows exactly.

What can be asserted with complete assurance, however, is that since the great depression there has been a sharp scaling down of the monetary incentives upon which the American economy has traditionally relied for much of its driving force. This has been done in two general ways. One is by reducing the penalty for doing nothing -- by lightening the load of the stick, in the standard analogy of the carrot and the stick. The other is by reducing the rewards for doing something, either through the direct application of labor or through investment -- that is, by reducing the size and the succulence of the carrot.

The principal way by which the incentive of necessity has been reduced is by the extension of social security arrangements. The most important way by which the incentive of monetary reward has been scaled down is by taxation, particularly progressive income taxation; but monetary incentives have also been reduced in a variety of other ways.

When all the benefits provided by all of the prevailing arrangements for social security are added up, living on the income they would provide rarely if ever offers an attractive career financially. Unemployment insurance payments, made by the state with federal assistance, average less than $20 per week and, varying from state to state, last only from 10 to 26½ weeks. Old age benefits paid by the federal government, with supplements from the states, do not average much more than $50 per month. Of the 8 to 9 million workers now covered by private pension plans only about 3 million are now scheduled to receive benefits of more than $100 per month, including payments from the federal government. But when the myriad of arrangements, covering everything from the expenses of giving birth to expenses of being buried, are taken into account it is clear that a quite substantial cushion has been placed between the worker and the necessity of keeping at work and saving to avoid want.

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The effectiveness of the arrangements made since the great depression to impart a tolerable degree of stability to the economy also remains to be determined. The reason is, of course, that for most of the time since that depression the economy has been operating under a powerful forced draft created by war and preparation for war.

It is possible to make an impressive argument that institutional changes have been made which safely buttress the economy against anything like a repetition of the thirties. Such a demonstration would emphasize the fact that a repetition of the collapse of farm prices and wage payments, which greatly intensified the great depression, is now out of the question. The federal government has put props under the prices of key farm products, and wage rates, if not necessarily wage payments, are protected against collapse by the agreements negotiated by powerful unions. The demonstration would also give stress to the facts that:

* A large fraction of the total national income (an annual average of about 20 per cent even before the rush to rearm was started) is now accounted for by the expenditures of national, state and local governments. These expenditures are powerfully resistant to sharp contraction.

* Unemployment insurance, which covers three out of five jobs, and continuing pension payments steady the flow of consumer income and purchases. This flow is further insured by very great accumulations of individual savings.

* Danger of runs on banks by depositors is largely eliminated by the insurance of bank deposits by the federal government; and danger of ruinously rapid contraction of bank credit is eliminated by great abundance of the reserves held against such credit.

* Since the great depression, the statistical tools for analyzing the economy have been greatly improved, and substantial progress has been made in the art of economic analysis. This is particularly true of analysis of the relationship between investment and the level of employment, the bearing of fiscal policy on the general level of economic activity and the performance of business, in terms of the adequacy of competition.

Indeed, as one studies the barriers standing in the way of another great depression it is easy to gravitate toward the conclusion that the principal problem of stability does not lie in this direction, but in the direction of chronic price inflation which has dominated the post-World War II economic scene to date. Pointing in the direction of continuing inflation are the facts that:

* All three of the major political pressure groups -- farmers, organized workers and business -- have improved their relative position in terms of real income during the great postwar inflation. Hence, they tend to be apathetic toward doing what is necessary in the political field to stop it.

* An expansion of credit and currency sufficient to sustain continuing inflation of prices is technically feasible.

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So long as the forced draft of the defense drive continues, this added weight of taxation imposes no insupportable burden on private investment. Profits, upon which business has been forced to rely primarily for added investment in new facilities, are sufficient to sustain it not only at high, but record-breaking levels. But if the forced draft maintained by the government were to be removed or suddenly reduced without a prompt downward readjustment of taxation, capital investment would encounter a very considerable vacuum, so far as both monetary incentive and private capacity to sustain it is concerned. This is particularly true of that venturesome and, hence, risky type of investment upon which the growth of the economy has so largely depended.

To be sure, some new potential sources of venture capital have emerged as old sources have been destroyed by taxation. Many industrial workers now receive incomes large enough to accommodate some direct participation in American industry through purchase of common stock. Also, over the years, financial institutions, such as savings banks and insurance companies, might reasonably be expected to participate in this type of investment in larger measure than they are now permitted to do. As matters stand, however, the new rich among industrial workers have little knowledge of or appetite for investment in common stock, and making the requisite changes to enlarge the participation of this type of investment by financial institutions of the sort indicated is, at best, a time-consuming process.

If private investment were to fall down seriously, and prosperity with it, there is no reason to expect that the populace would simply grin and bear it. On the contrary, there is every reason to expect that there would be effective popular demand that the federal government make up the deficiency with public investment in industrial facilities. And there is equally good reason to believe that once the federal government embarked on such a course, the magnitude of the problem of making up the deficiency in investment by governmental participation would grow because the attractiveness of private investment in industry would shrink.

Thus the answer to the question of how far we are going to continue to rely upon private capital investment, particularly in its more dynamic sector of investment of venture capital, turns in large measure on the question of how far we are going to carry the process of levelling individual incomes which has been so vigorously pressed since the great depression. Anything approaching complete equality of individual income and a vigorous system of private capital investment are obviously incompatible. Even if the income received by the individual produces a surplus above immediate needs why save, why invest, most of all in risky enterprises, if all incomes come out about the same in the end anyway?

Likewise, anything approaching perfect stability is inconsistent with the venturesome type of enterprise which has been so preeminently successful in producing the great growth of the American economy. In the process of taking risks and losing, in leaving what appears to be a region of declining opportunity and hurrying to another of greater promise, there are inevitable ups and downs which, if they balanced out in anything approaching perfect stability, would indeed constitute a miracle.

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Finally, there is, I believe, a slowly growing appreciation of the peculiar compatibility between an economic system which places primary reliance upon private initiative and the personal and political freedom we have come to accept as our birthright. As an antidote for the widespread disenchantment with this economic system which was created by the great depression, we have had a long period of unprecedented prosperity. Also, we have had a back-drop in Europe, notably provided by the Iron Curtain, against which it is possible to see with greater clarity than ever before that governmental control of an economy and personal and political freedom may turn out to be deadly enemies. In his recent book, "Capitalism," David McCord Wright remarks that, "if we but keep in mind the values of opportunity, competition, democracy, productivity, then it is our capitalistic society which is the truly revolutionary one -- the only society which offers true hope to the masses for release from the long nightmares of tyranny. It is we, not the Marxists with their reactionary ideas of the good dictator who have the truly constructive, the truly revolutionary ideal."* I anticipate that growing awareness of that idea will temper the drives for stability and income which would put an end to it.

To be sure, if the choice were between economic freedom with depression, and security with a modicum of well being, I would fear for freedom. But that is not the choice. We can have a tolerable degree of economic stability, along with a distribution of individual income which eliminates socially destructive extremes and still provides strong incentives for that individual effort which is the only certain safeguard of personal and political freedom. That, I believe, is what we shall probably get. In expressing this view, I can only hope that the art of foreseeing the future by examining the past has improved since the ancient philosopher Aristotle remarked that "It is part of probability that the improbable happens."

* "Capitalism." David McCord Wright. McGraw-Hill. New York. 1950. p. 236.

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