chapter 1
THE AMERICAN ECONOMY—AN OVERVIEW

"The economy" is the term used to describe the system of making, distributing, and consuming material goods and services. The many facets of a country's economy include the spending habits of consumers, labor issues, employment patterns, the banking and financial industries, taxes, and the government regulation designed to help keep the economy running smoothly. There are two distinct branches of economics: macroeconomics and microeconomics. Macroeconomics is the study of the economic big picture, measuring broad trends in the economy, such as employment or inflation, as well as the way these trends interact. Microeconomics analyzes the economy on a smaller scale, focusing on individual consumers and companies.

The American economy depends on a combination of natural resources, labor, and technology to produce and distribute goods and services. It is the world's largest and, in many ways, most efficient economy: Americans make up just 5% of the world's population but produce more than 20% of its economic output. According to the World Bank in World Development Indicators (September 2004), the U.S. total GDP in 2003, at $10.9 trillion was more than double the nearest competitor, Japan, which had a GDP of $4.3 trillion. Other leading economies in 2003, according to the World Bank data, included Germany ($2.4 trillion), the United Kingdom ($1.8 trillion), and France ($1.7 trillion).

MEASURING THE ECONOMY

The Money Supply

The central bank of the United States—called the Federal Reserve and commonly known as the Fed—uses its power to control interest rates in order to manipulate the money supply—the total amount of coins and paper currency in circulation, along with all holdings at banks, credit unions, and other financial institutions.

The total amount of money in the United States at any one time is counted according to three measures (called money aggregates):

• M1: The total amount of paper money and coins in circulation plus all money in checking accounts.
• M2: All paper money and coins, all money in checking accounts, certain savings accounts, money market accounts, and certificates of deposit worth less than $100,000.
• M3: All paper money and coins, all money in checking accounts, certain savings accounts, money market accounts, certificates of deposit over $100,000, euros (the currency of the European Union) held in American accounts, and all repurchase agreements (when securities are sold with the promise that they will be bought back at a later date).

According to the Federal Reserve Statistical Release of February 17, 2005, the M1 count in January 2005 was $1,353 billion; the M2 count was $6,430 billion; and the M3 count was $9,468 billion.

Inflation

Inflation is an increase in prices of goods and services across an economy. It is also sometimes defined as a decline in the buying power of money—in other words, when prices outpace the value of money. In general, when the money supply increases, interest rates decrease, which leads to more spending and causes the economy to expand. Too much expansion causes money to become devalued, so at that point the Federal Reserve typically raises interest rates to cause the economy to contract and lower the risk of a spike in inflation. Government agencies use a number of indexes to measure the way inflation affects individuals and businesses. An excessively high rate of inflation can destroy an economy and lead to dangerous social instability; for example, historians believe that inflation was a principal cause of the economic failure in Germany that led to the rise of Adolf Hitler and, eventually, World War II. According to statistics published by the Bureau of Labor Statistics in March 2005, inflation in the United States has averaged about 4% per year since World War II. For the five years between 2000 and 2004 the annual inflation rate averaged 2.56%.

the consumer price index. The Consumer Price Index (CPI; also called the retail price index) measures the way inflation affects consumers on a daily basis, tracking price changes for goods and services, including housing, utilities, fuel, food and beverages, travel, and tuition. There are two categories of consumers tracked by the CPI. CPI-U measures All Urban Consumers and is the most commonly cited component of the CPI. CPI-W measures Urban Wage Earners and Clerical Workers; it is used in negotiating salary increases in contracts. The Chained Consumer Price Index (C-CPI-U) is a newer index that many consider to be a more accurate measure of the cost of living. CPI-U and C-CPI-U reflect about 87% of the total U.S. population and include not just general wage earners but professionals, managers, technicians, and the self-employed, along with retirees, the unemployed, and others not in the labor force. Table 1.1 shows the CPI for 2002 and 2003.

