Статья: U.S. Economy

Статья: U.S. Economy

words, larger markets always allow for greater levels of specialization. For

example, in small towns with few customers to serve, there is often only one

clothing store that carries a small selection of many different kinds of

clothing. In large cities with a million or more potential customers, there

are much larger clothing stores with many more choices of items and styles,

and even some stores that sell only hats, gloves, or some other particular

kind of clothing.

International trade is a dramatic way of expanding the size of a firm’s

market. In markets where transportation costs are low compared with the

selling price of a product, it has become possible for producers to compete

globally to take full advantage of highly specialized production. But

international trade also means that businesses must compete more efficiently

against firms from all around the world. That competition also makes them try

to take advantage of greater specialization and the division of labor.

In many cases, products are produced and sold by firms from two or more

countries that have large production and employment levels in the same

industry. Often, however, these firms still specialize in the kinds of

products they produce. For example, though many small cars and small pickup

trucks are made in Japan and sent to the United States, large pickups and

four-wheel drive sport utility vehicles are often exported from the United

States to Japan and other nations. Similarly, the United States exports large

commercial passenger jets to most countries, but imports many small jets from

Canada, Brazil, and other nations. While this may seem strange at first

glance, it allows greater specialization in production for particular kinds

of products.

Transportation costs can also help to explain the pattern of international

production and trade. It often makes sense to produce goods close to the

markets where they will be sold, or close to where the resources used in the

production process are found or made. In recent years, the availability of a

skilled and hard-working labor force has become more important to producers

in many different industries, so new factories are often located in areas

with large numbers of well-trained workers and good schools that provide a

future supply of well-educated workers.

Production Patterns: Past, Present, and Future

Several dramatic changes in production patterns occurred in the United States

during the 20th century. First, most employment shifted from farming in rural

areas to industrial jobs in cities and suburbs. Then, during the second half

of the century, production and employment patterns changed again as a result

of technological advances, increased levels of world trade, and a rapid

increase in the demand for services.

Technological changes in the transportation, communications, and computer

industries created entirely new kinds of jobs and businesses, and altered the

kinds of skills workers were expected to have in many others. World trade led

to increased specialization and competition, as businesses adapted to meet

the demands of international competition.

Perhaps the greatest change in the U.S. economy came with the nation’s

growing prosperity in the years following World War II (1939-1945). This

prosperity resulted in a population with more money to spend on services and

leisure activities. More people began dining out at restaurants, taking

vacations to far-off locations, and going to movies and other forms of

entertainment. As family incomes increased, a wealthier population became

more willing to pay others for services.

As a result of these developments, the closing decades of the 20th century

saw a dramatic increase in service industries in the United States. In 1940

about 33 percent of U.S. employees worked in manufacturing, and about 49

percent worked in service-producing industries. By the late 1990s, only 26

percent worked in goods-producing industries, and 74 percent worked in

service-producing industries. This change was driven by powerful market

forces, including technological change and increased levels of world trade,

competition, and income.

Some observers worried that this growth of employment in service-producing

industries would result in declining living standards for most U.S. workers,

but in fact most of this growth has occurred in industries where job skill

requirements and wages have risen or at least remained high. That is less

surprising when you consider that this employment includes business and

repair services, entertainment and recreation occupations, and professional

and related services (including health care, education, and legal services).

United States consumers and families are, on average, financially better off

today than they were 50 or 100 years ago, and they have more leisure time,

which is one of the reasons why the demand for services has increased so

rapidly.

During the 20th century, businesses and their workers had to adjust to many

changes in the kinds of goods and services people demanded. These changes

naturally led to changes in where jobs were available, and in what kinds of

education, training, and skills employees were expected to have. As the base

of employment in the United States has changed from predominantly agriculture

to manufacturing to services, individuals, firms, and communities have faced

often-difficult adjustments. Many workers lost jobs in traditional

occupations and had to seek employment in jobs that required completely

different sets of skills. Standards of living declined in some communities

whose economies centered on farming or around large factories that shut down.

