The U.S. Economy: Historical Overview
It is not what we have that will make us a great nation; it is the way in which we use it.
—Theodore Roosevelt, 1886
The workings of the U.S. economy are complex and often mysterious, even to economists. At its simplest, the economy runs on three major sectors: consumers, businesses, and government. (See Figure 1.1 .) Consumers earn money and exchange much of it for goods and services from businesses. These businesses use the money to produce more goods and services and to pay wages to their employees. Both consumers and businesses fund the government sector, which spends and transfers money back into the system. The banking system plays a crucial role in the economy by providing the means for all sectors to save and borrow money. Finally, there are the stock markets, which allow consumers to invest their money in the nation's businesses—an enterprise that further fuels economic growth for all sectors. Thus, the U.S. economy is a circular system based on interdependent relationships in which massive amounts of money change hands. The historical developments that produced this system are important to understand because they provide key information about what has made the U.S. economy such a powerful force in the world.
DEFINING THE U.S. ECONOMY
The term market economy describes an economy in which the forces of supply and demand dictate the way in which goods and resources are allocated and what prices will be set. The opposite of a market economy is a planned economy, in which the government determines what will be produced and what prices will be charged. In reality all nations have mixed economies somewhere between these two extremes; that is, there are no true market economies or true planned economies.
Another important term is capitalism. In a capitalistic economic system the means of production (i.e., the businesses) are owned and controlled by the private (nongovernmental) sector, rather than by the government. In addition, there is a labor market, meaning that workers compete against each other for jobs, and business owners compete against each other for workers. Wage and benefit amounts are driven by market factors, such as supply and demand. Although there can be various noncapitalistic alternatives, the most extreme is one in which the government owns and controls all means of production, assigns workers to jobs, and dictates wage and benefit amounts.
The United States favors capitalism and free markets in which private producers anticipate what products the market will be interested in and at what price. Producers make decisions about what products they will bring to market and how these products will be produced and priced. These factors foster competition among businesses, which typically leads to lower prices and is generally considered beneficial for both workers and consumers. This does not mean that the U.S. economy is free from government manipulation. As will be explained in this book the U.S. government takes many steps to influence economic factors. Nevertheless the U.S. economy is so market oriented that it is often called a market economy. The same holds true for the economies of other developed nations, such as Australia, Canada, and western European countries. All of these nations embrace (to various degrees) economic production and distribution by the private sector. There are stark differences between the market-leaning economies in terms of government intervention. This is particularly evident in regards to wealth redistribution (moving money from the most affluent members of society to the less affluent), a topic discussed in Chapter 8 .
Countries whose governments exercise a great deal of control over national economic matters are said to have planned economies. These governments regulate
wages, production, and prices in accordance with centralized plans. They also typically own large companies in key industries, such as energy development. This is a hallmark of communist or socialist political systems in which adherents believe that economic production and distribution are best managed by the government for society as a whole. North Korea, China, and Cuba are said to have planned economies because their governments aggressively manipulate supply and demand factors. However, within this group the level of control is very rigid for some aspects of the economy and much looser for others. Every nation in the world blends elements of centralized control and free enterprise to achieve a unique economy.
The mixed economy of the United States combines aspects of a market economy with some government planning and control. This creates a system with both a high degree of market freedom and regulatory agencies and social programs that promote the public welfare. The U.S. economy did not develop overnight. Its origins date back to the nation's founding in the 1700s. The newly formed United States adopted economic principles that favored a competitive marketplace with little government interference. These principles would dominate the nation's economic policy for more than a century. During this time the U.S. government had a hands-off approach to business regulation, a tactic described by the French term laissez-faire (leave alone or ‘‘do as you please’’). It was generally believed that the government should not interfere in economic affairs but should instead allow supply and demand and competition to operate unfettered, resulting in a free market.
Panics and Depressions in the 19th Century
In economic terms a panic is a widespread occurrence of public anxiety about financial affairs. People lose confidence in banks and investments and want to hold onto their money instead of spending it. This can lead to a severe downturn, or depression, in the economic condition of a nation. Economists argue about the exact definitions of panics and depressions, but in general it is agreed that they occurred in the United States in 1819, 1837, 1857, 1869, 1873, and 1893.
The crises were triggered by a variety of factors. Common problems included too much borrowing and speculation by investors and poor oversight of banks by the federal government. Speculation is the buying of assets on the hope that they will greatly increase in value in the future. During the 1800s many speculators borrowed money from banks to buy land. Huge demand caused land prices to increase dramatically, often above what the land was actually worth in the market. Poorly regulated banks extended too much credit to speculators and to each other. When a large bank failed, there was a domino effect through the industry, which caused other banks and businesses to fail.
A panic or depression results in a downward economic spiral in which individuals and businesses are Page 3 | Top of Articleafraid to make new investments. People rush to withdraw their money from banks. As panic spreads, banks demand that borrowers pay back money, but borrowers may lack the funds to do so. Consumers are reluctant to spend money, which negatively affects businesses. Demand for products goes down, and prices must be lowered to move merchandise off of shelves. This means less profit for business owners. To reduce their costs, businesses begin laying off employees and do not hire new employees. As more people become unemployed or fearful about their jobs, there is even less spending in the marketplace, which leads to more business cutbacks and so forth. The cycle continues until some compelling change takes place to nudge the economy back into a positive direction.
THE EARLY 20TH CENTURY
The early 20th century was a time of social and political change in the United States. Public disgust at the corruption and greed of previous decades encouraged the movement called progressivism. Progressives promoted civic responsibility, workers’ rights, consumer protection, political and tax reform, ‘‘trust busting,’’ and strong government action to achieve social improvements. The Progressive Era greatly affected the U.S. economy because of its focus on improving working conditions for average Americans. Successes for the progressives included child labor restrictions, improved working conditions in factories, compensation funds for injured workers, a growth surge in labor unions, federal regulation of food and drug industries, and the formation of the Federal Trade Commission to oversee business practices.
