I am confident the aftereffects on the American economy from September 11 will not be large. The rapid success of the U.S.-led war to destroy the Taliban regime in Afghanistan and to break the al Qaeda terrorist network has greatly boosted morale not only in America but also in Europe, judging from a recent visit I made to celebrate the 100th anniversary of the Nobel prize.
The pain to families and others from the loss of life on September 11 is dreadful and can never be forgotten. While valuable property was also destroyed, it amounted to a tiny portion of the physical resources of the U.S. A slightly more rapid rate of investment in plants and equipment for less than a year will quickly bring the physical capital stock beyond its previous heights. Fortunately, the knowledge possessed by the American people, the main engine of modern economic growth, remains largely intact. To be sure, the effects on New York will last longer, but that great city, too, will recover and gain strength.
Turning now to the American-led world recession, let me share the following thoughts. The American economy during the 1990s was the locomotive of the global economy, which explains why its recession spread to Europe, Asia, and beyond. Since I believe the economic impact of the terrorist attack will be small, world economic performance in 2002 and beyond will primarily depend on how rapidly the U.S. pulls out of its prolonged, although not severe, recession. Fortunately, the Federal Reserve, under Alan Greenspan's leadership, has taken early and repeated steps to reduce interest rates and to raise the rate of growth of the money supply and liquidity.
These actions, along with the great inner strengths of the American economy--human capital and entrepreneurship--will bring this recession to an end during 2002. How soon is hard to predict, but I do not expect it to last beyond the first two quarters of the year. Although industrial production has declined for about a year, the effect has been smaller than in the past, since industry now accounts for a much smaller share of aggregate American output. And the slowdown of industrial output may already be largely over.
The service and construction sectors have held up, and while unemployment has climbed rapidly, it still is under 6%. This is rather good, considering that not long ago, economists believed 6% or even 7% were full employment levels for a modern economy.
Some commentators have feared that the American economy during the coming decade will duplicate the weak performance of Japan during the 1990s, since both countries had excessively booming stock markets and rapid rates of investment. But I believe this comparison is erroneous because these economies differ in fundamental ways. The Fed has moved far more quickly than the Japanese did, not only to lower interest rates but also to increase the rate of growth of the money supply and liquidity.
Moreover, the Japanese banking system was and remains fundamentally unsound, with negative net worth for some large banks. By contrast, most American banks and other financial institutions are in good shape, and can readily expand credit and equity. The U.S. economy, although overregulated, is highly flexible compared with Japan's, especially in services and construction.
The Japanese authorities tried fiscal stimulus, but these efforts utterly failed to jump-start that economy and raised the ratio of public debt to gross domestic product to a very high level. There is similar pressure in Congress to use the excuse of the American recession to increase public spending and cut taxes to curry the favor of important interest groups.
I do not believe that either tax cuts or greater public spending are useful ways to promote short-term recovery. Indeed, they could hinder recovery if they are misplaced. To discourage future terrorism and other conflicts, and to stimulate long-term economic growth through greater rates of investment and entrepreneurship, I do support larger defense spending, a flatter income tax, and lower taxes on capital.
I often see the glass as half empty, but not today. I believe 2002 will bring renewed economic growth not only in the U.S. but also in Europe, Asia, and elsewhere. The main risk is not any inherent weakness of advanced economies or even future terrorist attacks, although these must be guarded against. The risk lies in misplaced public spending and tax actions that do more harm than good. Gary S. Becker, the 1992 Nobel laureate, teaches at the University of Chicago and is a Fellow of the Hoover Institution.