In recent decades, populations have decreased in some states where

agriculture provides a significant number of jobs. While high-technology

industries in places such as California's Silicon Valley were booming and

attracting larger populations, some textile and clothing factories in

Southern and Midwest states were closing their doors.

Public Policies to “Protect” Firms and Workers

Historically in the United States, the government has rarely stepped in to

protect individual businesses from changing levels of demand or competition.

There have been some notable exceptions, including the federal government’s

guarantee of $1.5 billion in loans to the Chrysler Corporation, the nation’s

third-largest automobile manufacturer, when it faced bankruptcy in 1980.

Although direct financial assistance to corporations has been rare, the

government has provided subsidies or partial protection from international

competition to a large number of industries. Economic analysis of these

programs rarely finds such subsidies and protection to be a good idea for the

nation as a whole, though naturally the companies and workers who receive the

support are better off. But usually these programs result in higher prices

for consumers, higher taxes, and they hurt other U.S. businesses and workers.

For example, in the 1980s the U.S. government negotiated limits on Japanese

car imports, and the price of new Japanese cars sold in the United States

increased by an average of $2,000. The price of new U.S. cars also rose on

average by about $1,000. Although the import limits did save some jobs in the

U.S. automobile industry, the total cost of saving the jobs was several times

higher than what workers earned from these jobs. When fewer dollars are sent

to Japan to buy new automobiles, the Japanese companies and consumers also

have fewer dollars to spend on U.S. exports to Japan, such as grain, music

cassettes and CDs, and commercial passenger jets. So the protection from

Japanese car imports hurt firms and workers in U.S. export industries. Still

other U.S. firms and workers were hurt because some U.S. consumers spent more

for cars and had less to spend on other goods and services.

It is simply not possible to subsidize and protect everyone in the U.S.

economy from changes in consumer demands and technology, or from

international trade and competition. And while most people agree that the

government should subsidize the production of certain types of goods required

for national defense, such as electronic navigation and surveillance systems,

economists warn against the futility of trying to protect large numbers of

firms and workers from change and competition. Typically such support cannot

be sustained over the long run, when the cost of protection and subsidies

begins to mount up, except in cases where producers and workers represent a

strong special interest group with enough political clout to maintain their

special protection or subsidies.

When the special protection or support is removed, the adjustments that

producers and workers often have to make then can be much more severe than

they would have been when the government programs were first adopted. That

has happened when price support programs for milk and other agricultural

products were phased out, and when policies that subsidized U.S. oil

production and limited imports of oil were dropped in the 1970s, during the

worldwide oil shortage.

For these reasons, if public assistance is provided to a particular industry,

economists are likely to favor only temporary payments to cover some of the

costs of relocation and retraining of workers. That policy limits the cost of

such assistance and leaves workers and firms free to move their resources

into whatever opportunities they believe will work best for them.

Most producers in the United States and other market economies must face

competition every day. If they are successful, they stand to earn large

returns. But they also risk the possibility of failure and large losses. The

lure of profits and the risk of losses are both part of what makes production

in a market economy efficient and responsive to consumer demands.

CORPORATIONS AND OTHER TYPES OF BUSINESSES

Three major types of firms carry out the production of goods and services in

the U.S. economy: sole proprietorships, partnerships, and corporations. In

1995 the U.S. economy included 16.4 million proprietorships, excluding farms;

1.6 million partnerships; and about 4.3 million corporations. The

corporations, however, produce far more goods and services than the

proprietorships and partnerships combined.

Proprietorships and Partnerships

Sole proprietorships are typically owned and operated by one person or

family. The owner is personally responsible for all debts incurred by the

business, but the owner gets to keep any profits the firm earns, after paying

taxes. The owner’s liability or responsibility for paying debts incurred by

the business is considered unlimited. That is, any individual or organization

that is owed money by the business can claim all of the business owner’s

assets (such as personal savings and belongings), except those protected

under bankruptcy laws.

Normally when the person who owns or operates a proprietorship retires or

dies, the business is either sold to someone else, or simply closes down

after any creditors are paid. Many small retail businesses are operated as

sole proprietorships, often by people who also work part-time or even full-

time in other jobs. Some farms are operated as sole proprietorships, though

today corporations own many of the nation’s farms.

