American Exceptionalism: A Sequel

A few posts ago, I wrote about American Exceptionalism. For economic historians, this typically refers to the United States' industrialization and efficiency gains in the second half of the nineteenth. Economic historians refer to the first two thirds of the twentieth century  as the "American Century," due to the United States' considerable edge in productivity and wealth over the rest of the world. The American Century is thus the conceptual and chronological sequel to American Exceptionalism.

I previously explained how the concept of American Exceptionalism had become a rallying cry for Republican politicians. So too for the American Century. Here's Mitt Romney:

In 1941, Henry Luce called on his countrymen -just then realizing their strength - "to create the first great American century." And they succeeded: together with their allies, they won World War II, they rescued Europe, they defeated Communism, and America took its place as leader of the free world. Across the globe, they fought, they bled, they led. They showed the world the extraordinary courage of the American heart and the generosity of the American spirit...

Like a watchman in the night, we must remain at our post - and keep guard of the freedom that defines and ennobles us, and our friends. In an American Century, we have the strongest economy and the strongest military in the world. In an American Century, we secure peace through our strength. And if by absolute necessity we must employ it, we must wield our strength with resolve. In an American Century, we lead the free world and the free world leads the entire world.

Again, economic historians have to look for explanations other than the "extraordinary courage of the American heart and the generosity of the American spirit." Explanations of American Exceptionalism in the late nineteenth century largely focus on factors within the U.S.: factor endowments, technological development, railroadization, education, and so on. For the American Century--which included both world wars and the Great Depression-- international explanations are in order.

A few other grad students and I currently have a book club on Barry Eichengreen's "Golden Fetters." We read and discuss a chapter per week, and are on chapter 9 now. It has me convinced that the international monetary system, and especially the gold standard, is a key thread to understanding those remarkable decades. The pre-WWI gold standard worked well because of credibility and international cooperation. Eichengreen's intuition for political economy is strong, and he carefully traces why credibility and cooperation were sustainable before WWI but not in the interwar period.

The war greatly strengthened the U.S. balance of payments. Germany paid reparations to the Allies, who in turn repaid war debts to the U.S. American lending to Central Europe and Latin America rounded the circle of capital flows. But the balance of the whole system hinged on the U.S. keeping domestic interest rates low to encourage American gold to flow abroad. And for awhile, this worked just fine. The U.S. was more than happy to maintain low interest rates when it was also convenient for their domestic goals. However, starting in 1928, around the time of the Wall Street boom, Federal Reserve officials decided to tighten monetary policy, which curtailed foreign lending. To stay on the gold standard, other countries had to respond drastically, causing the U.S. downturn to both spread and deepen. The "golden fetters" also prevented policymakers from injecting liquidity into the banking system to contain bank runs. I strongly recommend reading at least the first chapter of Golden Fetters for more. The book is filled with examples of cooperation and coordination failures in the interwar period.

Anyhow, by the mid 1930s most countries dropped off of the gold standard and finally began to recover. The U.S. economy grew rapidly, save for a downturn in 1937-38. After that, monetary expansion in the form of huge gold inflows stimulated the economy. The gold inflows were at least in part due to fears of another war on European soil, causing capital flight from Europe. After WWII, the dollar was the dominant currency for international transactions and reserves. The Bretton Woods agreement of 1944 established a system of fixed exchange rates based on gold valued at $35 per ounce. Both world wars, then, were inadvertently beneficial to the United States relative to other countries. And our Great Depression was detrimental to the rest of the world. So it is hardly surprising that the United States' relative productivity and wealth grew in this era. Or that by the mid 1960s, Japan and Europe began to narrow the gap, and that Bretton Woods collapsed by 1971.

I will try to add more in future posts about what was going on in the American Century. So far it is not apparent that we want to repeat it. But maybe there are some features of the American Century worth striving for. For now I need to get back to studying for my economic history field exam on Wednesday. Today was macro-- quite difficult, a heavier than expected emphasis on stochastic dynamic programming.

American Exceptionalism, Then and Now

I am currently studying for my field exams in macroeconomics and economic history, which are on August 13 and 15. At Berkeley, we take field exams after our first two years in the PhD program, in two fields of our choice. Each field exam is a three hour written exam and can cover any of the papers, books, models, and techniques from your courses in that field as well as general knowledge associated with that field. So I have been revisiting the reading list from 210A, the economic history course taught to first years by professors Barry Eichengreen and Brad DeLong. The course was structured to cover a different theme each week. One week, the theme was "American Exceptionalism." In honor of the Olympics, let's have at it!