Despite its laissez-faire attitude, the federal government took two actions in 1913 that had long-lasting effects on the U.S. economy:
- Established the Federal Reserve System to serve as the nation's central bank, furnish currency, and supervise banking
- Ratified the 16th Amendment to the U.S. Constitution authorizing the collection of income taxes
World War I and Inflation
World War I erupted in Europe in August 1914. The United States entered the conflict in April 1917 and fought until the war ended in November 1918. Although the nation spent only 19 months at war, the U.S. economy underwent major changes during this period.
It is sometimes said that ‘‘war is good for the economy’’ because during a major war the federal government spends large amounts of money on weapons and machinery through contracts with private industries. These industries hire more employees, which reduces unemployment and puts more money into the hands of consumers to spend in the marketplace. This increase in production and hiring also benefits other businesses that are not directly involved in the war effort. On the surface, these economic effects appear positive. However, major wars almost always result in high inflation rates.
Inflation is an economic condition in which the purchasing power of money goes down because of price increases in goods and services. For example, if a nation experiences an inflation rate of 3% in a year, an item that cost $1.00 at the beginning of the year will cost $1.03 at the end of the year. Inflation causes the ‘‘value’’ of a dollar to go down over the course of the year. In general, small increases in inflation occur over time in a healthy growing economy because demand slightly outpaces supply. Economists consider an inflation rate of 3% or less per year to be tolerable. During a major war the supply and demand ratio becomes distorted. This occurs when the nation produces huge amounts of war goods and far fewer consumer goods, such as food, clothing, and cars. This lack of supply and anxiety about the future drive up the prices of consumer goods, making it difficult for people to afford things they need or want.
Although the government tried to impose some level of price control in the food and fuel industries, inflation still occurred. Figure 1.2 shows the average annual inflation rate between 1914 and 1924. The rate was unusually high between 1916 and 1920, peaking at 18% in 1918. Wartime inflation was particularly hard on nonworking citizens, such as the elderly and the sick, because they had no means of increasing their incomes, and, unlike later generations, they were not protected by government assistance programs.
A lasting legacy of World War I was the assumption of large amounts of debt by the federal government to fund the war effort. Figure 1.3 shows the enormous differences that occurred between government spending and revenues (receipts) during the war years. In 1919 government spending peaked at nearly $19 billion, whereas revenues for that year were just over $5 billion. The government made up the difference by borrowing money. One method used was the selling of Liberty bonds. Bonds are a type of financial asset—an IOU (an abbreviation for ‘‘I Owe yoU’’) that promises to pay back at some future date the original purchase price plus interest.
THE ROARING 20S AND THE GREAT DEPRESSION
The Roaring 20s featured several years of robust economic growth that were characterized by increases in mass production, the availability of electricity, consumer demand for goods, and consumer use of credit to fund purchases. However, the prosperity of the 1920s was not shared by all Americans. Financial problems rocked
the agricultural sector, and there were economic downturns in the coal mining and railroad industries.
The Stock Market Crash
During the late 1920s the stock market became a major factor in the U.S. economy as businesses sold stock (i.e., ownership shares) in their companies. Investors were richly rewarded when their stocks increased dramatically in value. Many people took out loans from banks to pay for stock or purchased stock by “buying on margin.” In this arrangement an investor would make a small down payment (as little as 10%) on a stock purchase. The remainder of the balance would be paid (in theory) by the future increase in the stock value. Buying on margin was extremely risky but was widely practiced by investors of the time. Overoptimism caused stock prices to rise higher than the actual worth of companies. During the fall of 1929 investors began to get nervous and selling frenzies occurred as people tried to get rid of stocks they thought might be overvalued. On Tuesday, October 29, 1929 (“Black Tuesday”), panic selling took place all day. Stock values dropped dramatically. By the end of the day many margin buyers had lost their life savings and their stock. Those who managed to hold on to their stock found it was worth only a fraction of its former value.
According to Harold Bierman Jr. of Cornell University, in “The 1929 Stock Market Crash” (March 26, 2008, http://eh.net/encyclopedia/the-1929-stock-market-crash ), the U.S. stock market lost 90% of its value between 1929 and 1932.
The Great Depression
The U.S. economy suffered a devastating downturn following the stock market crash. The depression was so deep and long (more than a decade) that it is called the Great Depression. It brought long-term unemployment and hardship to millions of people. The unemployment rate soared from 3.2% in 1929 to 24.9% in 1933. (See Figure 1.4 .) It remained more than 10% throughout the 1930s. The public lost confidence in the stock market, the banking system, and big business and at the same time was saddled with large amounts of debt that had been taken on during the 1920s.
The Great Depression was aggravated by a crisis in the banking industry. Some banks had invested heavily in the stock market using their depositors’ money or lent large amounts of money to stock market investors. These banks failed after the crash, and the depositors lost their savings. Fear of further failures caused so-called bank runs, in which large numbers of depositors rushed to withdraw their money at the same time. This caused more bank failures, which perpetuated the cycle. In addition, some economists believe that the banking market became oversaturated during the 1920s with underfunded and loosely regulated banks that lent money too easily. These institutions were already financially troubled before the crash and could not survive the stress.
When the Great Depression began, the laissez-faire attitude still dominated political opinion. However, in 1933 newly elected President Franklin D. Roosevelt (1882–1945) instituted what he called ‘‘a New Deal’’ for the nation. His administration acted aggressively in economic affairs by creating work programs, trying to revive farming and business, and spearheading laws that were designed to reform the stock market and banking industry. After nearly 80 years, economists still argue about whether the New Deal was actually ‘‘a good deal’’ for the nation. They all agree, however, that it was a turning point in U.S. economic history.
