THE US ECONOMY 2009

For 200 years, there were substantial differences among U.S. regions in per capita incomes and economic growth. Each region had a distinct set of economic activities and, to a major degree, the differences in regional economic performance were linked to the differences in economic structure. Individual states experienced periods of expansion and contraction as the basic business activities dominating their economy expanded and contracted. These changes led to significant migration of people and businesses among regions and to a gradual narrowing, since the 1930s, of regional disparities. The Northeast experienced de-industrialization in the 1950s and 1960s. However, while the area was experiencing de-industrialization, it was also experiencing an expansion of white-collar office jobs in the business service sector and in the university research sector. New high-tech industries chose to locate in the Boston area where they were often linked to universities. Consequently, the labour force became increasingly polarized, as did the urban landscape. Central business districts included new office complexes in the downtown areas. Yet these were surrounded with declining, often slum-like conditions. At the same time, upper-income groups were moving to the expanding and attractive suburbs of the old cities. New manufacturing plants were also locating in the suburbs. In the period 1975-85, de-industrialization became particularly acute in the Midwest. States like Michigan, Ohio and Illinois lost millions of jobs as a result of cheap imports from low-wage foreign competitors and the shift of corporations to the South. Throughout the 19th century and until the 1970s, the South experienced relatively low average per capita incomes compared with the rest of the United States. Corporations viewed the low wage rates as a powerful incentive to locate there, particularly when faced with intense price competition from low-wage countries. The federal governments huge and growing military expenditures also favoured southern jurisdictions. Municipal governments in the South developed a wide array of subsidy programs to attract corporations. They were also slow to introduce the generous welfare programs and the expensive.

SUCCESS IN PRODUCTIVITY AND GROWTH Over the period 1990-2007, the United States experienced outstanding economic success. Its unemployment rate was consistently less than five per cent, while its annual inflation rate was in the two per cent range. Average annual economic growth exceeded three per cent. Many analysts expressed the view that this economic success rested on consistently high productivity growth. Output per worker and output per unit of capital increased steadily so that incomes could rise without causing inflation. In explaining this productivity growth, many analysts emphasized the entrepreneurial nature of U.S. business, and the ability of new small firms to succeed quickly. The public philosophy supported low taxes and low government expenditures for health, education and welfare, with a heavy reliance on the need for each individual to succeed on ones own. The continual and pervasive pursuit of material success was a key driver of the economic system. Particularly with the small business success, many pointed to the U.S. financial system as an essential element in business startups. With all of these issues, there was a sharp difference between the U.S. economic success and the low growth and high unemployment experienced by many European countries.

THE TRIPLE HELIX: UNIVERSITIES, GOVERNMENTS AND BUSINESSES With technological capability increasingly becoming the touchstone of competitiveness in an open and integrated world environment, the role of universities in economic growth is taking on a greater salience. Not only do they impart education but also they are coming to be viewed as sources of industrially valuable technical skills, innovations and entrepreneurship.1 During the first half of the 20th century, a small number of universities in the United States and Western Europe engaged in research and technology development through various types of relationships with businesses. However, most of the worlds universities were not involved in this process. In the second half of the 20th century, a general recognition developed that knowledge has a major impact on economic growth, and that increasingly intense international competition is based upon knowledge and innovation. Hughes presented the results of an extensive survey of innovation at firms in the United Kingdom and the United States.2

University-industry interactions that have contributed to innovation have, in both countries, included informal contacts, employee recruitment, publications and conferences. Hughes

concluded that U.S. firms have experienced a greater depth and achievement in their university-industry linkages (UILs). This difference was particularly striking for small and medium-sized firms. U.S. firms in all size classes were more likely to rank universities as sources of knowledge than are U.K. firms. Furthermore, U.S. firms pursue an open innovation system in which they actively pursue innovations outside of their immediate industrial context. Each nation, as well as each region within a nation, has a distinct innovation system. The success of UILs depends upon the strength of this innovation system as a whole. The start-up and growth of a firm based in the knowledge economy depends upon a financial system that can provide it with adequate funding. Traditionally a firm could borrow with fixed assets as security for a loan, and the firms book value could provide some guidance in valuing its stock. With the knowledge economy, the firm has to borrow against knowledge assets that are far more difficult to value. Hence the traditional banking system, where a bank borrows from depositors, charges a spread in interest rates and lends to borrowers, may become a severe limitation in the knowledge economy. Supplementing the traditional banking system is the process of disintermediation in which the firm obtains funding directly from investors. This process involves a wide range of new financial intermediaries, including venture capitalists, angel investors, investment bankers, private equity funds, bought deals, and initial public offerings. The availability of these supplementary financial activities and the terms and conditions that they present to the firm for raising capital have differed significantly among nations. Consequently, the financial environment of business has become a very important element of firm success in the knowledge economy, and the extent and nature of the knowledge economy differs significantly among nations. At the forefront has been the United States. In recent years, U.S. financial institutions have extended these new financial activities to other countries, but the gap remains an important determinant of relative productivity growth among nations.

THE 2007-09 FINANCIAL AND ECONOMIC CRISIS The U.S. economy peaked in December of 2007. By March 2008, the Bush administration felt that it was necessary to implement a broad-based tax cut of $150 billion, with personal cheques sent to each taxpayer. By the fall of 2008, it was clear that the United States had entered a major financial and economic crisis. The lack of adequate government regulation had allowed mortgage brokers to arrange house financing geared to skyrocketing real estate prices. Sub-prime mortgages enabled households to borrow more than they could afford to repay. Institutions combined these mortgages to create collateralized debt obligations (CDOs), and this securitization process distributed the tainted assets worldwide. When real estate prices started to fall, this financing process came to an abrupt halt, with many banks holding CDOs that were worth much less than face value. At this point, insurance companies that had offered credit default swaps, under which CDOs were insured, suddenly found that they did not have adequate funding to meet their commitments. President Obamas administration acted quickly and decisively to attempt to remedy the financial and economic crisis. Assistance to financial institutions included loans, the purchase of shares, the guarantee of debts, and the purchase of non-performing loans. Monetary policy lowered interest rates and expanded the money supply. Fiscal policy included tax cuts and huge increases in expenditures, resulting in a deficit that exceeded 10 per cent of GDP. Apart from the financial sector, the housing and automobile sectors were special targets of financial assistance. It was not clear how long the recession would last, what its impacts would be and what the results of the government policies might be. In particular, some feared that recovery would bring rapid inflation due to expension of money supply.

a) Analyze the causes of the US financial and economic crisis and possible reforms. b) Evaluate the sources of US productivity and growth. c) Evaluate the forces underlying US adaptability to changing economic forces.