America's Fortunes

In terms of personal prosperity most people are doing better than they think. But prospects for the unemployed are only getting worse. And two big storm clouds loom over everything

At any given moment the state of any nation—and especially the state of any stable industrial democracy, where a measure of political calm and social order can generally be taken for granted—is determined largely by the state of its economy. Wars, relative military strength, terrorist attacks, natural disasters, demographic changes, social trends, election outcomes, even the results of international sporting competitions, can all contribute significantly to a country's perception of its own well-being. At times, certainly, one or more of these factors can outweigh the economy in affecting the collective sense of how the country is faring. But as any presidential candidate will tell you, for the average American citizen the most basic measure of national well-being amounts one way or another to economics. Is my income higher or lower than it was last year? Is my job more or less secure? Across the spectrum of class or income well-being is measured to a considerable degree by the question "Can I afford ... ?" Can I afford to put the kids through college? Buy a house? Put my mother in a nursing home? Pay for day care? Put food on the table? Buy a vacation home?

But as important as the economy is in determining the state of the union, it is also a problematic measure, because the "real" state of the economy does not match our collective perception of it. That is, although one could in theory deduce America's exact sense of its economic well-being at any given moment by extrapolating from each citizen's income and expenses a kind of aggregate national answer to the question "Can I afford to ... ?," that would provide only an indirect and backward-looking measure of the economy's real strength. The true condition of the economy is best seen not as a snapshot of individuals' circumstances but as the movement of deeper forces through time; economists look back for measures of what has already happened, and then use various logical assumptions to project what will happen in the future.

Obviously, the state of the economy is a somewhat relative thing; how we judge it depends greatly on what we use as a basis for comparison. Compared with 2001, for instance, last year was in some respects a good one for the economy. Compared with 1999, however, it was in many ways disappointing. And in fact the economy of 2003 was by several measures comparable to the economy of 1997. Does this mean the economy has regressed? Or that it has returned to its natural level after a period of aberration? And what, if anything, can these historical comparisons tell us about the coming years?

Although the essays in "State of the Union" cover a wide variety of topics—from the long-term federal budget deficit to the changing nature of the middle class, from the health-care-cost conundrum to the rising level of anger in American society—all these topics are ultimately bound up with (either as influences on or as derivatives of) the state of the economy. In this opening essay we aim to establish the broader context that underlies all these issues, and to provide a balanced view of the U.S. economy—not just of how it's doing today, or this year, but of the deeper structural forces that will determine our prosperity over the long term.

In retrospect, the late 1990s appear to have been a golden age produced in part by the serendipitous confluence of unsustainable factors such as the stock-market boom, the post-Cold War "peace dividend," and a consumer borrowing binge of historic proportions. (Today, three years after the stock-market bubble burst, we are still suffering something of a hangover from the excesses of that giddy era.) But as accidental as that brief golden age may in some ways have been, and as irrational as the exuberance that propelled it was, the underlying forces at work in the late 1990s were real, and they began to reshape the economy in fundamental ways. We can now begin to see the enduring effect of those forces.

In the short term—let's say the next couple of years—the majority of Americans can expect to keep improving their economic lot; however, a significant minority—mainly the newly jobless in certain old-line industries—will watch their already dim prospects darken even further. And over the longer term—let's say ten years or more—a much broader swath of the American population will have reason to be very concerned about the economic future.

The Reverse-Lottery Economy

Recent media coverage of the economy has focused on the troubled state of the job market. We are told that proportionally fewer adults are working today than at any time in the past ten years; that not since the Great Depression have we failed to produce an increase in the number of jobs for such a long period of time; and that median household incomes have fallen.

All this is true. Yet the overall picture that emerges from these facts is largely false. The "jobless recovery" has hardly been jobless: the unemployment rate—which stood at 5.9 percent in November—is lower than the average for the past thirty years, and is right at the threshold that most economists as recently as the mid-1990s believed was the lowest it could go without triggering inflation. Although it is true that some jobless people have given up looking for work, and are therefore no longer even counted in official unemployment statistics, about half these people are teenagers, many of whom have forsaken the part-time-job market in order to focus on schoolwork—hardly the stuff of a national crisis. In fact only 5.4 percent of those who have left the work force fit the definition of "discouraged workers" —people who have given up looking for work principally because they don't believe they can find it.