Perhaps the most significant legacy of Roosevelt's New Deal was the new role of the federal government as a manipulator of economic forces and a provider of benefits to the needy. In U.S. history the New Deal is considered the birth of big government.
By 1940 the unemployment rate was 14.6%. (See Figure 1.4 .) Although the rate was down from a peak of 24.9% in 1933, it was still high by historical standards. The hardship suffered by many Americans had been softened by nearly a decade of New Deal programs, but the country was still gripped by the Great Depression.
WORLD WAR II AND THE COLD WAR
The United States was involved in World War II from 1941 to 1945. After the war began, businesses rushed to
increase production and hire workers to produce the goods needed for the war effort. Unemployment dropped dramatically, and wages went up, particularly for workers in low-skilled factory jobs. Laborers found themselves in high demand and joined labor unions in record numbers to consolidate their power and seek better working conditions.
The federal government made efforts to avoid the huge inflation increase that had occurred during World War I. This required unprecedented interference in private markets and control of supply and demand factors. Rationing (tight controls over how much of an item a person can use or consume in a certain amount of time) was instituted on some goods to prevent dramatic price increases. Federal agencies oversaw wartime production, labor relations, wages, and prices. Overall, these efforts were successful. Figure 1.5 shows the annual rates of inflation that were experienced in the United States between 1940 and 1950. Inflation spiked during the early years of the war and immediately after but was not consistently high over the decade.
World War II was an expensive endeavor for the United States. However, it was believed that the stakes were so high that the war had to be won at any cost. As shown in Figure 1.6 , government spending during the war far outpaced revenues. By 1945 the federal government was spending about $90 billion per year and taking in revenues around half this amount. Once again, the difference was made up by borrowing.
Following World War II it appeared obvious that huge government spending had helped fuel recovery from the Great Depression. General belief in the laissez-faire approach to economics gave way to a new approach advocated by the economist John Maynard Keynes (1883–1946). Keynesian economics stresses strong government intervention in the economy and became the operating principle of the U.S. government during the post–World War II era. Although Keynes had his critics, and his methods have been revised over time, he is considered by many to be the father of the mixed economy system that is still being used in the United States.
Another innovation of this era was the compilation by the federal government of economic data on the nation's inputs and outputs, such as labor and production of goods and services. Researchers at the National Bureau of Economic Research (NBER) began estimating national income (e.g., wages, profits, and rent) as part of a program called the National Income and Product Accounts. Development was overseen by the U.S. Department of Commerce's Division of Economic Research, which evolved into the modern Bureau of Economic Analysis.
During World War II the federal government began compiling another economic measure called the gross national product (GNP). The GNP is the amount in dollars of the value of final goods and services that are produced by Americans over a particular period. It is calculated by summing consumer and government spending, business and residential investments, and the net value of U.S. exports (exports minus imports).
The GNP provides a valuable tool for tracking national productivity over time. The National Income and Product Accounts and GNP became important economic indicators of the state of the economy as a whole—that is, the macroeconomy.
The decades following World War II were generally prosperous times for the U.S. economy as the nation continued to grow industrially. Postwar euphoria drove a spending spree by consumers and a baby boom.
Dwight D. Eisenhower (1890–1969) was president from 1953 to 1961. His administration is associated with low inflation rates and general prosperity. However, the prosperity was not shared equally in American society. An oversupply of agricultural goods meant lower prices for consumers, but lower profits for farmers. Agriculture became increasingly an industry in which large factory farms run by corporations were able to survive, whereas many smaller farmers could not compete.
Minority populations (largely African American) also suffered financial hardship during this era. Figure 1.7 shows the dramatic difference between the unemployment
rates for whites and minorities during the postwar decades. By the mid-1950s unemployment among minorities was twice as high as it was among white workers, a disparity that lingered well into the 1960s. It was in this atmosphere that the civil rights movement gained strength and urgency.
The Cold War, Korea, and Vietnam
The United States left World War II in sound economic shape. By contrast, all other industrialized nations had suffered great losses in their infrastructure, financial stability, and populations. As a result, the United States was able to invest heavily in the postwar economies of Western Europe and Japan, with the hope of instilling an atmosphere conducive to peace and the spread of capitalism. U.S. barriers to foreign trade were relaxed to build new markets for U.S. exports and to allow some war-ravaged nations to make money selling goods to Ameri-can consumers.
The Union of Soviet Socialist Republics (or the Soviet Union) had been an ally of the United States during World War II, but relations became strained after the war. The Soviet Union had adopted communism during the early 1920s. During World War II it liberated a large part of eastern Europe from Nazi occupation and through various means assumed political control over these nations. The Soviet Union had been largely industrialized before World War II and quickly regained its industrial capabilities. It soon took a major role in international affairs, placing it in direct conflict with the only other superpower of the time: the United States. A cold war began between the two rich and powerful nations that had completely different political, economic, and social goals for the world. Unlike a “hot war” or direct and large-scale military conflict, the conflict between the United States and the Soviet Union was called a “cold war” because it was waged mostly by politicians and diplomats.
A direct and large-scale military conflict between U.S. and Soviet forces never occurred. Regardless, an expensive arms race began in which both sides produced and stockpiled large amounts of weaponry as a show of
force to deter a first strike by the enemy. In addition, both sides provided financial and military support to smaller countries throughout the world in an attempt to influence the political leanings of those populations. Communist China joined the Cold War during the 1950s and often partnered with the Soviet Union against U.S. interests.
By the 1950s the United States was embroiled in two Asian conflicts over communism: the Korean War (1950–1953) and the Vietnam War (1954–1975). In both wars the United States chose to fight in a limited manner without using its arsenal of nuclear weapons or engaging Chinese or Soviet troops directly for fear of sparking another world war. Unlike World War II, full-scale mobilization of U.S. industries was not required for these wars. Instead, a defense industry developed during the Cold War to supply the U.S. military on a continuous basis with the arms and mate´riel it needed.