The Bureau of Labor Statistics uses CPI data to track the prices of products and consumer buying power over time. For example, the BLS estimates that the purchasing power of $100 in 1945 was equal to $298.89 in 1975 and $1,065.56 in 2005. A loaf of white bread that cost about seventy-seven cents in February 1995 cost $1.00 in February 2005, and Grade A large eggs that were eighty-six cents per dozen in February 1995 cost about $1.05 in February 2005. In addition to grocery products, CPI data also tracks electricity and fuel. According to the BLS, a gallon of regular unleaded gasoline that cost $1.13 in February 1985 was actually less expensive in February 1995 ($1.12) but then rose 77.7% to $1.99 by February 2005.

producer price indexes. Producer Price Indexes (PPIs; formerly called Wholesale Price Indexes) measure changes over time in the prices received by U.S. producers of goods and services; in other words, PPIs track prices from the viewpoint of sellers rather than buyers. The amount of money paid for goods and services is often different from the amount of money producers actually receive because of taxes, distribution costs, and government subsidies. Regular PPIs are available for the mining, manufacturing, trade, finance, and service sectors of the economy—as well as for individual products and groups of products—and are organized according to product endusers and materials used in production. According to the Department of Labor, between 1985 and 2003 the PPI for finished consumer goods increased an average 2.05% annually. During the five years from 1999 through 2003 the PPI for finished consumer goods increased an annual average

TABLE 1.1

of 2.44%, which was slightly higher than the annual average inflation rate of 2.32% during the same period. Table 1.2 shows the PPI for intermediate goods and crude goods from December 2003 through November 2004.

import and export price indexes. The Import Price Indexes (MPI) and Export Price Indexes (XPI) are kept by the International Price Program to measure

changes in the prices of nonmilitary goods and services that the United States trades with other nations. These products and services include a wide range of imports to the United States and exports from it to other countries, such as petroleum, livestock, automobiles and vehicle parts, clothing, crops, chemicals, precious stones, and international airline service. The Import and Export Price Indexes released on March 18, 2005, by the Bureau of Labor Statistics indicated that overall import prices rose 0.8% in February 2005, while the overall Export Price Index was unchanged after a rise of 0.9% in January 2005. Import prices in February 2005, however, were 6.1% higher than they had been in February 2004, largely because of a 29.6% increase in petroleum products during that period. However, over the five years between February 2000 and February 2005 import prices had risen during some periods and fallen during others, ending with a 6.4% increase overall. Petroleum imports had increased

by approximately 71% over the same five-year period. The price of U.S. exports to other countries during the five years from February 2000 through February 2005 had risen 6.1%. These increases were higher than the inflation rate, which was averaging roughly 2.5% annually during the early 2000s.

the consumer expenditure survey. The Consumer Expenditure Survey (CE) is actually two kinds of surveys—one an interview and the other a diary—that the BLS uses to gain information on consumer spending habits and demographic characteristics. The CE is used by the BLS to revise the Consumer Price Index. Public and private agencies also use the data collected to study the economic wellbeing of various segments of the American population.

Gross Domestic Product

The Gross Domestic Product (GDP) measures in dollars the total value of U.S. goods and service output in a given year. It is one of the most important and accurate ways the government tracks the health of the economy. In the United States the GDP more than tripled in a twenty-year period, from $3.4 trillion in 1983 to approximately $11 trillion in 2003. In Table 1.3 the left-hand column shows the actual number of dollars for a given year, while the right-hand column shows the number of

TABLE 1.2

GDP dollars adjusted for inflation to the year 2000. In 2003, according to estimates by the Central Intelligence Agency (CIA), the GDP of the United States was $10.4 trillion, almost twice as large as that of the next closest country, China, at $5.7 trillion. The world's total GDP in 2003, according to the CIA, was $49 trillion. Table 1.4 shows CIA estimates of GDP figures for the top twenty-five countries in 2003.

Every three months the U.S. Commerce Department releases quarterly GDP figures, and economists use a variety of indicators to determine what may have caused rises and declines in the numbers. Among other factors, they look at consumer spending (see Table 1.5), durable goods purchases (see Table 1.6), nondurable goods purchases, and savings levels, which become particularly important during economic downturns, when Americans earn less and need to tap into their savings to make purchases, which keep the economy moving forward.

DEFINING THE AMERICAN ECONOMY

Capitalism

The American economy was first described as "capitalist" by the nineteenth-century German economist Karl Marx (1818–1883), who used the term to describe an economy in which a small group of people control the capital, or money available for investment, and, by extension, control the power within the economy. Marx and his followers advocated socialist economies, in which the capital is controlled by the workers. They were highly critical of capitalist economies, maintaining that those economies—particularly that of the United States—concentrate power in the hands of wealthy business people who are more focused on their profits than on the well-being of their workers.