The phrase "American Exceptionalism," originally coined by Stalin in derision, carries a variety of connotations depending on who says it and in what context. In 2009, at the NATO Summit in Strasbourg, France, President Obama said, "I believe in American exceptionalism, just as I suspect that the Brits believe in British exceptionalism and the Greeks believe in Greek exceptionalism." This provoked outrages from the likes of Herman Cain, who wrote:

"Let me be clear," President Obama: America is the greatest nation on Earth. We are not just any other nation, and we are certainly not analogous to our friends in Europe and elsewhere.

For economists, American exceptionalism means something a little more precise than how much you love America. In the context of the history course, American exceptionalism refers to the differences in American industry and manufacturing, particularly compared to Western Europe, that arose in the mid-nineteenth century. In the eighteenth century, Britain was far ahead in terms of industrialization and productivity, but the U.S. accelerated in the nineteenth, and by the end of the world wars was the global leader. In 1853 and 1854, two small groups of British men visited the United States and reported back to Parliament on American industrial establishments, manufactures, and machinery. They were quite impressed with the efficiency and all the "labour-saving" machinery they saw.

The visitors gave four possible explanations for the differences of the American system: (1) labor scarcity in the U.S., (2) the extent of the American market and the introduction of railroads, (3) the education of the American workman, and (4) the energy of the American people.

The first explanation, labor scarcity, was also the first to appeal to economists studying the issue. At first it seems pretty obvious that since labor was relatively scarce and land abundant in America in those days, the real wage was high, so labor-saving technology was be used. This is essentially what Erwin Rothbard claimed in his article "Causes of the Superior Efficiency of U.S.A. Industry as Compared with British Industry," published posthumously in 1946. H.J. Habakkuk formalized the argument somewhat in 1962. The "Habakkuk hypothesis" is that labor scarcity induced mechanization, the adoption of labor-saving technologies, and innovation. Then in 1966, Peter Temin showed that the hypothesis didn't hold up to scrutiny. (I got to have lunch with him last year. Cool, huh?)

Other economists have taken on the second explanation: the extent of the American market and railway. Alfred Chandler (1990) says that the U.S. was able to become the "seedbed of modern managerial capitalism" prior to World War I because its large geographic size and rapidly growing domestic market allowed economies of scale and scope. But Leslie Hannah (2008) argues that Europe, especially northwest Europe, was a larger and more integrated market at the turn of the 20th century than the U.S. The U.S. used rail much more than Europe, but Europe had more ships, especially for intra-European trade, and lower long-haul costs per tonne-km. Road transport was the main bottleneck, and for this Europe had an advantage by having less average distance between railheads. Americans were more dependent on horses. Tariffs in Europe were low, and there was an enormous volume of intra-European trade before World War I. Moreover, Hannah finds that giant plants (with 1000 or more workers) were basically as common in parts of Europe as they were in the United States. So the explanation that the U.S. had scale advantages may not hold up.

So far we have seen a supply-side view (based on factor endowments: land, labor, and capital) and a demand-side view (based on market size). Neither is "case closed" yet. In fact, the papers I have read only leave me more confused. The British visitors' third explanation, American education, would fall under the category of institutions, while the fourth explanation, American "energy," would fall under the more vague (to economists) category of culture or "other." These are the big four. Supply, demand, institutions, and culture. Explanations for most phenomena in economic history fall into one of these four categories. And from what I've seen, the fourth is the least accepted among economists and the most accepted among "laypeople." For an economist, it seems like cheating to explain anything by cultural differences, unless you in turn explain the cultural differences (a la Greg Clark's controversial hypothesis of genetic superiority in the countries that were earliest to industrialize). But culture really resonates with people. Bringing us back to Herman Cain:

We are blessed with unparalleled freedoms and boundless prosperity that for generations have inspired an innovative and industrious people. America is exceptional.

Or see Newt Gingrich's book, A Nation Like No Other: Why American Exceptionalism Matters.

Exceptional character, innate exceptional energy and drive, is the one kind of exceptionalism that can last. If either factor endowments or market size explains American exceptionalism, well, globalization means that factors flow and markets get integrated, which means nobody gets to be too exceptional for too long. That's not necessarily a bad thing. It's good for everyone if the rest of the world also becomes more productive. In fact, the freer the market, the faster the flow. So if you're a politician who's staunchly free market and wants America to maintain a huge productivity lead, to avoid a contradiction in terms, you've got to pray that there is something exceptional innate in the American culture and spirit. Maybe that's why talk of American exceptionalism had a huge surge under Reagan (wow, speeches used to be much better written!)

Most Americans believe this too-- 80%, according to a 2010 Gallup poll, believe that "the U.S. has a unique character that makes it the greatest country in the world." The dismal scientist in me sighs.