The U.S. economy, seemingly a world-dominant Goliath in the mid- and late-1990s, now faces major structural challenges from a new cast of Davids. The nation confronts a host of new economic challengers led by India and China. The U.S. economy recently took an unprecedented path when it regained strength during 2003 and 2004 without creating growth in jobs. The manufacturing sector's share of the economy continues to shrink. The growing service sector, once considered immune to global competition, now finds that advances in information and communications technology have enabled global competition in low-skilled service jobs and the beginning of competition in high-skilled service tasks.
Underlying these shorter-term developments is a major demographic shift. Historically, the U.S. economy has relied on steady 1 percent annual population growth to provide additional workers and increased output. In the coming decades, the country will face a rapid expansion of the nonproductive population of seniors. Furthermore, the aging baby boomers are propped up by a network of entitlement programs generally indexed to inflation. The Social Security Trustees recently estimated that the Social Security and Medicare programs create an unfunded liability for the taxpayers of $72 trillion (in net present value terms)--a daunting sum compared to total national wealth estimated at $45 trillion. A debt on upcoming generations of these dimensions, unsupported by any anticipated revenue stream, is an unprecedented national problem and has strong implications for the nation's future ability to invest in growth.
This new economic landscape raises a question: If the current economy faces structural difficulties, what could a renewed economy look like? Where will the United States find comparative advantage in a global economy? This is a threatening process, and even if the United States finds a way to meet the challenge, the transition will inevitably create losers as well as winners.
The last economic war
In the late 1970s and the 1980s, the United States faced strong competition, especially from Japan, which was making a serious bid to become the largest economy in the world. This competition focused on the manufacturing sector, particularly consumer electronics, automobiles, and information technology (IT). The United States lost dominance in consumer electronics but salvaged its auto manufacturing sector, in part through bilateral trade arrangements that set import quotas on imported Japanese vehicles but allowed Japanese auto production in the United States. The U.S. industry's light truck platform, which was protected by tariff from foreign competition, became the basis for the next several generations of U.S. vehicle innovations: minivans, pickups, and SUV's. In information technology, the United States retained its lead in advanced computer chips and software.
The United States benefited from the investments in science education in the Sputnik era and from major Cold War federal R & D investments. It explored public-private collaboration to bridge the gap between government supported research and private sector development. The most successful example was Sematech, which helped reverse the country's declining position in chip technology. The Defense Department's Defense Advanced Research Projects Agency (DARPA) came into its own as a unique organization focused on moving revolutionary technology from the research to the development stage, playing a crucial role in creating the Internet and promoting multiple generations of IT. New forms of capital support for innovation were developed, facilitating the birth of creative startup companies. The dramatic growth of the U.S. economy in the mid and late 1990s rode on the IT revolution that boosted productivity throughout the economy. Although excessive enthusiasm about IT fueled a stock market bubble, the gains in productivity were real and …