Figure 1.8 shows the percentage of the national budget devoted to national defense between 1940 and 1970. Spending on national defense soared during World
War II and then declined dramatically afterward. However, military spending quickly climbed again as the Cold War intensified during the early 1950s and remained above 40% for nearly two decades.
THE 1960S: SOCIAL UPHEAVAL AND ECONOMIC GROWTH
The 1960s were a time of social and economic change for the United States. The decade began with the election of President John F. Kennedy (1917–1963), who promised to ensure economic growth and address growing social problems within the United States. In 1963 Kennedy's efforts were cut short by his assassination. Lyndon B. Johnson (1908–1973) took over as president and dramatically enlarged the federal government and its role in socioeconomic affairs. Johnson's administration initiated large-scale programs for the needy, including the health care programs Medicare (for the elderly and people with disabilities) and Medicaid (for the poor), jobs programs, federal aid to schools, and food stamps for low-income Americans. The so-called War on Poverty and the escalating war in Vietnam proved to be extremely expensive. At the same time, the United States was pursuing a costly (but ultimately successful) endeavor to land astronauts on the moon before the end of the decade.
Consumer and government spending drove the nation's GNP during the 1960s. However, inflation became a problem (as it often does in a fast-growing economy) during the late 1960s. At the macroeconomic level, there was too much money in the hands of consumers, which resulted in consumer demand that was higher than supply.
According to the NBER, in “US Business Cycle Expansions and Contractions” (November 2012, http://www.nber.org/cycles.html ), the United States experienced the longest continuous stretch of positive GNP growth in history, from the first quarter of 1961 to the last quarter of 1969. However, high inflation was about to become a major problem.
THE 1970S: STAGFLATION AND ENERGY CRISES
The term stagflation was coined during the 1970s to describe an economy suffering stagnant growth, high inflation, and high unemployment all at the same time. This combination of economic problems was unprecedented in U.S. history. Previously, high inflation had occurred when the economy was growing quickly, such as during World War II, and high production had meant high employment levels. By contrast, economic downturns were associated with higher unemployment but lower inflation (and even deflation). These relationships had been considered natural and certain.
The 1970s were unique because both unemployment and inflation were high by historical standards. The economist Arthur Okun (1928–1980) created the term discomfort factor to describe this condition. His discomfort factor, which became popularly known as the Misery index, is computed by summing the unemployment rate and the inflation rate. Table 1.1 shows the annual average Misery index calculated between 1968 and 1989. It ranged from a low of 7.8% to a high of 20.6%.
There were three presidents during the 1970s: Richard M. Nixon (1913–1994), Gerald R. Ford (1913– 2006), and Jimmy Carter (1924–). Although they tried a variety of measures to stem stagflation, their efforts were considered ineffective.
Foreign Oil and Competition
U.S. economic problems were aggravated by the country's dependence on foreign oil and competition from foreign industries. In 1973 the Middle Eastern members of the Organization of the Petroleum Exporting Countries halted oil exports to the United States in retaliation for U.S. support of Israel. The oil embargo lasted five months. When shipments resumed, the price of oil had dramatically increased. Americans faced high prices, long lines, and shortages at the gas pumps. During the late 1970s a political and cultural revolution in oil-rich Iran brought a second wave of shortages to U.S. energy supplies.
The energy crisis of the 1970s had a ripple effect throughout the U.S. economy, causing the prices of other goods and services to increase. Lower profits and uncertainty about the future caused businesses to slow down and reduce their workforces. At the same time, U.S. industries in steel, automobiles, and electronics endured stiff foreign competition, particularly from Japan. Small fuel-efficient Japanese cars became popular in the United States. U.S. carmakers struggled to compete, having always relied on consumer demand for large automobiles that were now considered “gas guzzlers.”
One of the measures that President Carter instituted to combat stagflation was deregulation. For decades, certain U.S. industries had been given government immunity from market supply and demand factors. The railroad, trucking, and airline industries were prime examples. Companies in these industries were guaranteed rates and routes and were allowed to operate contrary to antitrust laws. In 1978 the airline industry was deregulated. The result was that airlines began competing with each other over fares and routes, and new companies entered the industry. Some of the large, well-established companies were unable to compete in the new environment and went out of business. However, demand increased as prices came down and air travel became available to many more Americans. By 1980 deregulation had been completed or was under way for the railroad, trucking, energy, financial services, and telecommunications industries.
THE 1980S: RECESSION AND REAGANOMICS
In November 1980 the American people elected Ronald Reagan (1911–2004) as the new president. Inflation was at 13.5% that year, which was incredibly high for a peacetime economy. (See Table 1.1 .) Unemployment was at 7.1%, meaning that millions of people were unemployed and faced with rapidly increasing prices in the marketplace. The economic situation was dire, and drastic measures were required to turn the economy around.
Slaying the Inflationary Dragon
In late 1979 President Carter had appointed a new chair of the Federal Reserve board of governors, Paul A. Volcker (1927–), who promised to “slay the inflationary dragon.” Volcker began by tightening the nation's money supply. This had the effect of making credit more difficult to obtain, which drove up interest rates. The government knew that rising interest rates would probably trigger a production slowdown (a recession) that would push unemployment even higher. It was a trade-off that policy makers during the previous decade had been unwilling to accept.
Volcker forged ahead with his policies, and by the early 1980s interest rates had reached historical highs. Figure 1.9 shows that the prime loan rate (the interest rate that banks charge their best customers) peaked at 21.5% in December 1980. According to the Federal Home Loan Mortgage Corporation, in “30-Year Conventional Mortgage Rate” (August 4, 2014, http://research.stlouisfed.org/fred2/data/MORTG.txt ), in 1981 the average interest rate for a conventional 30-year mortgage soared to nearly 18.5%, the highest rate ever recorded.