Those workers who have kept their jobs have for the most part prospered, despite the slackening of the job market. Real hourly-wage growth has continued through the recession and the recovery, albeit at a slower pace than in the late 1990s. And wage growth has been broadly distributed, meaning that most workers, including most of the middle class, have benefited. In fact, there is a wide gap between how most people feel the economy in general is faring (poorly) and how they feel they themselves are doing (quite well). A poll conducted by the Gallup Organization in August found that 75 percent of respondents rated the financial well-being of "average Americans" as "poor" or "only fair," and that 89 percent considered the employment situation specifically to be either "poor" or "only fair." (Nearly 50 percent rated it as downright "poor.") Yet when asked about their personal experiences, only 19 percent of those currently working said they were worried about being laid off, and even fewer worried about having their hours or wages reduced—the same percentage that feared these things in 1997, when the economy was booming. Another recent poll, by the Pew Research Center, found that only 35 percent of Americans disagreed with the statement "I'm pretty well satisfied with the way things are going for me financially." The percentage of Americans disagreeing with that statement has been lower only three times out of twelve since Pew first began asking about it, in 1987. Similarly, the percentage of respondents agreeing with the statement "I often don't have enough money to make ends meet" has been lower only twice—in 2002 and in 1999.

None of this is to deny that the job market is weaker today than it was in 1999—and policymakers should be taking steps to strengthen it. But for most Americans things are still going pretty well.

The real problem is neither flagging income for the unemployed nor the sheer number of workers laid off but, rather, the economic prospects of those workers who do lose their jobs. In June the average duration of unemployment hit 20.1 weeks—the highest it's been since January of 1984. And 43 percent of workers who signed up for unemployment benefits in 2002 exhausted them. This may have been an unusually mild recession for most Americans, but it's been unusually harsh for those who have lost jobs.

The problems facing recently laid-off workers—those who are still unemployed and also those who have found new jobs at reduced pay—are not likely to disappear as the economy picks up; these problems lie deeper than the business cycle. Over the past ten years, through boom and bust, unanticipated job loss has become a more wrenching experience for many workers. In earlier decades the unemployment rate and the average number of weeks unemployed tended to move in tandem: out-of-work people had a harder time finding jobs during recessions and an easier time during recoveries. But by the early 1990s [see chart above] many unemployed workers had trouble finding new work even in a strong job market. In 1997, with the unemployment rate down to 4.7 percent, the average duration of unemployment stood at about sixteen weeks—higher than it had been in all but three years during the 1980s, when unemployment was much higher.

When unemployed workers did find new jobs during the 1980s and 1990s, they had to settle for wages that were on average 14 percent lower than those in their previous jobs. A 14 percent pay cut is financially painful enough—but it's even more painful when it occurs amid a widespread expectation of steadily rising income. And since the mid-1990s the situation has been getting worse. In fact, a 2003 analysis by Henry Farber, an economist at Princeton University, reveals that when workers who lost their jobs finally found new ones, the gap between their new wages and the wages they would have earned (had they been able to stay in their old jobs) was nearly triple what it would have been almost a decade ago. The gap is greatest for highly educated workers. According to Farber's analysis of the most recent Displaced Workers Survey from the Bureau of Labor Statistics, covering 1999 through 2001, shows that workers with more than sixteen years of education saw an average reduction in income of roughly 23 percent upon finding new jobs; in the mid-1990s the reduction averaged only 12 percent.

The worsening plight of the unemployed is closely related to changes in American business practice. As productivity has increased and global competition has intensified, firms have continually restructured their operations—not just by laying off workers in response to temporary downturns in demand but by eliminating positions, even whole classes of positions, altogether. The share of jobs lost owing to the abolition of positions rather than to slack work, plant closings, or other reasons has doubled since the early 1980s. Erica Groshen and Simon Potter, economists at the Federal Reserve Bank of New York, argue that the main reason higher unemployment has lingered so long into the current recovery is that most lost jobs have been restructured out of existence. Workers whose jobs have been eliminated outright often cannot find anything directly comparable, either because the work they do has become obsolete or because their skills are company- or industry-specific, and not easily transferable elsewhere. These displacements are still not exceedingly common, but they are quite damaging to individuals when they occur.

