July 26, 2003


The real American model: A dynamic free market? No. America's economy is about massive public subsidy of the middle class. The lesson for the world? Don't copy it. (James Galbraith, OpenDemocracy)
The "soft budget constraint" is an idea familiar to students of central and eastern Europe in the late years of communist rule. It described the condition of state-owned heavy industry under the communist regimes: entities that could not make profits, could not compete on international markets, and yet were so central to the social fabric of the system in which they were embedded, including its provision of social services, that they could not be allowed to fail. These entities became widely-deplored dependencies of the state budget and the state banks. Yet to millions, they provided the rudiments of a comfortable and secure life, the threads of which have not been picked up in the post-socialist orders that since emerged.

A brief examination of key American institutions shows that the concept goes very far toward explaining the structure and conduct of the US economy in the past twenty years, and particularly in the prosperous period of the late 1990s. But the institutions to which it is best applied in America are very different from those in eastern Europe. Indeed, the keys to the American model lie not in industry, but in those sectors providing social amenities to the middle class: health care, education, housing and pensions.

Health care, in the United States, consumes some 13% of GDP. A typical figure in Europe is 8-10%; in the UK the number is 7.3%. What few Europeans understand is that health expenditures within the direct US government budget consume 5.8% of GDP.

But whereas in (say) France a not-much-larger proportion of total output supplies medical services to the whole population, in the United States the direct public commitment is only to the elderly and disabled, the poor, and to veterans. For the rest of the covered population, medical care is paid out of private insurance, which enjoys tax advantages.

Overall, the tax-financed share is just under 60% of total health expenditure, or nearly 8% of GDP. The scandals of American health care do not lie in insufficiency of care (quite the reverse!), but rather in two notorious facts.

The first is that some 44 million persons lack either public or private insurance. This part includes many Latinos, who tend to avoid contact with the welfare system, as well as younger working people. Hence, deficient pre- and peri-natal care is an important problem.

The second is the rapacity of the private actors in the system - drug producers, doctors, nursing home operators, and insurance companies notably. Nevertheless, it is precisely the presence of those actors, and their political power, that has made the American health care system into the economic powerhouse that it is.

Higher education in the United States consumes about 2.25% of GDP. The figure for European countries is typically closer to 1%. Again the US spends more on public higher education as a share of GDP than do most Europeans: 1.07% as compared to 0.97% in Germany or 1.01% in France. But then in addition there is the private share, another 1.22% of GDP, centred on institutions whose multi-billion dollar endowments are highly motivated by the tax system. Many of these are to be found in the east, near traditional centres of capital wealth. Fully public institutions however dominate the scene in most of the country, including Texas and California.

The United States maintains two alternative public systems for keeping otherwise difficult-to-employ young people away from unemployment. These are the armed forces, with 1.4 million members, which consumes 4% of GDP and provides competent mechanical training to its members (including to virtually the whole of the population of commercial pilots, for example). And there is the prison system, whose much-expanded role in recent years is deplorable, but whose economic function also reduces unemployment. A major difference, of course, is that these three institutions provide very different levels of access to credit and other participatory mechanisms in later life.

Consumption of housing services accounts for about 9% of US GDP, while residential construction accounts for another 4%. The housing sector exists on its present scale thanks to a vast network of supporting financial institutions, subject to federal deposit insurance and to the secondary mortgage markets provided by quasi-public corporations (Fannie Mae, Ginnie Mae, Freddie Mac).

Despite continuing problems of discrimination against black neighbourhoods particularly, known as redlining, the fact remains that most Americans grow up in their own homes, and for the present moment home equity remains the major collateral against which middle class Americans are able to borrow to support their consumption.

Finally, social security payments to the elderly and disabled together with public pensions account for 8% of US GDP, on the reasonable assumption that these transfers are substantially spent rather than saved by their recipients. Some of this has been counted already in expenditures for health care and housing - but arguably not all that much. The American elderly live in paid-off homes and pay only a fraction of their medical (as distinct from pharmaceutical) expenses out of pocket. And social security funds a great deal of their ordinary consumption.

To be precise, social security alone provides the major source of disposable income of 60% of American elderly; only the top 40% of that population group has substantial other sources of income, public or private. The typical social security payment for an elderly couple in moderate health can reach $18,000 per year, which when combined with Medicare is adequate for modest comfort in most of the country. Pockets of elderly poverty remain, but overall, poverty among the old in America has fallen dramatically since the early 1970s, and is now lower than among the general population. This is the accomplishment substantially of expanded public pensions.

The point to emphasise is not merely that the United States is full of hospitals, universities, housing and pensioners, but that in the US these sectors are funded by a bewildering variety of financial schemes, involving public support in myriad direct and indirect ways, including direct appropriations, loans, guarantees, and tax favours. Some of these are on budget, some are off-budget, some are "discretionary", some are "non-discretionary". But there exists a broad political constituency behind them, which gives them political staying power - despite continuing assaults on them and some erosion under a right-wing congress, president and court system. The control of the scale of these activities has, to some extent, slipped away from those who ostensibly control the public budget.

And this is the genius, if one may call it that, of the American Model. The soft budget constraint (which as recently as the 1960s was entirely the province of the military) has come to apply precisely where it can do the least harm. And that is in providing income and employment in sectors that provide universally demanded human services to the population. In other words, powerful political constituencies exist to keep these sectors at the forefront of American life, and it is very likely that they will remain there.

Though he's obviously approaching the issue from a different point on the political spectrum, this much of Mr. Galbraith's case is correct. Moreover, while Americans may not understand the Model in precisely such terms, they do seem to feel that they are getting a reasonably good deal from government. They know that Grandma and Grandpa get checks from the feds, that Junior got a government loan for college, that when Mom was laid off she got a check, and so on and so forth. This intuition is the likely reason that conservative anti-government rhetoric ends up scaring so many people.

Now there are plenty of folks on the Right who would have us believe that the basic unpopularity of simply slashing government spending makes it some kind of test of manhood--to be a "true conservative" they suggest you have to advocate for policies that are ideologically pure but politically ludicrous. This is a recipe for returning the GOP to its marginal status of the 1930s. Instead, the challenge before the Right and the Party--the Compassionate Conservative Challenge o the Bush Project or whatever one chooses to call it--is to undertake an ephocal--but perhaps subtle?--shift and use the power of the State to keep the checks flowing but alter the funding mechanisms so that folks are in effect writing those checks to themselves, via the kinds of reforms discussed earlier in the week..

The benefits of such a privatized system of welfare are many, but the particular genius is that it could save democracy from what conservatives have long identified as its main weakness: the predations of the majority. As Alexander Tytler famously put it:
A democracy cannot exist as a permanent form of government. It can only exist until a majority of voters discover that they can vote themselves largesse out of the public treasury.

If conservatives could use their probably brief period of political dominance to restructure the institutions of the welfare state so that the largesse voters are getting comes instead from their own set of personal savings accounts--MSA, unemployment, & retirement--it would be only slightly less significant an achievement than the original Founding of the Republic. Posted by Orrin Judd at July 26, 2003 7:20 AM
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