The lack of credit caused a business slowdown—a reduction in GNP growth (or recession). As expected, the recession put more people out of work. Unemployment climbed at first, averaging 9.7% in 1982 and 9.6% in 1983, but then began to decline. (See Table 1.1 .) By 1989 it was down to 5.3%. Likewise, the inflation rate dropped from a high of 13.5% in 1980 to 4.8% by 1989. Although the spike in unemployment had been painful for Americans, the inflationary dragon was finally dead.
When Reagan took office in 1981, he brought a new approach to curing the nation's financial woes: supply-side economics. Traditionally, the government had focused on the demand side (the role of consumers in stimulating businesses to produce more). Reagan preferred economic policies that directly helped producers. In “Supply Side Economics” (2005, http://www.auburn.edu/~johnspm/gloss/supply_side ), Paul M. Johnson of Auburn University describes the philosophy this way: “Supply-side policy analysts focus on barriers to higher productivity—identifying ways in which the government can promote faster economic growth over the long haul by removing impediments to the supply of, and efficient use of, the factors of production.”
One of the cornerstones of supply-side economics is reducing taxes so that people and businesses have more money to invest in private enterprise. Reagan enacted tax cuts through two pieces of legislation: the Economic Recovery Tax Act of 1981 and the Tax Reform Act of 1986. The result was a much lower number of tax brackets (the various rates at which individuals are taxed based on their income), a broader tax base (wealth within a jurisdiction that is liable to taxation), and reduced tax rates on income and capital gains (the profit made from selling an investment, such as land).
At the same time, Reagan pushed for greater national defense spending as part of his “peace through strength” approach to the Soviet Union and for selective cuts in social services spending. However, no cuts were made to the largest and most expensive programs within the social services budget. The combination of all these factors resulted in high federal deficits during the 1980s. In other words, the federal government was spending more than it
was making each year. As shown in Figure 1.10 , the federal deficits of the mid-1980s were more than three times what they had been during the mid-1970s. According to the article “U.S. Debt Past $1 Trillion” (NYTimes.com, October 23, 1981), the national debt (the sum of all accumulated federal deficits since the nation began) reached $1 trillion in 1981.
THE 1990S: SPARKLING ECONOMIC PERFORMANCE
The 1990s were a time of phenomenal economic growth for the United States. President George H. W. Bush (1924–) took office in 1989 and served until 1993. Bush had been elected in large part because of his promise not to raise taxes. During his presidential campaign he famously said, “Read my lips: No new taxes.” The promise, however, was not one he could keep, given the economic realities of the time. During the late 1980s there had been a severe financial crisis in the savings and loan industry, which had been recently deregulated. A series of unwise loans and poor business decisions left most of the industry in shambles and necessitated a government bailout. At the same time, the government faced rapidly rising expenditures on health care programs for the elderly (Medicare) and the needy (Medicaid). Bush reluctantly agreed to a tax increase, a move that was politically damaging. In 1992 he lost his reelection bid to the Arkansas governor Bill Clinton (1946–), who was reelected in 1996.
Joseph Tracy, Henry Schneider, and Sewin Chan indicate in “Are Stocks Overtaking Real Estate in Household Portfolios?” (Current Issues in Economics and Finance, vol. 5, no. 5, April 1999) that, overall, the 1990s were a period of peace and prosperity for the United States: the Cold War ended when the Soviet Union disintegrated into individual republics; technological innovations, particularly in the computer industry, helped push the U.S. economy to new heights; and sterling business success led to robust investor confidence in the stock markets. From 1945 through 1998 real estate was the preferred investment in the United States. However, the 1990s saw tremendous increases in the holdings of corporate equity by the average American. During the mid-1980s the average household had only 10% of its assets in corporate equity. By 1998 this percentage had reached nearly 30%, roughly equal to the percentage held in real estate. The Dow Jones Industrial Average is a stock market index—a measure used by economists to gauge the value (and performance) of the stock of 30 large companies. Between the late 1970s and the late 1990s the index soared from about 1,000 points to 11,000 points, reflecting the tremendous value gained by these companies during this period.
The combination of low interest rates, low unemployment, and high investment rates and business growth combined to greatly expand the U.S. economy. According to the article “Excerpts from Federal Reserve Chairman's Testimony” (NYTimes.com, January 21, 1999), Alan Greenspan (1926–), the chair of the Federal Reserve board of governors, described this expansion as “America's sparkling economic performance.”
THE EARLY 21ST CENTURY
During the early years of the first decade of the 21st century the United States endured the September 11, 2001, terrorist attacks, the outbreak of wars in Afghanistan and Iraq, and devastating hurricanes. Nevertheless, the overall economy was robust at first. As the decade progressed, the nation's economic soundness began to unravel, culminating in problems of historic proportion.
The Internet Bubble Bursts
During the late 1990s the stock market witnessed tremendous growth, driven in large part by investor enthusiasm for Internet-related businesses. Access to the Internet became widespread in the United States and in much of the developed world, which created many new market opportunities for entrepreneurs. Investors enthusiastically poured money into the stock of these new businesses. The National Association of Securities Dealers Automated Quotation System (NASDAQ) is a U.S.-based stock market on which the stock of many technology companies is traded. The NASDAQ composite index is a measure of the performance of many of the stocks on the NASDAQ. In 1990 the index was less than 500. In early 2000 it peaked above 4,000 during the height of the Internet stock craze. Many of the stocks had become overvalued, and their high prices could not be sustained based on the actual financial results that the companies were producing. What followed was a sharp market correction, as investors sold off many Internet-based stocks and prices plummeted. By late 2002 the NASDAQ composite index was about 1,200, from which it slowly began to climb again.
In economics a bubble is a phenomenon in which investors overzealously invest (speculate) in a particular commodity or market sector that becomes overvalued. Page 14 | Top of ArticleExcitement about possible gains overrules frank analysis of the underlying financial factors. What frustrates investors and analysts alike is that the very existence of a bubble is not evident until after the fact, when the bubble has burst and much value has been lost in the investments and the businesses involved.