In short, we have entered what might be called a "reverse-lottery economy." The broad majority of American workers continue to do well; yet in any given year—even in boom times—a few workers hit the negative jackpot and must accept lengthy or even permanent reductions in living standards. Increasingly, these unfortunates hail from a variety of educational backgrounds and occupations. (One recent study found that U.S. financial-service firms are planning to move more than 500,000 jobs—or eight percent of the total work force in that sector—offshore within the next five years. These relocations will include higher-status, higher-income jobs than such transfers have typically included in the past; jobs in financial analysis, research, accounting, and graphic design are among those expected to be moved offshore.)

In a society where many people buy on credit, counting on ever expanding good fortune, the decline in income from job displacement is especially hard to bear financially. It is hard to bear psychologically as well. As the anthropologist Katherine Newman observed in Falling From Grace: Downward Mobility in the Age of Affluence (1988), the downwardly mobile family "jealously guards its public face, even if this means that everyone must eat a dreary diet so that the children can have some stylish clothes for school." Displays of desperation by these families are presumably kept within the walls of homes they can no longer afford.

The Miracle of American Productivity

But here's the rub: the force that has produced deepening problems for reverse-lottery winners is the same as the force that has produced good fortune for many more Americans: the sudden and continuing acceleration of labor-productivity growth over the past eight years. Rising productivity is driving much of the change in American society. Yet its role is often misunderstood.

As the economy has pushed through its second year of jobless recovery, the media have mistakenly cast rapid productivity growth as the villain in a simplistic contest between people and technology. If productivity rises, this story goes, fewer people can generate the same output, and (all else being equal) unemployment will go up; if four workers can produce as much as five could only eight years ago, why hire the fifth? In the short term this is true; rising productivity has almost certainly helped to suppress new hiring after the recession. But beyond the short term this story is simply wrong. And it misses the bigger picture entirely.

Productivity growth is the bedrock of a healthy economy over time. In fact, continued rapid growth in productivity is certainly the best—and arguably the most important—feature of the U.S. economy today. It is no accident that past eras of high productivity growth (such as the 1920s and the 1950s) coincided with a national climate of energy and optimism. An annual productivity growth rate of 1.4 percent (roughly the average from 1973 to 1995) causes real national income to double every fifty years; increase the rate to 2.8 percent (roughly the average in the 1950s and 1960s), and real national income will double in just twenty-six years, and nearly quadruple in fifty years. Throughout the second half of the twentieth century unemployment was lowest and real wages grew fastest during eras of rapid productivity gains. In some individual years, of course, high productivity growth coincided with high unemployment or low wage growth; but over a longer period of time—say, five years or more—high productivity growth has consistently buoyed both incomes and employment.

Since the sudden acceleration in productivity growth eight years ago, economists have worried that it might prove ephemeral, or even illusory—the result of either a short-lived technology boom or an exceptionally strong (and unsustainable) increase in demand. But these concerns have diminished markedly over the past three years: demand has cooled, and the high-tech bubble has burst, yet productivity growth has continued unabated. In fact, from 1995 to 2002 labor productivity grew at an average rate of 2.8 percent a year, matching the rate of the post-World War II "golden era" that lasted from 1948 to 1973. That's almost double the rate of growth from 1973 to 1995, and nearly one percentage point more than the annual average for the twentieth century as a whole. There is even evidence that productivity growth may be continuing to accelerate; from 2001 through the first half of 2003 (a period that included a recession, which typically slows productivity growth) it averaged an annual rate of about 4.1 percent. In 2002, the most recent year for which complete data are available, productivity grew by 4.8 percent—the highest annual increase since 1950. (One must be careful in interpreting these last figures: productivity growth typically accelerates in the early stages of economic recovery, and figures are often revised downward over time, as more-extensive data become available. Nonetheless, at an absolute minimum there is no sign of a falloff in growth.)