Partnerships are like sole proprietorships except that there are two or more

owners who have agreed to divide, in some proportion, the risks taken and the

profits earned by the firm. Legally, the partners still face unlimited

liability and may have their personal property and savings claimed to pay off

the business’s debts. There are fewer partnerships than corporations or sole

proprietorships in the United States, but historically partnerships were

widely used by certain professionals, such as lawyers, architects, doctors,

and dentists. During the 1980s and 1990s, however, the number of partnerships

in the U.S. economy has grown far more slowly than the number of sole

proprietorships and corporations. Even many of the professions that once

operated predominantly as partnerships have found it important to take

advantage of the special features of corporations.

Corporations

In the United States a corporation is chartered by one of the 50 states as a

legal body. That means it is, in law, a separate entity from its owners, who

own shares of stock in the corporation. In the United States, corporate names

often end with the abbreviation Inc., which stands for incorporated

and refers to the idea that the business is a separate legal body.

Limited Liability

The key feature of corporations is limited liability. Unlike proprietorships

and partnerships, the owners of a corporation are not personally responsible

for any debts of the business. The only thing stockholders risk by investing

in a corporation is what they have paid for their ownership shares, or

stocks. Those who are owed money by the corporation cannot claim

stockholders’ savings and other personal assets, even if the corporation goes

into bankruptcy. Instead, the corporation is a separate legal entity, with

the right to enter into contracts, to sue or be sued, and to continue to

operate as long as it is profitable, which could be hundreds of years.

When the stockholders who own the corporation die, their stock is part of

their estate and will be inherited by new owners. The corporation can go on

doing business and usually will, unless the corporation is a small, closely

held firm that is operated by one or two major stockholders. The largest U.S.

corporations often have millions of stockholders, with no one person owning

as much as 1 percent of the business. Limited liability and the possibility

of operating for hundreds of years make corporations an attractive business

structure, especially for large-scale operations where millions or even

billions of dollars may be at risk.

When a new corporation is formed, a legal document called a prospectus is

prepared to describe what the business will do, as well as who the directors

of the corporation and its major investors will be. Those who buy this

initial stock offering become the first owners of the corporation, and their

investments provide the funds that allow the corporation to begin doing

business.

Separation of Ownership and Control

The advantages of limited liability and of an unlimited number of years to

operate have made corporations the dominant form of business for large-scale

enterprises in the United States. However, there is one major drawback to

this form of business. With sole proprietorships, the owners of the business

are usually the same people who manage and operate the business. But in large

corporations, corporate officers manage the business on behalf of the

stockholders. This separation of management and ownership creates a potential

conflict of interest. In particular, managers may care about their salaries,

fringe benefits, or the size of their offices and support staffs, or perhaps

even the overall size of the business they are running, more than they care

about the stockholders’ profits.

The top managers of a corporation are appointed or dismissed by a

corporation’s board of directors, which represents stockholders’ interests.

However, in practice, the board of directors is often made up of people who

were nominated by the top managers of the company. Members of the board of

directors are elected by a majority of voting stockholders, but most

stockholders vote for the nominees recommended by the current board members.

Stockholders can also vote by proxy—a process in which they authorize someone

else, usually the current board, to decide how to vote for them.

There are, however, two strong forces that encourage the managers of a

corporation to act in stockholders’ interests. One is competition. Direct

competition from other firms that sell in the same markets forces a

corporation’s managers to make sound business decisions if they want the

business to remain competitive and profitable. The second is the threat that

if the corporation does not use its resources efficiently, it will be taken

over by a more efficient company that wants control of those resources. If a

corporation becomes financially unsound or is taken over by a competing

company, the top managers of the firm face the prospect of being replaced. As

a result, corporate managers will often act in the best interests of a

corporation’s stockholders in order to preserve their own jobs and incomes.