The Great Recession
Overall, the U.S. economy prospered through the early part of the first decade of the 21st century. This soundness was evidenced by relatively low unemployment rates, moderate rates of inflation, and growth in the nation's production. National production is tracked through a numerical measure called the gross domestic product (GDP). The GDP is similar to the GNP described earlier, but the GNP includes production of U.S. companies outside the United States, whereas the GDP considers only production of U.S. companies within the United States.
The nation's GDP is considered a key measure (or metric) of how the economy is doing. The GDP is expected to increase over time, for example, from quarter to quarter. If the GDP stagnates or declines, then the economy is ailing. Declining GDP means that businesses are producing less. Because they need fewer workers, unemployment rises. As noted earlier, the term recession refers to a national production slowdown.
In “Determination of the December 2007 Peak in Economic Activity” (December 11, 2008, http://www.nber.org/cycles/dec2008.html ), the NBER officially defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators. A recession begins when the economy reaches a peak of activity and ends when the economy reaches its trough [lowest point].” According to the NBER, the U.S. economy reached a peak in December 2007 and then went into a recession.
The NBER (September 20, 2010, http://www.nber.org/cycles/sept2010.pdf ) notes that its analysis of national economic data indicates the recession ended in June 2009. In total, the recession spanned 18 months, making it the longest recession since World War II.
There have been many recessions in U.S. history; most were short and rather unremarkable. The exception is, of course, the Great Depression. The economic downturn that occurred from December 2007 to June 2009 was so deep and so damaging that many economists dubbed it “the Great Recession.” One contributing factor was the bursting of another bubble, this time in the housing industry, which is described in detail in Chapter 4 . The financial industry consequently suffered deep financial losses. Some banks and investment corporations failed, whereas others were rescued by enormous inflows of cash from the U.S. government.
GOVERNMENT INTERVENTION. The Great Recession officially began during the second administration of President George W. Bush (1946–) and ended during the first administration of President Barack Obama (1961–). Bush was a Republican conservative and thus generally favored a laissez-faire attitude toward the economy. However, the extreme depth of the recession prompted Bush and Congress to take action. Congress passed the Emergency Economic Stabilization Act of 2008, which Bush signed in October 2008. The law created the Troubled Asset Relief Program and authorized the U.S. Department of the Treasury to spend up to $700 billion to purchase or insure “troubled assets.” These included mortgages and related investments (i.e., securities and financial instruments). The federal government also provided troubled companies in the auto industry and other sectors with loans and purchased ownership shares in them to keep them from failing.
The bailout of big businesses proved extremely unpopular politically, but the policy was continued by Obama when he assumed the presidency in 2009. In addition, Obama spearheaded passage of the American Recovery and Reinvestment Act (ARRA) of 2009, a multibillion-dollar stimulus package that was designed to revive the economy. In “The Recovery Act” (2014, http://www.recovery.gov/Pages/default.aspx ), the Recovery Accountability and Transparency Board notes that ARRA funding totaled $840 billion. It was directed toward tax cuts and benefits for families and businesses; funding for entitlement programs, such as extending unemployment benefits for unemployed workers; and funding federal contracts, grants, and loans for the private sector.
The Federal Reserve, the nation's central bank, also took aggressive actions to boost the economy. It lowered interest rates in an effort to encourage consumers and businesses to borrow money for spending or investing. As is explained in Chapter 9 , the Federal Reserve also created billions of dollars of “new” money which it transferred to banks by buying investment assets, such as bonds, from them.
The Great Recession officially ended in June 2009 as the economy began to recover. Analysts disagree about whether the government's actions alleviated or aggravated the economic downturn. Republicans generally criticized Obama's Keynesian actions, whereas some Democrats complained that the federal government should have injected even more money into the economy. Despite these disagreements, Obama secured another presidential term during the November 2012 general election.
Health Care System Reform
During his first term President Obama spearheaded a comprehensive reform of the nation's health care system. Two primary objectives drove this effort: reducing the number of uninsured Americans and reducing health care spending. In 2010, after significant debate, the Congress passed the Patient Protection and Affordable Care Act. It is commonly called the Affordable Care Act (ACA) or Obamacare. A follow-up law, the Health Care and Education Reconciliation Act of 2010, amended the ACA. Overall, the ACA represents a significant change to the nation's health care system. To better understand the law's economic impacts it is first necessary to examine the nation's health care system and the roles of the private and public sectors in it.
PRIVATELY FUNDED HEALTH PLANS. Privately funded health plans are financed by businesses and individuals. Insurers have long preferred to provide health plans on a group basis, for example, to a large group of employees. Each group includes members with varying medical needs. The healthiest members (i.e., those who use insurance the least) help pay for the higher medical costs of the more unhealthy members. Thus, the overall costs are spread across the group. Private insurers negotiate payment rates with medical providers (i.e., hospitals, doctors, etc.). Each insurer has a specific network of providers that have agreed to the payment rates and other terms and conditions.
Many Americans have access to group health insurance plans through their employers. Some employers subsidize (pay part of the cost of) health insurance plans as a benefit for their employees. Subsidized and non-subsidized group plans may be offered by employers, religious groups, labor unions, and trade and professional organizations. People who do not have access to group plans can buy so-called individual plans directly from insurance companies; however, individual plans are typically more expensive and impose more restrictions than do group plans.
In 1996 Congress passed the Health Insurance Portability and Accountability Act (HIPAA). The law prohibits employer-sponsored group plans from discriminating against plan members based on their health. HIPAA essentially ended the practice of excluding new members from group plans because they had preexisting health problems (i.e., preexisting conditions). HIPAA did not affect preexisting condition coverage in individual health plans. As a result people with preexisting conditions who did not have access to group health plans found it very difficult to obtain individual plans.