The lesson here is that the New Economy is real. Most economists now believe that productivity—and living standards—will continue to rise rapidly over the next five to ten years (according to many of the estimates productivity will rise by two to three percent a year). The advances in information technology—particularly in computer processing power—that helped launch the boom have not slowed. Meanwhile, productivity growth in nontechnological industries, which remained low through much of the mid-1990s, has accelerated, as managers begin to integrate cheaper, more powerful information technology into their businesses. (Indeed, the real exemplar of the New Economy may be not—the Internet courier that burned through $280 million in venture capital before going bust—but Wal-Mart, the ubiquitous discount chain that has pioneered ways of using information-technology advances to cut costs.) Interestingly, the pattern we are now witnessing—productivity growth rippling from industry to industry after the initial acceleration in computer production—is similar to the pattern that followed the development of another "transformative technology": the electric generator. In this case the resulting boom in productivity lasted well over a decade.

High productivity growth in recent years has also allowed most Americans to enjoy wage growth even as unemployment has risen. And relatively high employment levels and continued wage growth most likely contributed to relatively strong consumer demand throughout the recession, mitigating its effects.

Over the longer term broad-based productivity gains should mean not only higher incomes for most Americans but also cheaper products and more-competitive U.S. industries. The widespread diffusion of new technology will probably continue to give rise to products and services that would have been neither technologically feasible nor widely affordable just a few years ago. (Recent examples of such products include cell phones and iPods.) The combination of higher incomes and new products should spur both demand and production—and over the long run these will produce new jobs. Theoretically it's possible to conceive of a future in which productivity gains yield no new, widely adopted products; in which consumer confidence and consumer demand never rise despite rising incomes; and in which employment therefore remains stagnant or even in decline. But history suggests that such a future is quite unlikely.

Winners and Losers

For all the good that rapid productivity growth has yielded, its benefits have not been felt equally by all Americans—even among those who have managed to avoid layoffs. Nor is productivity growth by any means the only factor shaping our fortunes; other forces, more sweeping and just as fundamental, have pushed and pulled the various socioeconomic classes in different directions. Which of these forces prevails will go a long way toward determining the depth of class division in the United States in the coming years.

Viewed through the lens of class politics, one of the most striking elements of the past quarter century has been what Gary Burtless, an economist at the Brookings Institution, calls "the slow erosion of bargaining power" among low-income and middle-income workers. Better information technology and more-sophisticated robotics have significantly reduced job opportunities for many types of "routine" laborers, such as factory workers and middle managers, especially as globalized production has allowed U.S. companies to move many jobs—particularly low- and middle-skilled jobs—to countries where wages are lower. Increased global competition and the aggressive expectations of the financial markets (mainly in the form of shareholders demanding increased earnings per share every quarter) have eroded traditional managerial notions of "fairness" in setting wages and benefits and replaced them with a relentless focus on reducing cost; many companies now refuse to pay workers more than their immediate ability to contribute justifies, regardless of how old they are, how long they've worked for the company, or how much they've earned in the past. On top of all this, increased immigration of low-skilled workers since 1970 has disproportionately increased the labor supply at the lower end of the economy, probably depressing wages for less skilled workers.

This story—told repeatedly in recent years—is clearly reflected in the numbers. Between 1973 and 1995, while real wages for the top five percent of Americans rose (and while total income for the top five percent of American households increased by about 30 percent), the bottom half of the American work force experienced an outright decline in real wages. Median hourly wages declined from $12.54 to $10.44 per hour.

But the numbers—and the story they reflect—changed in the mid-1990s. Since then, the upward pressure on wages associated with rapid productivity growth has been stronger than the downward pressure on the pay of many low- and middle-skilled workers that automation and the decline of benign corporate paternalism generates. Thus even socioeconomic classes that should be made worse off by the fact of technological changes (because technology displaces them from their jobs) may be left better off by the rapid pace of it (because wages rise and the job market tightens). This is basically the story of the late 1990s. Despite technological advances, continual corporate restructurings, and heavy job churning, the wages and incomes of workers of every socioeconomic status and education level increased, while the growth in income inequality slowed down. Globalization, immigration, and the substitution of machinery for labor have not stopped exerting powerful forces on the economy since 1995—but the effects of rapid productivity and economic growth have been even more powerful.

