From New Economy to War Economy

Dean Baker

This article is from the November/December 2001 issue of Dollars and Sense: The Magazine of Economic Justice available at

issue 238 cover

This article is from the November/December 2001 issue of Dollars & Sense magazine.

Now that the economy needs stimulus, why not insist that government spending shape economic development in socially beneficial ways?

Now that the "New Economy" appears to have gone the way of the hula hoop, it looks like the "War Economy" will be the latest craze.

But before we get carried away with the idea that the September 11 attacks threw us into recession, a bit of a retrospective is in order. As some of us pointed out years ago, the main feature of the "New Economy" was a stock bubble of unprecedented proportions. At its peak in March 2000, the ratio of stock prices to corporate earnings reached more than twice its historic average. At the time, the Congressional Budget Office was projecting that real (adjusted for inflation) profits would barely grow over the next decade. But simple arithmetic showed that the market had a bubble on the order of $10 trillion, more than $30,000 for every person in the country.

This bubble—and its inevitable collapse—have had enormous consequences. The Federal Reserve Board's research suggests that the bubble led to an additional $400 billion in annual consumer spending, as families spent more money based on wealth they accumulated in the stock market. This additional spending propped up the economy as the bubble was building. But now that this paper wealth has evaporated, consumption can be expected to fall.

The stock bubble also bolstered the economy by allowing dot.coms and other high-tech startups to obtain hundreds of billions of dollars of capital in exchange for now-worthless shares of stock. Many investors paid ridiculous prices for these shares, and much of the money funded projects which subsequently proved useless. The spending did help to support an investment boom. But now that reality has set in on the stock market, the boom is over, leading to a gap of close to $100 billion in demand in the economy.

In addition, millions of families bought into the stock market bubble, encouraged by political leaders and financial advisors who insisted that their investment was sound. As a result of the collapse, many people in their late 50s or early 60s are looking at a far less comfortable retirement than they had anticipated two or three years ago.

This collapse in consumption and investment demand caused the recession, which had already set in before September 11. And it could have been prevented if our political leaders had not substituted free-market ideology for common sense. It was virtually impossible to tell a coherent story that made sense of the stock market bubble. (I asked hundreds of economists to try.) But the people in a position to warn of the dangers—most notably Federal Reserve Board Chair Alan Greenspan, President Clinton, and Treasury Secretaries Robert Rubin and Lawrence Summers—were unwilling to state the obvious: the market had gone crazy.

Now we're paying a huge price for their colossal mistake. And the devastation to the airline and tourism industries since September 11 will only make the situation worse. But now that the economy needs stimulus, why not insist that government spending shape economic development in socially beneficial ways?

We need to think more clearly about how to strengthen forms of transportation other than air travel—especially since the airlines are getting billions of dollars in bailouts. Trains that reach speeds in excess of 200 miles per hour have been in service in Europe and Japan for more than two decades. By comparison, long-distance trains in the United States often creep along at speeds of less than 30 miles per hour. Fast trains that go between city centers can allow for quicker travel than planes on all but the longest routes, especially if air travel is going to require advance check-in of two hours or more. (At an average speed of 175 miles per hour, the trip from New York to Chicago would take four hours.) Trains also do much less harm to the environment. And since they use far less fuel per passenger mile than planes, they will also reduce the nation's dependence on imported oil.

Building a network of fast trains will require a serious commitment of public money. But of course, the airline industry was not exactly an outcome of the free market—the public paid to build the airports and much of modern aerospace technology was a spin-off from military spending.

In addition, as the United States enters a "war on terrorism" where the size, duration, and battlefield are completely unknown, we should pay close attention to how our money is being spent. Of course, the September 11 attacks do not make every military program the Bush administration has proposed worth funding. As of this writing, it's not clear what Congress will approve. But however much is appropriated, the public should be assured that military contractors won't being making fortunes. During World War II, some defense contractors voluntarily pledged to be paid at a rate of "cost plus a dollar"—to show that they were not profiteering from the war. If today's military contractors wish to demonstrate their patriotism, making a similar commitment would be an appropriate gesture.

Finally, if the United States wants to avoid being the target of future acts of terrorism, it should try doing some good in the world. More than 35 million people in the developing world are HIV positive. The United States pledged $200 million—six hours of the Pentagon's budget—to address the problem. At the same time, it threatens trade sanctions against countries that provide low-cost drugs by ignoring the patents of U.S. pharmaceutical companies. The meager amount of official aid that the United States does distribute (approximately 0.15 percent of GDP) goes overwhelmingly to reward political loyalty—Israel and Egypt are the two largest recipients.

After World War II, the United States put forward a genuine development policy, the Marshall Plan, to rebuild a war-devastated Europe. As a result, the continent prospered, and to this day millions of Europeans remain grateful to the United States. This is not a call for defeating the left in other countries, as the Marshall Plan was designed to do. But in the end, a strategy of pragmatic humanitarianism will be the most effective way to keep people in the United States—and in other countries—secure.

The attacks of September 11 show how the obsession with free-market ideology has harmed the nation. Security at the nation's airports is provided by private services, often contracted by the airlines. The workers are generally paid near the minimum wage, with few if any benefits, and they receive little or no training. Not surprisingly, turnover is high, with the average airport security worker spending only six months on the job. (See Darius Mehri, "Safety in Numbers," p. 46.) This sort of security system may have saved the airlines money, but it certainly increased the risk of attacks. Now we have a chance to improve matters. Anyone without ideological blinders should be able to recognize that airport security is one area best dealt with by the public sector—where public safety, not profits, are the main goal.

The attacks have created a new political environment. There are enormous risks, but also enormous possibilities. The attack dealt a decisive blow to the market worship that characterized the New Economy. If progressives aggressively push our agenda—which is the only way to address the real concerns demonstrated by the attacks—we may find a nation that is far more receptive than it has been over the last two decades.

Dean Baker is co-director of the Center for Economic and Policy Research, and the author of The Economic Reporting Review.