What strikes me most about “Boom and Bust: AN American Economic History” is its ending, which leaves the reader with a sombre note, after reviewing America’s spectacular economic history from 1776 to 2017: “The US is trapped in an iron cage of its own making, where runaway power and ill-considered regulations force it to perform well below its potential. The US has all the keys it needs to open the cage. The big question is whether it has the political will to turn the keys. If not, the U.S. growth rate will decline forever.”
Alan Greenspan served as chairman of the Council of Economic Advisers under Republican President Gerald Ford from 1974 to 1977. He was appointed chairman of the Federal Reserve by Republican President Ronald Reagan in 1987 and served under three Republican and one Democratic presidents until 2006.
In his book, Mr Greenspan recalls how the US was the world’s largest economy for 118 years (1894) and remained so for 123 years. The book’s summations are insightful, but they do not deserve credit for cracking the code of American economic growth, for the embrace of creative destruction, business nation-building, optimism, the rule of law, and protection of property rights are also well documented in other books on American economic history.
The real value of this book is that the author has lived through two complete cycles of boom and bust, both at the centre of decision-making. Therefore, the author’s perspective and thinking are quite different from the bystander perspective of other economic history writers.
Reaganomics was born
Greenspan served President Ford at a time when the United States was in its worst postwar recession and facing a new economic phenomenon, stagflation. When he first became Fed chairman, the US economy was at the height of the Reagan boom. He then presided over America’s “new economic era,” which, in his second year in office, plunged the country into the worst financial crisis and recession since the Great Depression.
“America is trapped in an iron cage of its own making,” Mr Greenspan says of the US in 2017 at the end of his book, as it was in the 1970s, when he entered power. In nearly half a century, through eight presidents, the key to the cage was always in the lock, but only one, Ronald Reagan, who was president from 1981 to 1989, had the political will to turn it.
Before Reagan took office, America was struggling at home and abroad, with confidence at its lowest level since World War II. Politically, the Soviet Union invaded Afghanistan in the east and entered CAM Ranh Bay in Vietnam in the south. The United States retreated from Vietnam in a discomfited way and then met the Iranian revolution. The embassy staff in Iraq were held hostage for a year but there was nothing to do, which made the whole world laugh. On the one hand, the economy is stuck in stagflation, and on the other hand, one after another pillar industries such as steel, home appliances and automobiles are losing ground to the competition of Japanese companies. In 1979, the book “Japan No. 1” was born, best-selling in the United States, the author is Harvard University professor Vogel.
Reagan’s economic policies came to be known as Reaganomics, the most important part of which came from the supply-side side. Later, as Reagan became more popular, they were simply called Reaganomics. The so-called supply-side school is the opposite of Keynesianism, which dominated the Western world after World War II. Starting from the bitter lessons of laissez-faire capitalism leading to the Great Depression, Keynes advocated increasing government spending and regulating the economy through government regulation of aggregate social demand. It worked for the first 20 years, as the economy grew and the gap between rich and poor narrowed, turning the pyramid into a spindle. But by the late 1960s and early 1970s, Keynes’s playbook was broken, marked by stagflation. The problem with Keynesianism is that the government suppressed production while expanding demand. If the Great Depression was a crisis of overproduction and insufficient demand, then stagflation is a crisis of overproduction and insufficient demand.
Thus came Reaganomics, with its emphasis on invigorating the productive end. How do you do that? The first was tax cuts. Big government + welfarism was prevalent in the West at that time, and personal and corporate income taxes were very high. In the United States, the highest individual income tax rate is 70%, the lowest rate is 14%, and the highest federal corporate income tax rate is 46% and the lowest rate is 15%. Some of the money earned from hard work has to be handed over to the government. At the same time, the government bureaucracy is getting bigger and bigger, and the phenomenon of welfarism supporting the lazy is becoming more and more serious. This makes many people think, “Why should I work so hard? Echoing popular opinion, Reagan slashed taxes, cutting the top personal income tax rate to 50% (28% in his second term), the bottom rate to 10%, and the top federal corporate tax rate to 34%.
The second is deregulation. Americans are the most entrepreneurial people on the planet. From Vanderbilt, Carnegie, Rockefeller, Morgan, Edison, Ford, Watson and Noyce, the history of the United States is a business history filled with entrepreneurial spirit. Richard S. Tedrow, a professor at Harvard Business School and an expert on business history, goes further: “Entrepreneurs are the main architects of the American dream.”
But by the Keynesian 1960s and 1970s, a regulated economy and unionized welfares were everywhere, America’s entrepreneurial spirit was fading, unable to withstand the rise of Japanese and German companies, and America’s vaunted auto industry was a bust, with Chrysler on the verge of bankruptcy. Reagan’s response was to awaken American entrepreneurship and entrepreneurship by deregulating government (market access, price controls, etc.) and cutting social welfare spending.
