An Outline of the
American Economy

Part 1
Introduction

PART 2

How the United States Economy Works:
An Overview

The marriage between the United States economy and the free enterprise system has been a hugely successful one, but not one without problems. From the time of early American statesman Alexander Hamilton, there has been conflict over what should be the proper role of government in the economy; at various times government has intervened to stimulate the growth of certain industries, to regulate business when abuses began to appear, to provide protection in the form of tariffs for industries hurt by imports, and sometimes to redistribute wealth. Government's role has ebbed and flowed, according to the needs of the time.

The United States has what is usually described as a capitalist economy. But capitalism is a term coined by Karl Marx that referred to the concentration of control of the most important parts of the economy by a small group of capitalists. By contrast, most Americans think of capitalism as meaning "free enterprise," a system that benefits millions, not just a few. Free enterprise as an idea can be simply described, but it is how this idea is applied to real life that is important. This chapter attempts to describe how free enterprise works in the United States as evidenced by the historical record.

BASIC INGREDIENTS OF THE U.S. ECONOMY

Every economic system tries to anticipate and then meet human needs through the production and distribution of goods and services. The economic system is the mechanism that brings together natural resources, the labor supply, technology, and the necessary entrepreneurial and managerial talents. Although the type of economic system used by a nation is the result of political decision, it is also in even larger part the result of a historical experience that, over time, becomes a national culture.

The first ingredient of an economic system is the natural resources from which goods are produced. The United States is a land rich in mineral resources and fertile farm soil, together with a moderate climate.

Second, the amount of available labor helps determine the health of an economy. Generally, the United States has been fortunate in having enough people to provide the labor necessary for a constantly expanding economy. Until shortly after World War I, most of these workers were either immigrants (or their immediate descendants) who came to America from Europe, or African Americans whose forebears were brought to the Americas as slaves. When too many laborers arrived to be absorbed on the East Coast, they could usually move on to farmland in the interior and be productively absorbed in that part of the economy.

In the early years of the 20th century, large numbers of Asian (Chinese, Japanese, Filipino) immigrants came to the United States, while large numbers of Latin American immigrants came in the later years. Economic opportunity also attracted black Americans from Southern farms to Northern cities in the first half of the 20th century.

Although the United States has sometimes experienced periods of acute unemployment or the reverse, labor shortages, on the whole, immigrants came when work was plentiful. The U.S. economy usually grew fast enough to absorb the newcomers, provided they were willing to work productively at slightly less than the wage rates paid to acculturated workers. Overall, immigrants prospered, earning far more than they would have in their native lands, and the economy of the nation prospered as well.

Another factor in any economic system is the quality of available labor -- how hard people are willing to work and how skilled they are. In the United States, the frontier demanded hard work, and the Protestant work ethic supported that demand. The strong emphasis placed on education, including technical and vocational education, also contributed to America's economic success. Likewise the willingness to experiment, to change and to invest in technology was significant in a land that had prided itself on being a new experiment in freedom.

But the existence of abundant natural resources and a skillful and willing labor force accounts for only part of the structure of an economic system. The resources must be directed as efficiently as possible into the areas where they will be most productive. In the American economy, managers of enterprises responding to signals from markets perform this function.

Large blocks of resources must be available for major investments. In America, entrepreneurs accumulate money and then invest in projects -- buy supplies, hire workers and sell products -- that seem likely to give a high return on the original investment. This is determined on the basis of an assessment of the wants and needs of those who buy goods and services -- what is known as consumer demand.

In the United States, the corporation has proved to be an effective device for accumulating funds for investment. This is a voluntary association of owners, known as stockholders, who form a business enterprise that is marked by limited liability.

Once the first entrepreneurial investment of capital has been made, someone must be hired to manage the new business, factory or other endeavor. Modern America has developed a chain of managerial command, from the foreman at the loading dock to the chief executive in the boardroom, whose job is to see that the business runs smoothly and efficiently. Good management often can make the difference between a successful or unsuccessful operation. In early 20th-century America, management was said to be based heavily on systematic analysis; "scientific management" became a veritable movement. But later in the century, views on management became more diverse.