The poor have done well, relatively speaking, in this economic environment. Jobs in such sectors as retail sales, hotel services, and basic health-care provision have proved tough to automate, and so haven't been substituted out of existence. Moreover, because jobs in the service sector—where the most low-skilled jobs have been created in recent years—are less affected by recession than are jobs in manufacturing, employment has been remarkably stable for the poor. And real wages for "McJobs," though still low in absolute terms, rose during the late 1990s as rapid economic growth tightened the labor market. Job growth and wage growth at the lower end of the economy—along with welfare reform—helped lift millions of people out of poverty since the mid-1990s; and a large portion of them have stayed out, even through the recent recession.

The middle class, too, has done well recently. And although the New Economy has eliminated certain kinds of middle-class jobs, it has created others. Manufacturing, for instance, continues its slow decline, but construction work and other high-paying blue-collar fields have grown significantly since 1995; and technologically driven "job destruction" in middle management is outweighed by strong growth overall in white-collar fields. In short, concerns about an emerging job market in which some jobs pay six figures, many jobs pay minimum wages, and a few jobs exist in between appear overwrought. As unemployment began to rise in 2000, real median incomes did falter somewhat—but at the end of 2002 they were still six percent higher than in 1995, and 21 percent higher than in 1970.

The contradictory forces that pull the middle-class and the poor up while simultaneously pushing them down have tended to push the wealthy and well-educated in only one direction: upward. Advances in information technology have complemented the skills of workers in analytic occupations (such as management consultants, financial analysts, and marketing executives), hence raising these workers' value. Globalization has almost certainly created more opportunities for this class of workers than it has eliminated; white-collar U.S. workers are now able to manage, advise, or provide analysis for a growing number of international plants and businesses. The shift toward a "winner-take-all" society has produced rapid pay increases for executives and high-end professionals. (And large reductions in the upper tax brackets have allowed high earners to keep more of their pay.)

Though growth in inequality slowed in the late 1990s, it did not stop; while incomes rose at every socioeconomic level, they rose fastest for the workers who were already earning the most money. Without significant policy shifts—toward much higher marginal income-tax rates for high earners, for example, or an immigration policy that strongly favors skilled immigrants over unskilled ones—the rich are likely to continue to pull away economically (and perhaps culturally and socially, as well) from the rest of society.

At the moment it appears to be an open question whether in the coming years the middle class and the poor will advance quickly (as they did in the late 1990s) or stagnate (as they did throughout much of the 1970s and 1980s). We're poised on the cusp between broad-based wealth creation and stagnation: while productivity growth has helped keep wages rising for the employed, immigration and the continued movement of jobs to offshore locations weakens the labor market and depresses wages. Given the continuing rapid pace of innovation and productivity growth, it appears likely that broad-based income gains will eventually resume, and that the prevailing conditions of the next several years will more closely resemble those of the late 1990s than those of the 1970s. But for that to be assured of happening, unemployment will need to drop significantly below six percent. And however much the typical middle- or working-class family sees its income rise on an absolute basis, the incomes of the richest families will likely improve even faster.

Smoothing Capitalism's Rough Edges

Whether or not the fortunes of the various socioeconomic strata rise or fall together in the future, the fortunes of individuals—regardless of what class they hail from—are more volatile today. For some workers rapid improvements in income and socioeconomic status may be punctuated by sudden and painful declines in both. This volatility has become one of the defining attributes of the economy.

The flexibility of the American labor market—its ability to shift workers quickly from fading companies or industries to growing ones—is among the U.S. economy's greatest assets; but such rapid shifts are often bad for individual workers, at least temporarily. (For older workers, or for people who lack geographic mobility, these negative reversals are more likely to be permanent. A married worker, for example, may fare worse than other workers after being laid off, especially if a spouse's job has anchored the family to a particular community.) And many traditional remedies for worker displacement, such as protectionism and inflexible labor laws, are often rightly considered to hurt the nation's economic competitiveness.