In the second half of Reagan’s first and second terms, the ECONOMY enjoyed six years of prosperity, high growth and low inflation, sweeping away years of stagflation. But his greatest contribution was to reawaken America’s entrepreneurial spirit. The US did not regain its lead in traditional industries such as steel, appliances and cars, but Reagan ushered in the “new economy”. For more than 30 years, American entrepreneurs have emerged as heroes in the fields of IT, the Internet, cloud computing, artificial intelligence, new energy, biomedicine and genetic engineering, no less than their predecessors who have built the world’s largest economy. It was these entrepreneurs who put paid to the theories of Japanese firsts and American decline that prevailed in the 1970s and 1980s.
The past is the judge of the present. Although China and the United States differ in political and economic systems and cultural traditions, they are the only two countries in the world that can be compared in terms of economic size and market size. Compared with the United States, China is in greater need of entrepreneurship and innovation, because the United States has far more natural resources, a larger livable land area and a longer coastline than China. Only when China tries its best to cultivate its advantage in human resources can it make up for its disadvantage in natural resources.
Reform and opening up to China created the human history of the most brilliant miracle, 40 years from a GDP per capita less than $200 of poor countries, the development for more than $10000 per capita GDP is the upper middle income countries (classified by the world bank), China is also the most hope to get rid of the “middle-income trap”, into the ranks of developed countries in developing countries. So what are the obstacles for China to continue its upward march?
GDP is the total wealth, including goods and services, that a country creates in a year. Table 1 shows China’s GDP, which is calculated by expenditure method. It shows where the wealth goes, whether it is consumed by local residents, the government, enterprises or foreign countries. Corporate consumption is actually investment. After deducting the wages and bonuses paid to employees and payments to suppliers, it is capital formation, including fixed assets and inventories. Foreign consumption is net exports, the difference between exports minus imports, which is positive in the long run for some countries, such as China, Japan and Germany, and negative in the long run for others, such as the United States, Britain and France.
Judging from the structure of China’s GDP in the past five years, the biggest problem is that household consumption is too low and corporate consumption is too high. In other words, businesses took the most of the new wealth in that year, while households accounted for less. Among large economies with a GDP of more than $1 trillion, China is the only country where the share of enterprises is more than 40 percent and the share of residents is less than 40 percent. In other large economies, household consumption accounts for more than 50% of GDP. Under this structure, the Chinese economy is characterized by the fact that when ordinary people earn less, they spend less, and when enterprises earn more, they spend more. This is reflected in the driving force of growth, that is, investment is greater than consumption. Of course, Corporate consumption in China has its own characteristics, which we will talk about later.
Compared with the United States and Japan, China’s economic preference for enterprises over residents becomes more intuitive. Due to the special data in the last two years of the epidemic,
Reading this, some readers may ask: why is it bad that the economy is driven by investment?
For latecomers, it is a good thing that the acceleration of industrialization is driven by investment. It means that there is a chance of leapfrog development, because latecomers will not be able to slowly transform from agricultural to industrial countries in a century or two, as the first countries did. Instead, latecomers will have to take decades to complete the journey of a century or two. This requires concentrated resources to invest in basic industries such as transportation, power, industry and equipment, resulting in a high capital formation rate in GDP. Japan and South Korea have experienced this stage. However, from 1955 to 2019, the household consumption ratio of Japan’s GDP never fell below 50 percent, and has stabilized at 55-60 percent in the past two decades.
China’s economy has been marked by decades of over-investment and under-consumption. The economy has long been investment-driven, meaning that economic growth has not materially improved people’s lives.
Another question from readers might be: Didn’t you start your article with a big talk about entrepreneurship? The high rate of corporate consumption in China’s GDP shows that Chinese entrepreneurs have the courage to invest and the entrepreneurial spirit.
It is true that China’s ratio of corporate consumption to GDP is 2.4 times that of the US and 2.7 times that of Japan, but that does not mean China is more entrepreneurial
Since 2005, the growth rate of China’s private investment has been declining all the way. In 2020, it was as low as 0.6 percent, almost zero growth. Gratifying changes appeared in 2021, rebounded to 7%, but statistics from the National Bureau of Statistics of the whole (including various economic entities), has been the most dynamic sector, such as software and information technology services (12.1%), wholesale and retail (5.9%), style (1.6%), the real estate industry, entertainment industry (5%), and other negative or low growth, These are areas where private enterprises are concentrated.
In the context of low private investment, China’s high corporate consumption rate in GDP is supported by state-owned enterprises. A significant portion of soE investment should be counted as government investment but counted as corporate investment, which should be noted when comparing Chinese and foreign data. Generally speaking, government investment is characterized by low efficiency, low return on capital when investing in traditional industries and high failure rate when investing in emerging industries. Second, the government’s ability to create jobs is inadequate because it invests in capital-intensive industries that require little labor.
Therefore, the high corporate consumption rate in China’s GDP shows the lack of entrepreneurship in China’s economy. What I discussed at the beginning is that entrepreneurship is the source of economic growth and the driving force of economic transformation and upgrading.
As a matter of fact, the Central Economic Work Conference at the end of 2015 has fully recognized the structural contradictions of the Chinese economy and the driving force for its transformation and upgrading. “Micro-market entities are the creators of social wealth and an inexhaustible source of endogenous driving force for economic development. Judging from China’s current situation, one of the key factors that has not fully stimulated market vitality is too much government intervention in market players.”