A MIXED ECONOMY: THE U.S. SYSTEM

The economic system of the United States is principally one of private ownership. This system, often referred to as a "free enterprise system," can be contrasted with a socialist economic system, which depends heavily on government planning and public ownership of the means of production.

Yet government has to some extent always been involved in regulating and guiding the U.S. economy. At the same time, U.S. citizens have always had the freedom to choose for whom they will work, and what they will buy. Most importantly, Americans vote for officials who set economic policy.

In the U.S. economic system, consumers, producers and the government make decisions on a daily basis, mainly through the price system. The dynamic interaction of these three groups makes the economy function. The market's primary force, however, is the interaction of producers and consumers; this has led analysts to dub the U.S. economic system a "market economy."

As a rule, consumers look for the best values for what they spend, while producers seek the best price and profit for what they have to sell. Government, at the federal, state and local levels, seeks to promote the public safety, assure reasonable competition, and provide a range of services believed to be better performed by public rather than private enterprise. Some of these public services include the administration of justice, education (although there are many private schools and training centers), the postal (but not the telephone) service, the road system, social statistical reporting and, of course, national defense.

In this system, when economic forces are unfettered, supply and demand establish the prices of goods and services. Entrepreneurs are free to develop their businesses. In theory, unless they can provide goods or services of a quality and price to compete with others, they are driven from the market, so only the most efficient and those who best serve the public remain in business. In practice, government regulations can interfere with pure competition in order to promote other national policy objectives such as price and income stability, regional development or environmental preservation. Similarly, businesses can interfere with pure competition, through price fixing or other monopolistic practices, in order to maximize profits.

In the United States, most people are simultaneously consumers and producers; they are also voters who help influence the decisions of government. The mixture among consumers, producers and members of government changes constantly, resulting in a dynamic rather than a static economy. In recent years consumers have made their concerns known, and government has responded by creating agencies to protect consumer interests and promote general public welfare.

The U.S. economy has changed in other ways as well. The population and the labor force have moved dramatically from farms to cities, from fields to factories and, above all, to service industries. In today's economy, the providers of personal and public services far outnumber producers of agricultural and manufacture goods. Statistics also reveal a rather startling shift away from self-employment to working for others.

Generally there are three kinds of businesses: single-owner operated businesses, partnerships and corporations. The first two are important, but it is the latter structure that best permits the amassing of large sums of money by combining the investments of many people who, as stockholders, can buy or sell their shares of the business at any time on the open market. Corporations make large-scale enterprise possible.

GOVERNMENT'S ROLE IN THE ECONOMY

While consumers and producers obviously make most decisions that mold the economy, government activities have at least four powerful effects on the U.S. economy:

DIRECT SERVICES
Each level of government provides direct services. The postal system, for example, is a federal system serving the entire nation, as is the large military establishment. By contrast, the construction and maintenance of most highways is the responsibility of individual state governments. The public education systems are primarily paid for by state, county or city governments. In general, police and fire protection are the responsibilities of local government.

REGULATION AND CONTROL
The government regulates and controls private enterprise in many ways in order to ensure that business serves the best interests of the people as a whole. Regulation is usually considered necessary in areas where private enterprise has been granted a monopoly, such as in electric or local telephone service, or in other areas where there is limited competition, as with the railroads. Public policy permits such companies to make reasonable profits, but limits their ability to raise prices "unfairly" (as defined by the regulators) because the public depends on their services. Often control is exercised to protect the public, for example, when the Food and Drug Administration bans harmful drugs, or requires standards of quality in food. In other industries, government sets guidelines to ensure fair competition without using direct control.

In the 1970s and 1980s, Americans became increasingly divided on the issue of government regulation of the economy. Proponents argued that government regulation was needed to protect consumers, workers and the environment; critics insisted that regulations interfered with free enterprise, increased the costs of doing business and thus contributed to inflation. These factors, coupled with rapid technological change, prompted President Jimmy Carter to reduce regulation of the transportation and communication industries in the 1970s. Also, at this time, federal agencies were encouraged to be more flexible in applying regulations.