PUBLICLY FUNDED HEALTH PLANS. Publicly funded health plans are financed by taxpayer dollars and cover very specific population segments. As noted earlier in this chapter, the Medicare and Medicaid programs were created during the 1960s to assist with health care expenses of elderly and low-income Americans, respectively. Medicare is wholly administered by the Centers for Medicare and Medicaid Services (CMS), an agency within the U.S. Department of Health and Human Services. Originally designed only for people aged 65 years and older, Medicare has been expanded over the decades to include younger people with certain disabilities and diseases. Since its inception Medicare has been partially funded by taxes paid by employers and employees (including self-employed persons).
Medicaid is a joint federal-state program. Each state sets its own eligibility criteria and benefits (within broad federal guidelines) and provides part of the funding. Additional funding is provided by the federal government. The Children's Health Insurance Program (CHIP) is funded similarly to Medicaid. It provides health coverage for children in families whose incomes are too high to qualify for Medicaid, but too low to afford private health plans. Government agencies set payment rates for covered services in the Medicare, Medicaid, and CHIP programs. In other words the prices paid to medical providers for particular services are determined by the government, not by the market.
The U.S. Department of Defense and U.S. Department of Veterans Affairs operate their own medical facilities that provide care to certain existing and former members of the military and their families. In addition, the Defense Department's TRICARE program includes health plans operated by private insurance companies.
INSURANCE COVERAGE BEFORE THE ACA. Data regarding health insurance coverage in the United States are available from a variety of government and private sources. Most sources calculate national estimates based on polling and survey data. For example, the U.S. Census Bureau collects data as part of the Current Population Survey Annual Social and Economic Supplement, a sample survey of approximately 100,000 U.S. households.
Because nearly all of the nation's elderly population (i.e., those aged 65 years and older) is covered by Med-icare, discussions of the uninsured typically center around nonelderly people. The Kaiser Family Foundation (KFF) is a nonprofit organization that focuses on national health issues. In Overview of the Uninsured (March 2012, http://kff.org/interactive/uninsured-tutorial ), Rachel Garfield of the KFF indicates that in 2000 an estimated 36.3 million nonelderly people in the United States were uninsured. By 2010 the number had increased to 49.1 million or 18.5% of the total nonelderly population. According to Garfield, these values are based on Current Population Survey Annual Social and Economic Supplement data.
The Gallup Organization has conducted polling in which it asks respondents of all ages about their health
insurance coverage. In In U.S., Uninsured Rate Sinks to 13.4% in Second Quarter (July 10, 2014, http://www.gallup.com/poll/172403/uninsured-rate-sinks-second-quarter.aspx ), Jenna Levy of the Gallup Organization notes that the uninsured rate from 2008 through 2013 varied from 14.4% to 18%.
In July 2014 the Board of Governors of the Federal Reserve System (the Fed) published Report on the Economic Well-Being of U.S. Households in 2013 (http://www.federalreserve.gov/econresdata/2013-report-economic-well-being-us-households-201407.pdf ). The report contains data gleaned from the Fed's Survey of Household Economics and Decisionmaking, which was conducted in September and October 2013 using a sample population of 4,134 people. According to the Fed, “The sample is designed to be representative of the U.S. population.” As shown in Table 1.2 , nearly 84% of the respondents indicated they had health insurance coverage. The highest coverage rate (99.6%) was for those aged 65 years and older. The lowest coverage rate (75.8%) was for those aged 18 to 29 years. A breakdown by income for non-elderly respondents is provided in Table 1.3 for the 3,102 respondents who reported their incomes. Overall, 81.5% of them were insured. The coverage rate was lowest (69.2%) for respondents making less than $25,000 annually. The rate increased with income, with 95.8% of those earning $100,000 or more per year having health insurance coverage.
PREMIUMS AND OUT-OF-POCKET COSTS. There are four major cost components paid by persons with health insurance. These costs are associated with all privately funded health plans and some publicly funded health plans:
- Premium—an amount paid (usually monthly) by the insured to be covered by an insurance plan. A premium for a privately funded plan can total many hundreds of dollars per month. Employers that provide subsidized coverage typically pay at least half of the premium cost for each covered employee.
- Co-pay—an amount paid upon each visit to a doctor or other medical provider.
- Deductible—an amount that must be paid by the insured toward covered medical expenses each year before the insurer will begin paying.
- Coinsurance—the percentage of covered medical expenses that the insured must pay each year after paying co-pays and the deductible. For example, the insurer may pay 80% of the total leaving the insured with 20% to pay.
Together, co-pays, deductibles, and coinsurance amounts are called out-of-pocket expenses for the insured.
NATIONAL HEALTH SPENDING. Every year the CMS calculates the nation's total health spending. In January 2014 it released data indicating that $2.8 trillion was paid in 2012. A breakdown by source is shown in Figure 1.11 . The sources included health insurance plans; consumer out-of-pocket payments; private and government investments in medical facilities, equipment, and research (excluding commercial research, for example, to develop new drugs); government public health activities; and various other payers and programs. Health insurance (both private and public) comprised the largest portion (72%) of the spending.
In “Sponsor Highlights” (January 2014, http://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/National HealthAccountsHistorical.html ), the CMS provides a breakdown by specific spending source in 2012:
- Households—28% of total
- Federal government—26% of total
Note: Among those who reported their income.
Note: Sum of pieces may not equal 100% due to rounding.