But there may be ways to help displaced workers without harming the economy. In "Are We Still a Middle-Class Nation?" (page 120) Michael Lind proposes that the federal government grant equity-market stakes to every citizen, so that all Americans, not just the richest, might draw extra income from investments.

For both political and practical reasons Lind's plan would take time to implement. For the shorter term Robert Litan, an economist at the Brookings Institution, and Lori Kletzer, an economist at the University of California at Santa Cruz, have proposed a fairly inexpensive extension of unemployment insurance to cover workers who find new jobs that pay much less than their old ones. "Wage insurance" would make up a portion of the difference between old and new incomes for up to two years, so that the transition to a lower-income lifestyle would be more gradual. (A pilot program already exists for workers displaced by the movement of jobs overseas.) But wage insurance has potential as more than just a safety net; if unemployed workers knew they could more easily afford to take lower-paying jobs, they might feel freer to jump into whole new industries or career tracks; this would help the economy grow faster (by increasing the speed at which new industries grow) and might also ultimately increase the long-term income prospects of individual workers.

A more radical variation on this concept comes from Robert Shiller, an economist at Yale, who believes that continuing financial-market innovations may soon enable private insurers to offer "livelihood insurance" that could protect workers from potential declines in their occupations (though not against an individual worker's underperformance within a flourishing field). Similar products might insure against the eventual devaluation of specific academic degrees in the United States (such as those in software engineering or Russian language), or even against declines in the performance of the U.S. economy as a whole, relative to the rest of the world. (As Shiller notes, the fact that the past century was a good one for America does not necessarily mean that the next one will be.) Collectively, these products might lessen the large and arguably increasing risks inherent in the U.S. capitalist system.

These are bold ideas; it may be hard at first to wrap one's mind around them. And it is perhaps ironic that financial markets—which are regarded by many people as amoral if not immoral—might ultimately solve some of the problems that socialist and utopian thinkers have been trying for centuries to address. But as improbable as livelihood insurance may sound, advances in data collection, data analysis, and financial-risk theory are lowering the technical barriers to such a system. Government action could help the creation of livelihood insurance on a large scale. Part of the government's role would be technical—for instance setting the standards for the collection and sharing of personal income data that are necessary if livelihood insurance is to work. But two equally important tasks would be the articulation of a new vision of society—one where people are protected against the unexpected shocks that accompany rapid economic change—and the promotion of financial-services products that can sustain that vision. Without large markets covering a wide range of occupations, carriers offering livelihood insurance might have difficulty hedging their risk sufficiently.

Economists argue that the benefits of technological advance, freer trade, and greater competition are great enough that when—as inevitably happens—some people suffer as a result of these forces, those people can in theory be fully compensated for their losses. But in practice such workers are rarely, if ever, compensated—and the consequences of the setbacks they suffer are more severe in the New Economy than they were in the past. Our economic (and political) system can tolerate a certain level of inequality resulting from differences in ability and work ethic (though just how much is an open question). But too often inequality is gratuitous; many people's economic fortunes are buffeted by factors they cannot reasonably predict and over which they have no personal control. As a society we should seek to minimize the randomness of fortune that is inherent in democratic capitalism.

The Long Term

It is hard to say at any given point in time what the exact best recipe for growth is; economic and business environments vary widely from boom to bust. Yet when they stand back from the vicissitudes of the business cycle and consider longer periods of time, most economists agree that three factors are crucial for rapid, sustainable economic growth: new ideas and the technologies they create; business investment in new technologies and equipment; and ample "human capital": the collective skills and knowledge of the work force.

In 2000, though expectations of what the stock market and the economy in general could produce were wildly unrealistic, there was genuine cause for optimism. Ideas and innovations were proliferating. Investment in these ideas and the technologies they created was considerable. And a flexible, highly educated work force stood ready to adopt new technologies quickly, and to generate still more innovations for the future.