In the 1980s, President Ronald Reagan's legislative agenda, based largely on his belief that an unfettered private sector would assure economic prosperity and growth, pushed deregulation efforts still further. Regulations or the implementation of regulations designed to protect workers, consumers and the environment were cut back. In addition, during the Reagan administration, a voluntary approach was taken to some regulations. For example, the Consumer Product Safety Commission adopted a voluntary compliance program, allowing individual companies to design their own remedies for targeted safety programs.

In the early 1990s, the drive to push still further deregulation in a broad, across-the-board manner appeared to have slowed considerably. Although proponents of deregulation continued to stress its benefits, criticism of how deregulation had actually worked in practice mounted. Airline deregulation, for example, initially fostered increased competition that lowered the cost of flying. But, within a few years a wave of airline mergers and consolidations shrank the number of airlines, and critics argued that the benefits of deregulation had either disappeared or become minor. On the other hand, deregulation of telecommunications unquestionably brought increased competition to certain parts of the telephone services industry.

At the same time, by the 1990s the number of federal government officials occupied with regulatory matters was on the increase again after having been cut back during the 1980s. According to an analysis of regulatory institution staffing by the Center for the Study of American Business, in 1992 the number of federal government regulatory officials was expected to be around 122,000, which surpassed the previous record set in 1980. The study particularly noted increases in staffing at agencies concerned with such activities as protection of the environment and regulation of the financial sector. These were areas where increasing numbers of Americans appeared to be troubled by disturbing events or trends.

STABILIZATION AND GROWTH
Branches of government, including Congress and such entities as the Federal Reserve System, attempt to control the extremes of boom and bust, and of inflation and depression, by adjusting tax rates, the money supply and the use of credit. They can also affect the economy by changing the amount of public spending by the government itself. Normally, the aim is a balanced federal budget. But since 1960 a deficit has prevailed in the federal accounts in every year except 1969, and it has generally widened, reaching a high of some $200 thousand-million in the mid-1980s, before dropping back again.

DIRECT ASSISTANCE
The government provides many kinds of help to businesses and individuals. For example, tariffs permit certain products to remain relatively free from foreign competition; imports are sometimes taxed or limited by volume so that American products can better compete with foreign goods. Government also provides aid to farmers by subsidizing prices they receive for their crops.

In quite a different area, government supports individuals who cannot adequately care for themselves by making grants to low-income parents with dependent children, by providing medical care for the aged and indigent, and through social insurance programs that assist the unemployed and retirees. Government also supplies relief for the poor and help for the disabled.

OUTPUT OF GOODS AND SERVICES

Almost two-thirds of the nation's total economic output consists of goods and services bought by individuals for personal use. The remaining one-third is bought by government and business. Because of this ratio, the nation is sometimes characterized as a "consumer economy."

It is evident, then, that the consumer will exert a measure of influence over the market economy. Naturally, most consumers look for good values when they buy, as well as product reliability and safety. If one automaker, domestic or foreign, produces a better car at a lower price, the market will begin to shift as that car attracts more sales than its competitors. In theory, this phenomenon rewards efficient producers who maintain high quality at low prices, and drives out those who cannot compete.

Providers of goods and services include owners, managers and workers. Owners and managers make decisions on what and how to produce, relying on what they think the public will buy and expecting to earn a profit from their business operations.

The gross national product (GNP) measures the total output of goods and services in a given year. A word of caution is in order when using GNP -- or a somewhat similar measurement known as gross domestic product (GDP) -- as an indicator of national well-being. Environmentalists and social commentators point out that neither GNP nor GDP is an adequate measure of the quality of life in a nation -- they only measure the market value of the goods and services. By contrast, economic growth can contribute to pollution and exacerbate the difficult problem of maintaining a clean and healthy environment.