Since 2016, the central government has promoted supply-side reform and achieved remarkable results. However, from the perspective of private investment, the supply-side reform ideas of “streamlining administration and delegating power, cutting taxes and fees, releasing water to feed fish and activating microeconomy” still need to be firmly implemented. We must recognize that the demand-side measures have been used to the hilt. If we add the government part of corporate consumption back to government consumption, assuming half, then China’s government consumption rate is close to 40%, far exceeding Japan’s deficit-fueled economy (around 25%), with little room for manoeuvre.
Therefore, we must shift our attention to the supply side, and the most powerful means is to cut taxes and fees. Although Chinese governments at all levels are facing considerable financial pressure, as Premier Li Keqiang pointed out at a press conference on March 11, “Tax rebates and fee cuts are subtracting, but in essence they are also adding. Today’s retreat, tomorrow is an increase, today’s reduction, tomorrow may be an increase. Last year, market players in China paid more in new taxes than they did in tax cuts.” Finance Minister Liu Kun also said during the two sessions that the scale of tax rebates and tax cuts this year will reach 2.5 trillion yuan, a record high.
It can be said that the supply-side approach adopted by President Reagan 40 years ago is the same as the supply-side reform measures adopted by the Chinese government since 2016, both of which seek to revive the economy by stimulating enterprise vitality. But there are also significant differences: Reagan’s tax cuts focused on individuals, while China’s supply-side reforms focused on businesses. This is related to the tax systems of China and the US. The US tax system is dominated by direct taxes, with personal income tax accounting for about half of the total tax revenue, social security tax accounting for about one third, and corporate tax accounting for only about one tenth. China’s tax system is still dominated by indirect tax, which is levied in the link of commodity circulation, also known as turnover tax. China’s largest tax category is value-added tax, accounting for 36.8 percent in 2021; The second largest tax category is corporate income tax, accounting for 24.3 percent. The third largest tax category is personal income tax, at 8.1%; Consumption tax is a close fourth, at 8%.
China’s supply-side reform has not yet touched on personal income tax, which is just a blank space that can play the role of a small horse and a big cart, and should be the focus of further deepening reform.
Table 2 shows the current individual income tax system, with a threshold of 5,000 yuan per month and seven brackets. The lowest tax rate is 3% and the highest tax rate is 45%. About 65 million people pay personal income tax nationwide, accounting for 8.7 percent of the employed population of 747 million.
The biggest criticism of China’s personal income tax system is that the rate is too high. China is still a developing country. Its per capita income is only a fraction of that of developed countries, but its individual income tax rate is higher than that of many developed countries. Although the population of individual income tax payers in China is small, they are concentrated in areas with the most dynamic economy and the highest cost of living. This group also has the strongest consumption willingness and entrepreneurial spirit. The excessively high rate of individual income tax not only dampens consumption on the demand side, but also dampens entrepreneurship, innovation and entrepreneurship on the supply side.
During the two sessions of the National People’s Congress (NPC) this year, members of the Chinese People’s Political Consultative Conference (CPPCC) have suggested lowering the top rate of individual income tax to 25 percent, which is the same as the corporate income tax rate. Some of the deputies and members who hold this opinion mentioned in particular that the reduction of individual income tax is particularly important to attract overseas talents. Because the talents that China desperately needs in technology, finance, design, creativity and other fields are also desperately needed in other countries. But China’s high personal income tax is a serious deterrent for Chinese companies to attract high-end talent from abroad. Not only that, domestic talent will also be drained.
In July 2021, Shenzhen issued the Guidelines for Application of Industrial Development and Innovation Talent Awards, allowing high-end talents from financial institutions and venture capital enterprises registered in Shenzhen to apply for tax refund. Based on the amount returned, this is equivalent to lowering the top rate of individual income tax to 25%. The move is well received by enterprises and employees and is a typical case of deepening supply-side reform. The case has been hotly discussed at this year’s national two sessions, and many deputies and members hope to promote it nationwide.
I fully agree with the proposal to lower the top rate of individual income tax to 25 percent, but I don’t think Shenzhen’s levy first and return later approach is a long-term solution. First, having two more procedures is inherently inefficient. Second, whose tax can be refunded and whose tax cannot be refunded, the ruling is subjective and difficult to be fair and reasonable. For example, why is an Internet programmer a high-end talent, but an engineer in a car company not?
A fair and reasonable institutional solution would be to change the individual income tax code so that the top 25 per cent rate applies to everyone.
In chapter 12 of Boom and Bust, titled “America’s Declining Dynamism,” Greenspan offers his analysis of why the United States has stagnated:
The most important reason is that welfare spending stifles productivity. Between 1965 and 2016, the share of GDP spent on social welfare jumped from 4.6% to 14.6%; Second, uncertainty about the political and business environment — rising government deficits, angry politics, disappointing economic growth rates — has made businesses reluctant to invest for the long term. The third is that increased regulation means taxing entrepreneurs’ two most valuable resources: their time and ability to try new things.
It may not sound much different than it did 40 years ago, but the United States no longer has a president like Ronald Reagan.