Market and Mixed Economies

The term "market economy" describes an economy in which the forces of supply and demand dictate the way in which goods and resources will be allocated and what prices will be set. The opposite of a market economy is a "planned economy," in which the government determines what will be produced and what prices goods will be sold for. In a market economy, producers anticipate what products the market will be interested in, and at what price, and they make decisions about what products they will bring to market and how they will be produced and priced on that basis. Market economies foster competition among businesses, which typically leads to lower prices and is generally considered beneficial for both workers and consumers. A planned economy, on the other hand, is directed by a central government that has a far greater degree of influence over prices and production, as well as tighter regulation of industries and manufacturing procedures. The United States is a "mixed economy," in which the principles of capitalism combine with those of planned economies to create a system with a high degree of market freedom along with regulatory agencies and social programs that promote the public welfare.

government regulation and deregulation. Since the late 1970s the federal and many state governments have lessened their restrictions on certain industries. Called

TABLE 1.3

deregulation, this process allows industries to set their own standards and control their own systems of pricing and other business functions. For example, beginning in 1938 the airline industry was regulated by a federal body called the Civil Aeronautics Board (CAB), which controlled airlines' schedules, flying routes, and prices. In order to stimulate

TABLE 1.4

competition in the industry, Congress passed the Airline Deregulation Act (PL 95–504) in 1978. The industry experienced a flood of new airlines offering low fares to compete with the established airlines. Although deregulation has actually caused some problems with larger airlines having too much control (or monopolizing) the industry and with overly crowded flight routes, most economists agree that the

TABLE 1.5

end result has been an air transportation system that offers some of the lowest costs and safest flights in its one-hundred-year history. Other industries that have experienced some degree of deregulation include electric utilities, telephone services, trucking, railroads, and banking.

THE MAIN COMPONENTS OF THE AMERICAN ECONOMY

America's rise as an economic leader since the nineteenth century is largely due to its combination of ample natural resources, a motivated and educated labor force, and a great number of technological innovations.

Natural Resources

Natural resources are commodities that can be taken from the environment and either used in the manufacture of other products or sold in their original form. Forestry, fishing, and mining are classified as natural resources industries. Natural resources are considered either renewable or nonrenewable. Renewable resources are those that can be replanted or restocked (such as trees and fish), while nonrenewable resources, such as minerals, cannot be replaced once they become depleted. A country's natural resources can affect the overall health of its economy. As the fourth-largest country in the world, at 3.7 million square miles, the United States has direct access to two oceans; numerous rivers and waterways; coal, oil, and mineral deposits; fertile soil for farming; and many heavily forested areas, all of which make it one of the richest geographical regions on the planet.

Labor

The highly skilled and well-trained U.S. labor force is one of the most important elements of America's economic

TABLE 1.6

success. Education policy plays an important role in building a solid base of workers. Table 1.7 shows government spending on education and job training. Over the forty-two-year period covered by the table, total spending—reflected as a percentage of Gross Domestic Product—has declined. However, as Figure 1.1 shows, the

United States is second only to Switzerland in its per-student spending. Productivity measures are used to track labor effectiveness—namely, how much work a single worker can accomplish in a certain period of time and how efficient a worker is in his or her job. Productivity generally increases with advances in technology. Table 1.8 shows productivity as measured by GDP per job and per hour worked, as well as average rates of growth, between 1961 and 2003.

Technology

American companies have long been at the forefront of technological innovation, pioneering such developments over the years as steam engines, factory assembly lines, and computer software. These new technologies have increased both worker productivity and business efficiency, which, in turn, allows companies to deliver goods and services at lower costs to consumers, stimulating spending and boosting the economy. At the same time, advances in technology can affect the job market. At times new technologies lead to more jobs as workers are needed to design, manufacture, and service them. On the other hand, such advances can also cause job losses as increased efficiency streamlines processes so that fewer employees are needed.

REGIONAL AND LOCAL ECONOMIES

Part of microeconomics study involves the economic health of various geographical regions and communities. A regional economy can be an area as small as a neighborhood or as large as a group of states with climate, geography, industry, or culture in common. The relative strength of a regional economy reflects broader national trends. For example, in the late nineteenth and early twentieth centuries—with the economy of the American South in shambles after the Civil War—northern cities attracted millions of workers to their rapidly growing industrial centers, such as the steel mills of Pittsburgh and the car factories of Detroit. Later, as the population migrated elsewhere, this region became known as the Rust Belt. Similarly, in the late twentieth century western and southwestern states experienced unprecedented growth with the rise of the computer industry, thanks in large part to Microsoft, which is headquartered in Seattle, and the

TABLE 1.7

FIGURE 1.1

"dotcom" companies centered in California's Silicon Valley. Other major economic regions of the United States include the Farm Belt of the Great Plains and the Sun Belt states of the South and southwestern United States, with warm climates that make them popular tourist destinations and a strong agricultural region.

