Slow Decline of the American Empire

This is the third recession I am witnessing in the USA. The first one started in late 1990 when Saddam Hussein had attacked and captured Kuwait. Each time, the recession has ended and growth has resumed. But what remained unnoticed is that each recession permanently reduced the standard of living of a huge section of Americans. The American Empire has been declining slowly but surely for some time now. The USA is not alone but is accompanied by most western nations and Japan.
After World War II, Europe was shattered. Asia, Africa as well as Latin America remained poor and low skilled. The USA was the shining beacon of the world. The 1950s and 60s were perhaps best times for Americans. Usually the husband, who probably started working right after high school, worked in a company while the wife looked after the house and children.
As Europe came out of the disastrous condition partly using America’s help and Japan started exporting many consumer products to the USA, competition increased. As a result, the wife had to take up a full time job more often than not. High school education was not sufficient to guarantee a decent job in a good company. College degree became essential for a decent job.

Little gain in real income in last three decades
While there were very few 2-income households in the USA in the 1970’s, today almost all households with parents and small children have both parents working. In spite of doubling the number of persons working in the household, the real income did not increase significantly. In 1975, the median household income was little over $41348, measured in 2007 dollars. In 2007, it has gone up to $50233. In 32 years, the household income has increased only 22%. If the wife did not join the workforce, the income today would actually have been lower than in 1975.

The second bad news is that in 1999, the median household income measured in 2007 dollars was $50641. In each subsequent year, it has fallen slightly every year until 2004. In 2004, the income was $48665. After that it started rising again. But still the income in 2007 is less than in 1999. This shows that America’s households faced economic stagnation over the last 8 years.

Declining share of world GDP
Still America is one of the richest nations in the world. Based on United Nations Human Development Indicators (HDI), it was ranked 12th among more than 170 nations of the world. Its GDP of $14 Trillion is by far the highest in the world. But in relative terms, USA’s economic influence in the world is decreasing steadily. In 1960, USA had 30% of world GDP. In 1970, it declined to 24.2% and since then it has been declining slowly. In 2009, this share has come down to about 20%. By 2025, its share will decline further to about 17% while China’s GDP will be higher than America’s.

Reduced savings, reduced investment
America’s household savings rate was about 8 to 10% of GDP in early 1980’s. Since then it has steadily declined and went negative in 2005. It remained between 0 and 1% until 2008 when it showed some improvement. In the current year it might be 3 to 4% of GDP although we do not know if it is an anomaly or a long term trend. In contrast, India’s household savings stayed at about 22% of GDP from 2000 to 2008. China has an even higher rate. The total savings in a country is utilized for new investment which provides economic growth.

The steady reduction in savings has a direct correlation with income stagnation. Americans grow up hearing two myths. First, in the USA every person is expected to have a standard of living better than his/her parents. Second, Americans earn more than people of most other nations because of the unique American ingenuity.

In reality, most people found out that their family income was either decreasing or remaining stagnant. In such circumstances, the logical thing to do would be to cut back on expenses. In other words, families needed to reduce standard of living. But in order to maintain myth 1, most families did not cut back. Where would they get the extra money? They cut back on savings until it became zero. In coming years, when these people retire, they will face substantial poverty because of lack of savings. It is questionable how much they would be able to depend on Social Security benefits alone.

Cost of college education
In the 1950’s and 60’s most people would get a job right after high school graduation. A high school graduate would then join a company, learn skills and continue to grow within the company. As America became richer, the requirement of highly educated people increased. There was a significant shift toward college and graduate level education. A person with more education generally had higher income. Whereas in 1970, barely 11% of the people above the age of 25 had a bachelor’s degree, in 2005 the number has gone up to 28%. The positive correlation between higher education and higher income still persists.
The nearly mandatory requirement for at least a bachelor’s degree in order to attain middle class life has other repercussions. In 1950’s and 60’s since very few children went to college and public school education was free, cost of education was quite low in the parent’s annual budget. Today every family has to allocate significant amount of money to fund children’s college education. The cost of college education has been increasing at a rate much higher than the average inflation. This has become a burden on families. In addition, although public school education is free, it is financed primarily by property tax. As cost of education increases, property tax is also rising rapidly.

Ballooning Healthcare costs
It is well known that healthcare in America is expensive. In fact, from 1970 the healthcare cost has more than doubled. Most people depend on health insurance coverage paid by the employer. When the health insurance premium goes up, the employer is forced to effectively reduce the salary by that much.

Competition from developing nations
Since western European nations have income comparable to the USA’s, the American companies did not find it worthwhile to move large number of jobs to Europe. But, as India and China progressed and a small percentage of people in these two countries became highly educated, companies in the USA, Europe and Japan found it economical to start factories and offices in these two countries. China became the center of sophisticated manufacturing while India provided high tech knowledge workers. This caused severe movement of well paying jobs from the USA, Europe and Japan to China and India. The huge difference in wage between developed nations and China-India for same skill became the key factor.

Housing bubble
In early part of this decade, house prices were going up. Interest rate was low and banks became much less stringent about checking the eligibility of debtors. Some people saw an opportunity in making large amount of money quickly. They decided to “flip” house. A person would buy a very expensive house that he cannot afford. Suppose that the home costs $500000. Since house price is always supposed to go up, he would sell the house in 6 months to a year at, say $650000 and make a cool $150000 in profit. In an environment where jobs are uncertain and savings were dwindling, this highly risky procedure seemed a logical way to make money. However, the bubble popped when home price started going down. Even in 2009, it is still falling. We have seen the repercussions.

Tiny, 200 year spike
From the beginning of human civilization until around 1750, the standard of living of common people in almost all nations of the world was pretty much the same. Then came the industrial revolution in England and that changed everything. Soon it spread to other European countries and the USA. These nations became very rich compared to the rest of the world over the next 200 years. The difference in standard of living became so huge between the USA and China or between Sweden and India that people all over the world started believing in a myth that people in America and Europe were destined to live much better than the others. But the reality is that this is just a short spike spanning 200 years in the 10000 year human history. The current decline of western nations is a process that is removing the spike and bringing back economic equilibrium among nations slowly. It will take few more decades to complete.
Once it is completed, the standard of living of common people in every nation will be pretty much the same. Unfortunately, this equalizing process will cause pain to America, Western Europe and Japan.