Three years later these conditions—a decline in the level of business investment notwithstanding—remain largely in place. Moreover, technologies and business practices developed before the bust (and not yet fully exploited) have generated a momentum that should help the economy over the next several years.

The long-term picture, however, may be bleaker. Two key factors that have historically given the U.S. economy a competitive advantage—a superior education system and an attractive investment climate—now appear to be eroding.

To a substantial degree America's economic strength during the twentieth century was attributable to the quality of its education system, and in particular to the expansion of educational opportunity to a large proportion of its citizens. America began that century with the world's best-educated population, and spent much of the next hundred years further improving its standing. In 1940, 30 percent of American workers had graduated from high school and fewer than six percent had graduated from college. By 2000, 89 percent had graduated from high school and 28 percent had graduated from college. Overall, Americans born in 1975 spent nearly twice as many years in school as Americans born a century earlier.

Over the past twenty years, however, this trend has markedly slowed, and is expected to do so further in the coming decades. Whereas from 1980 through 2000 the proportion of the labor force with a college education increased by 8.6 percent, over the next twenty years that proportion is expected to increase by only 1.5 to five percent—despite the fact that the financial benefits of a college education have been increasing. In most other economically advanced countries the average number of years people stay in school is now growing faster than it is in the United States—and young adults in a handful of those countries are now more highly educated, on average, than their U.S. counterparts. Ever since the launch of Sputnik, in the late 1950s, Americans have been concerned—perhaps excessively so—with the quality of the education that U.S. citizens receive. But only more recently has the United States seen its relative advantage in quantity of education begin to decline.

The consequences of this stagnation must color any discussion of the future of the U.S. economy. (Two of its main causes are discussed elsewhere in "State of the Union." See "The Other Gender Gap," page 137, and "The Tuition Crunch," page 140.) As the rate at which we produce college graduates begins to slow the rate at which the U.S. economy creates and adopts new technologies and products will also slow. Income inequality will no doubt grow: the smaller the supply of college graduates, the higher the incomes they are likely to command. And the larger the supply of less-educated workers, the lower their wages will be. Indeed, every high school student who chooses not to attend college hurts not only his own income prospects but also (by adding to the pool of workers competing for low-skill jobs) those of other less-educated workers.

Just as our declining educational progress threatens the ability of the work force to absorb innovations quickly, so the deterioration of the government's fiscal position undermines the willingness of firms to invest in new technologies. The long-term fiscal problems of the federal government are covered in detail elsewhere in this feature (see "The $45 Trillion Problem," page 146). Suffice it to say here that the size of the budget deficit can have a real impact on the economy. Whereas low levels of debt keep interest rates down and inspire the confidence of foreign investors, high levels of debt ultimately discourage private investment by raising interest rates. It is no coincidence that as the federal budget swung into surplus in the second half of the 1990s, after a period of annual deficits averaging almost four percent of GDP in the early part of that decade, domestic investment as a share of GDP rose, by 3.5 percent. And although the country has managed to survive periods of high and rising debt in the past without calamity (in the late 1980s, for example, and during World War II), we are embarked on a period of deepening annual deficits of unprecedented size, with no end in sight. According to the Congressional Budget Office, if the government does not make significant changes in spending or taxation, debt will mount rapidly over the next few years, reaching $10 trillion by 2010—and that's before it begins an exponential increase as the Baby Boom enters retirement.

The long-term fiscal crisis facing the United States comes primarily from a growing imbalance between what the government spends—primarily on Medicare and Social Security—and what it reaps in taxes, which were not high enough to sustain current entitlements even before the series of sharp tax cuts enacted since 2000. Today we're simply foisting the many costs of this imbalance—rising debt, slower growth, and ultimately either higher taxes or broken promises—onto future generations.

A reasonable observer might conclude that all these problems are the ingredients for national economic decline. Historically, America has been an adaptable, resilient nation; decline is not inevitable. But unless we devote more attention to education and fiscal balance, two issues that are absolutely central to long-term prosperity, the conditions that have produced widespread growth will dissipate. As weak as today's economy may look relative to that of 1999, at the rate we're going we may look back on 2003-2004 in ten or twenty years with wistful longing.