When a region or community experiences a serious economic downturn—such as happened in the upper Midwest when the auto and steel manufacturers starting losing ground to foreign competitors, and in the Farm Belt with the rise of agribusiness and the subsequent demise of the small family farmer—its citizens often fall into a cycle of unemployment and poverty, leading federal and local governments and private nonprofit organizations to step in and offer assistance.

Housing

Perhaps the most important indicator of an area's economic sustainability is whether or not its citizens can afford housing. In HUD's "Fiscal Year 2005 Budget Summary" (http://www.hud.gov/about/budget/fy05/budgetsummary), HUD Secretary Alphonso Jackson called home ownership the "lynchpin of the nation's economy," noting that in 2003 American homeowners borrowed approximately $80 billion against their homes to invest in "home improvements, furnishings, education, consumer goods, and new businesses," which in turn spurred further economic growth for the country as a whole.

According to the Milken Institute, an independent nonprofit think tank that studies ways to improve the U.S. and global economies, especially for disadvantaged people, home prices in the United States rose 30% faster than wages between 1992 and 2004 ("Down Payment Assistance Program Essential Element for Low-Moderate Income Families to Overcome National Homeownership Affordability Gap," April 22, 2004, http://www.milkeninstitute.org/newsroom/newsroom.taf). Furthermore, home ownership for minorities falls far behind that for non-Hispanic whites: Fewer than 50% of all African-American and Hispanic families in the United States own homes, versus 75% of non-Hispanic white families.

Income and cost-of-living calculations have led the government to set a general figure of 30% of income as the amount most Americans can afford to pay for housing. According to HUD's 2005 estimates (http://www.hud.gov/offices/cpd/affordablehousing/index.cfm), approximately 12 million households—both renters and home-owners—spent more than 50% percent of their income on housing, causing these households to be what HUD terms "cost burdened"—meaning they were likely to be unable to pay for other necessities such as food, clothing, and health care. Home prices vary greatly across the country and depend largely on the overall economic stability of different regions. For example, the median price for a home in Boston, a growing economy, was $413,500 in 2003. In Pittsburgh, a declining economy, the median price for a home was $102,642 during the same year, according to Global Insight, an economic consulting firm. Table 1.9 shows the twenty-five cities with the highest median home values, according to the 2000 U.S. Census. According to the Federal Housing Administration (FHA), 69% of Americans were home owners in the third quarter of 2004, up from 68.4% in the third quarter of 2003 (http://www.hud.gov/offices/hsg/hsgtoday/ht_arch.cfm).

public and private housing and economic development assistance programs. The U.S. government

TABLE 1.8

offers programs to both rural and urban communities to spur economic development. The U.S. Department of Housing and Urban Development (HUD) runs the Initiative for Renewal Communities, urban Empowerment Zones, and urban Enterprise Communities (known as RC/EZ/EC), a series of incentive programs for communities that have experienced economic hardship due to a loss of population and jobs.

One of the most important elements of HUD's economic renewal function is its Office of Community Planning and Development (CPD), which contains sections that oversee laws and regulations related to affordable housing, community and economic development, energy and environmental issues that concern economically burdened communities, housing for HIV and AIDS patients, and assistance for the homeless. Each of these CPD section has an impact on a region's or a community's functioning, but the most economically significant are the housing and development programs.

In addition to government-sponsored development assistance, a number of privately funded, nonprofit organizations offer financial help in the form of downpayment assistance programs (DAPs) to lower- and middle-income people who could not otherwise afford to buy homes. With government budgets strained by a rising national debt—at more than $7.5 trillion in February 2005 and rising every day—and the recession of the early twenty-first century, these private programs can act as important resources for local and regional economies to build their tax bases and create sustainable employment and healthy living conditions.