In practice, the most common way for a takeover to occur is for one company to

purchase the stock of another company, or for the two companies to merge by

legal agreement under some new management structure. Stock purchases are more

common in what are called hostile takeovers, where the company that is

being taken over is fighting to remain independent. Mergers are more common in

friendly takeovers, where two companies mutually agree that it makes sense

for the companies to combine. In 1996 there were over $556.3 billion worth of

mergers and acquisitions in the U.S. economy. Examples of mergers include the

purchase of Lotus Development Corporation, a computer software company, by

computer manufacturer International Business Machines Corporation (IBM) and the

acquisition of Miramax Films by entertainment and media giant Walt Disney

Company.

Takeovers by other firms became commonplace in the closing decades of the

20th century, and some research indicates that these takeovers made firms

operate more efficiently and profitably. Those outcomes have been good news

for shareholders and for consumers. In the long run, takeovers can help

protect a firm’s workers, too, because their jobs will be more secure if the

firm is operating efficiently. But initially takeovers often result in job

losses, which force many workers to relocate, retrain, or in some cases

retire sooner than they had planned. Such workforce reductions happen because

if a firm was not operating efficiently, it was probably either operating in

markets where it could not compete effectively, or it was using too many

workers and other inputs to produce the goods and services it was selling.

Sometimes corporate mergers can result in job losses because management

combines and streamlines departments within the newly merged companies.

Although this streamlining leads to greater efficiency, it often results in

fewer jobs. In many cases, some workers are likely to be laid off and face a

period of unemployment until they can find work with another firm.

How Corporations Raise Funds for Investment

By investing in new issues of a company’s stock, shareholders provide the

funds for a company to begin new or expanded operations. However, most stock

sales do not involve new issues of stock. Instead, when someone who owns

stock decides to sell some or all of their shares, that stock is typically

traded on one of the national stock exchanges, which are specialized markets

for buying and selling stocks. In those transactions, the person who sells

the stock—not the corporation whose stock is traded—receives the funds from

that sale.

An existing corporation that wants to secure funds to expand its operations

has three options. It can issue new shares of stock, using the process

described earlier. That option will reduce the share of the business that

current stockholders own, so a majority of the current stockholders have to

approve the issue of new shares of stock. New issues are often approved

because if the expansion proves to be profitable, the current stockholders

are likely to benefit from higher stock prices and increased dividends.

Dividends are corporate profits that some companies periodically pay out to

shareholders.

The second way for a corporation to secure funds is by borrowing money from

banks, from other financial institutions, or from individuals. To do this the

corporation often issues bonds, which are legal obligations to repay the

amount of money borrowed, plus interest, at a designated time. If a

corporation goes out of business, it is legally required to pay off any bonds

it has issued before any money is returned to stockholders. That means that

stocks are riskier investments than bonds. On the other hand, all a

bondholder will ever receive is the amount of money specified in the bond.

Stockholders can enjoy much larger returns, if the corporation is profitable.

The final way for a corporation to pay for new investments is by reinvesting

some of the profits it has earned. After paying taxes, profits are either paid

out to stockholders as dividends or held as retained earnings to use in

running and expanding the business. Those retained earnings come from the

profits that belong to the stockholders, so reinvesting some of those profits

increases the value of what the stockholders own and have risked in the

business, which is known as stockholders’ equity. On the other hand, if the

corporation incurs losses, the value of what the stockholders own in the

business goes down, so stockholders’ equity decreases.

Entrepreneurs and Profits

Entrepreneurs raise money to invest in new enterprises that produce goods and

services for consumers to buy—if consumers want these products more than

other things they can buy. Entrepreneurs often make decisions on which

businesses to pursue based on consumer demands. Making decisions to move

resources into more profitable markets, and accepting the risk of losses if

they make bad decisions—or fail to produce products that stand the test of

competition—is the key role of entrepreneurs in the U.S. economy.

Profits are the financial incentives that lead business owners to risk their

resources making goods and services for consumers to buy. But there are no

guarantees that consumers will pay prices high enough to cover a firm’s costs

of production, so there is an inherent risk that a firm will lose money and

not make profits. Even during good years for most businesses, about 70,000

businesses fail in the United States. In years when business conditions are

poor, the number approaches 100,000 failures a year. And even among the

largest 500 U.S. industrial corporations, a few of these firms lose money in

any given year.