- Private businesses—21% of total
- State and local governments—18% of total
- Other private revenues (e.g., charitable donations)—7% of total
Figure 1.12 shows the major end uses for the $2.8 trillion spent on health care during 2012. Nearly a third (32%) was spent on hospital care, 20% went to physicians and clinics, and 9% was spent on prescription drugs. According to the CMS (December 2013, http://cms.hhs.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/Downloads/tables.pdf ), national health spending totaled $26 billion in 1960. Spending has grown dramatically since that time. Of course, the U.S. population also grew over this period. To compensate for this effect analysts examine spending on a per capita (per person) basis. Figure 1.13 shows the annual growth rate in per capita health spending for 1961 through 2013. As noted earlier inflation causes the costs of goods and services to increase over time. The values shown in Figure 1.13 are said to be “real,” meaning that inflationary effects have been removed. Real per capita spending grew at rates above 3.5% per year through the early 1990s. After falling briefly the rate soared again in the first decade of the 21st century before beginning to decline. According to the Executive Office of the President of the United States, in Economic Report of the President: Together with the Annual Report of the Council of Economic Advisers (March 2014, http://www.whitehouse.gov/sites/default/files/docs/full_2014_economic_report_of_the_president.pdf ), the real per capita spending rate grew on average by 4.6% annually from 1960 through 2010.
Figure 1.14 shows national health spending as a percent of GDP. The value has grown significantly from 5% in 1960 to 17.2% in 2012. A variety of factors are behind the increased spending:
- Technological advances in medical diagnosis and treatment options.
- An aging U.S. population coupled with longer life spans. Elderly people tend to have more medical problems than younger people.
- Lower mortality rates for people suffering from certain serious illnesses and conditions. Improved survival rates for these patients can mean long-term medical care costs for them.
Note: Sum of pieces may not equal 100% due to rounding.
Note: Data for 2013 is a projection.
- Greater prevalence of obesity and other health problems linked to unhealthy lifestyles.
- A growing population of uninsured people, which has forced medical care providers and taxpayers to cover more unpaid medical bills.
- Greater practice of “defensive” medicine by health care providers who conduct tests or procedures to protect themselves from being sued for malpractice.
- Rising prescription drug costs, particularly for so-called branded drugs for which there are no generic substitutes.
In The Cost Disease: Why Computers Get Cheaper and Health Care Doesn't (2012), the economist William J. Baumol points out that medical services are highly labor-intensive, and this increases their costs compared to other sectors of the economy. Medical professionals are required to be well-educated. They are highly skilled and hence highly paid compared with service providers in some other industries. In addition, some analysts believe there are cost drivers inherent to the U.S. health insurance system, which is based on a fee-for-service model. In other words, insurers pay medical providers for each service they provide (assuming the services are considered reasonable). There is little focus on the relative value, quality, or efficiency of the services that are provided.
ACA PROVISIONS. Table 1.4 lists and briefly describes the major provisions of the ACA. Two of the most controversial provisions are the individual mandate and Medicaid expansion. The individual mandate requires most legal residents of the United States to either obtain health insurance or pay a penalty to the government. Originally the ACA required all states to expand their Medicaid programs to cover more low-income people. These and other provisions of the law were the subject of much litigation. Their constitutionality was ultimately decided by the U.S. Supreme Court in 2012. In National Federation of Independent Business et al. v. Sebelius, Secretary of Health and Human Services, et al. (567 U.S. ___ ) the court upheld numerous ACA provisions, including the individual mandate. However, the court ruled that Congress could not force the states to expand their Medicaid programs.
As the deadline for the individual mandate approached in 2014 the federal government (and some state governments) established online insurance exchanges at which consumers could purchase individual health plans from various insurance companies. The federal exchange, in particular, suffered massive technical glitches after its roll-out in late 2013. These problems elicited sharp criticism from ACA critics, particularly Republican governors and legislators.
As shown in Table 1.4 , a key requirement of the ACA is that eligible applicants must be accepted regardless of preexisting conditions. In addition, certain low-income applicants are eligible for government-subsidized premiums and out-of-pocket expenses. Employers and insurance companies must meet specific requirements under the ACA, which also implements major reforms
of the Medicaid and Medicare programs. Details about specific provisions of the law and their effects on consumers, businesses, and the government are provided in subsequent chapters.
INSURANCE COVERAGE SINCE ACA IMPLEMENTATION. As noted earlier, polls and surveys conducted from 2008 through 2013 found that roughly 14% to 18% of Americans were uninsured. As shown in Figure 1.15 , Gallup data indicate the uninsured rate declined to 13.4% in the first quarter of 2014. This was down from an average of 17.1% in the fourth quarter of 2013 (i.e., immediately before the individual mandate went into effect). Table 1.5 provides a coverage breakdown by state and indicates which states
expanded their Medicaid programs and operated either a state exchange or a state-federal exchange for ACA enrollees. Texas had the highest uninsured rate (27%) in 2013. Its Republican governor, Rick Perry (1950–) declined to expand the state's Medicaid program or operate an ACA exchange. As of mid-2014, Texas had the highest uninsured rate (24%) in the nation. It was followed by Mississippi (20.6%), Georgia (20.2%), Florida (18.9%), and Louisiana (18.4%). These states also had Republican governors in 2014 and did not expand their Medicaid programs or operate ACA exchanges.
In “Obamacare Enrollment Falls Slightly to 7.3 Million in August” (LATimes.com, September 18, 2014), Noam N. Levey reports that the CMS announced that 7.3 million people were covered under plans purchased through the ACA exchanges as of August 2014. This value was higher than the 6 million enrollees that the Congressional Budget Office (CBO) predicted would be covered in 2014. (See Table 1.6 .) That prediction and projected coverage data for future years are included in the CBO report Updated Estimates of the Effects of the Insurance Coverage Provisions of the Affordable Care Act (April 2014, https://www.cbo.gov/sites/default/files/cbofiles/attachments/45231-ACA_Estimates.pdf ). As shown in Table 1.6 , the CBO predicts that by the year 2024 the insured rate for the nonelderly population will be 89% for all U.S. residents and 92% for all U.S. residents excluding unauthorized immigrants.
Notes: Figures for the nonelderly population include residents of the 50 states and the District of Columbia who are younger than 65.