The CPD's Office of Affordable Housing Programs (OAHP) handles programs such as the Self-Help Home-ownership Opportunity Program (SHOP), which falls under the authorization of the Housing Opportunity Program Extension Act of 1996 and provides federal funds to nonprofit organizations such as Habitat for Humanity International and ACORN Housing Corporation to buy land on which to build or rehabilitate affordable housing for low-income families. The Helping Hands for Home-ownership Act, signed into law in 2004 by President George W. Bush, allows prospective recipients of SHOP benefits to pay the required "sweat equity" to receive funding by helping to build their own houses and those of other SHOP families. In February 2005 HUD Deputy Secretary Roy A. Bernardi announced that approximately $27 million in grant money would be awarded to 1,700 lower-income families through Habitat for Humanity, the Housing Assistance Council, and PPEP Microbusiness and Housing Development Corporation ("Bernardi Awards Nearly $27 Million in 'Sweat Equity Grants' to Help Lower-Income Americans Become First-Time Homeowners: Record SHOP Funding Will Create More Than 1,700 New Homes for Lower-Income Families," HUD No. 05–020, February 22, 2005). The CPD also runs the Homeownership Zone (HOZ) program. HOZ is designed to stimulate local economies by allowing cities to reclaim vacant and/or decrepit property and build new neighborhoods of single-family houses. The HOZ program has not received funding since 1997.

A Milken Institute study of the impact of one nonprofit downpayment assistance program (that of the Nehemiah Corporation of America, a Sacramento, California-based nonprofit organization dedicated to community economic empowerment) found that the six housing markets that received Nehemiah DAP help—Atlanta, Columbus, Baltimore, Philadelphia, Sacramento, and St. Louis—all saw an increase in home equity appreciation (the amount of a home's monetary value that a home owner actually owns) since 1998, with appreciation ranging

TABLE 1.9

from 2.5% (St. Louis) to 65.2% (Sacramento) for African-Americans; 3.8% (Columbus) to 74.2% (Sacramento) for Hispanics; and 3.7% (Columbus) to 66.4% (Sacramento) for whites (Perry Wong, Daniela Murphy, Frank Fogelbach, and Rob Koepp, "Expanding Affordable Home Ownership with Private Capital: A Study of the Nehemiah Down Payment Assistance Program," Santa Monica, CA: Milken Institute, April 2004). Additionally, the study found that the fifty-seven counties represented in the six housing market areas had gained a total of 36,240 new home owners between fiscal year 1997–98 and 2004–05, generating an increase in property tax revenue of more than $287 million.

community and economic development. The CPD runs several programs and grants to revitalize economically disadvantaged communities. The Community Development Block Grant (CDBG) provides funding to states, counties, and urban communities in need of safe, affordable housing and business development to become economically viable. The RC/EC/EZ programs also fall under the CPD's economic development wing. Hollis Wormsby reported that in December 2001 forty economically distressed cities and communities across the country were named Renewal Communities and became eligible to receive a portion of $17 billion in tax incentives for residential and business development ("HUD Announces Black Belt Counties Selected as Renewal Community Eligible for $17 Billion in Tax Incentives," HUD No. 02013BBC, January 23, 2002). The Renewal Community program was part of the Community Renewal Tax Relief Act of 2000, which also authorized HUD to name seven urban Empowerment Zones. Renewal Community designation was set to run from 2002 to 2009. Benefits of the Community Renewal Tax Relief Act include:

• Tax credits for businesses that hire employees who live in a Renewal Community; for those that hire employees from a demographic group with a high unemployment rate; for those that hire people who were formerly receiving long-term welfare benefits; for investors who provide financing for businesses in RCs; and for rental-housing owners who build new properties or renovate old ones in RC zones.
• Tax deductions for states with one or more Renewal Community; for businesses to add $35,000 per year in necessary equipment and supplies; and for businesses to perform environmental cleanup in an RC zone.
• A Zero-Percent Capital Gains Rate allowing the purchase of an interest in or property of an RC business during an area's RC designation.
• Financing for certain public school programs and renovations in RC areas with Qualified Zone Academy Bonds.

THE ROLE OF THE INDIVIDUAL IN THE ECONOMY

Almost every aspect of American life is influenced by, and further influences, the economy. Whether you drive or fly on your next vacation, how you will pay for college and save for your retirement, what advertisements you see, what movies you watch, and what magazines you read all involve making economic decisions, which then impact the way the economy functions. If you work or plan to work, you are a small but important part of the economy. Likewise, every time you buy goods, or save money, you are participating in economic activity.

Economists maintain that the better off the economy is, the better its participants will be. In a healthy economy people tend to have more job security, earn more money, and are able to increase opportunities for themselves and their families—thus lifting their overall quality of life. But in an unstable, bad economy—such as in the United States during the Great Depression (1929–early 1940s) and during the recessions of the early 1990s and the first years of the twenty-first century—people are less certain of the future, face increasing pressures at work and may lose their jobs, and have less flexibility in being able to pay for goods and services, which in turn impacts trends in employment, interest rates, the cost of living, the money supply, and all other aspects of the economy, on both the macro and micro levels.