The U.S. GNP has been growing steadily, rising from more than $3,400 thousand-million in 1983 to around the $5,500 thousand-million mark by 1990.

THE CONTINUING PROBLEM OF POVERTY

Americans have been troubled over the years by the persistence of poverty in parts of their country, despite massive efforts by the federal government and others to eradicate it. Through the Department of Labor, the federal government has defined a minimum amount of income necessary for basic maintenance of a family of four. This amount may fluctuate, depending upon inflation, the cost of living and the location of the family. In 1990, a family of four with an annual income below $13,360 was classified as being in poverty.

The percentage of persons classified as being below the poverty level dropped consistently for almost two decades -- from 1959, when it was 22.4 percent, to 1978, when it was 11.4 percent. It increased slightly from 1979 to 1983, and then resumed its descent. In 1989 the percentage of individuals below the poverty level was 12.8.

Some analysts have suggested that fewer individuals are living in poverty than the Labor Department statistic would suggest because the statistic is based solely on cash income. It does not include government-provided noncash transfers such as food stamps, health care or public housing. However, other commentators point out that in-kind transfers rarely cover all of a family's food or health care needs and that there is a shortage of public housing. Some argue that even families whose incomes are as much as 185 percent of the poverty level sometimes go hungry, skimping on food to pay for such things as housing, medical care or clothing. Still others point out that people at poverty level sometimes get cash income from casual work and in the "underground" sector of the economy, which is never recorded in official statistics.

THE GROWTH OF GOVERNMENT

As the 20th century has progressed, the public has come to expect the government to provide more services than in any previous era. It might be added that a greater number of services becomes economically feasible for the government to provide when large numbers of people are crowded into cities. For example, organized collection of trash would be prohibitively expensive in rural areas because of the dispersed population, but it is practical -- and necessary -- in big cities.

The rate of growth of government has been greater at state and local levels than at the federal level. From 1960 to 1990, state and local governments increased their employees from 6.4 million to 15.2 million, while the number of federal employees rose only from 2.4 million to 3 million.

Partly because of this growth, and the rising costs of taxes to pay for it, toward the end of the 20th century many thoughtful observers were questioning whether government was the most efficient provider of needed services. In fact, a new word -- "privatization" -- was coined and quickly gained acceptance worldwide to describe the practice of government turning over to the private sector some of its functions, which in the United States (because so little economic activity is directly under the control of the federal government) has meant primarily at the municipal and regional level. By 1991, such major U.S. cities as New York; Los Angeles, California; Philadelphia, Pennsylvania; Dallas, Texas; and Phoenix, Arizona had employed private companies or nonprofit organizations to perform a wide variety of activities previously performed by the municipalities themselves, ranging from street-light repair to solid waste disposal and from data-processing to management of local golf courses. With a projected 1991 budget deficit of $3.5 thousand-million, New York City, the largest U.S. city, was under particularly heavy pressure to privatize; it had already contracted out some $5 thousand-million of city services, and was seriously considering contracting out still more.

In fact, some American politicians and analysts have argued that the federal government should privatize such major activities as the U.S. Postal Service.

Yet, in the 1990s, privatization of public services remains a highly controversial subject. While advocates insist that privatization reduces costs and increases public-sector productivity, others argue the opposite, that private contractors need to make a profit and thus cost more, while not necessarily being more productive. The difficulty in measuring the effectiveness of a social service that has been privatized is one problem. If only one private contractor bids on a social service, there may be no cost saving. Public-sector unions, not surprisingly, are adamantly opposed to most privatization. They point out that there have been cases where private contractors submitted very low bids in order to win contracts, but later raised prices substantially.

The crucial element in privatization questions is not just who provides the service, but whether there is an element of competition present. In a privatization, this usually means there must be more than one bidder before a contract is awarded. And sometimes with the spur of threatened privatization, local government workers may become more efficient in order to hang onto their jobs.

Clearly, more than 200 years after the United States achieved independence, the question of what the proper role of government in the economy should be remained a highly debatable one.

An Outline of the American Economy