Entrepreneurs invest money in firms with the expectation of making a profit.

Therefore, if the profits a company earns are not high enough, entrepreneurs

will not continue to invest in that firm. Instead, they will invest in other

companies that they hope will be more profitable. Or if they want to reduce

their risk, they can put their money into savings accounts where banks

guarantee a minimum return. They can also invest in other kinds of financial

securities (such as government or corporate bonds) that are riskier than

savings accounts, but less risky than investments in most businesses.

Generally, the riskier the investment, the higher the return investors will

require to invest their money.

Calculating Profits

The dollar value of profits earned by U.S. businesses—about $700 billion a

year in the late 1990s—is a great deal of money. However, it is important to

see how profits compare with the money that business owners have risked in

the business. Profits are also often compared to the level of sales for

individual firms, or for all firms in the U.S. economy.

Accountants calculate profits by starting with the revenue a firm received from

selling goods or services. The accountants then subtract the firm’s expenses

for all of the material, labor, and other inputs used to produce the product.

The resulting number is the dollar level of profits. To evaluate whether that

figure is high or low, it must be compared to some measure of the size of the

firm. Obviously, $1 million would be an incredibly large amount of profits for

a very small firm, and not much profit at all for one of the largest

corporations in the country, such as telecommunications giant AT&T Corp. or

automobile manufacturer General Motors (GM).

To take into consideration the size of the firm, profits are calculated as a

percentage of several different aspects of the business, including the firm’s

level of sales, employment, and stockholders’ equity. Various individuals

will use one of these different methods to evaluate a company’s performance,

depending on what they want to know about how the firm operates. For example,

an efficiency expert might examine the firm’s profits as a percentage of

employment to determine how much profit is generated by the average worker in

that firm. On the other hand, potential investors and a company’s chief

executive would be more interested in profit as a percentage of stockholder

equity, which allows them to gauge what kind of return to expect on their

investments. A sales executive in the same firm might be more interested in

learning about the company’s profit as a percentage of sales in order to

compare its performance to the performances of competing firms in the same

industry.

Using these different accounting methods often results in different profit

percent figures for the same company. For example, suppose a firm earned a

yearly profit of $1 million, with sales of $20 million. That represents a 5-

percent rate of profit as a return on sales. But if stockholders’ equity in

the corporation is $10 million, profits as a percent of stockholders’ equity

will be 10 percent.

Return on Sales

Year after year, U.S. manufacturing firms average profits of about 5 percent

of sales. Many business owners with profits at this level or lower like to

say that they earn only about what people can earn on the interest from their

savings accounts. That sounds low, especially considering that the federal

government insures many savings accounts, so that most people with deposits

at a bank run no risk of losing their savings if the bank goes out of

business. And in fact, given the risks inherent in almost all businesses, few

stockholders would be satisfied with a return on their investment that was

this low.

Although it is true that on average, U.S. manufacturing firms only make about

a 5-percent return on sales, that figure has little to do with the risks

these businesses take. To see why, consider a specific example.

Most grocery stores earn a return on sales of only 1 to 2 percent, while some

other kinds of firms typically earn more than the 5-percent average profit on

sales. But selling more or less does not really increase what the owners of a

grocery store (or most other businesses) are risking. Each time a grocery

store sells $100 worth of canned spinach, it keeps about one or two dollars

as profit, and uses the rest of the money to put more cans of spinach on the

shelves for consumers to buy. At the end of the year, the grocery store may

have sold thousands of dollars worth of canned spinach, but it never really

risked those thousands of dollars. At any given time, it only risked what it

spent for the cans that were at the store. When some cans were sold, the

store bought new cans to put on the shelves, and it turned over its inventory

of canned spinach many times during the year.

But the total value of these sales at the end of the year says little or

nothing about the actual level of risk that the grocery store owners accepted

at any point during the year. And in fact, the grocery industry is a

relatively low-risk business, because people buy food in good times and bad.

Providing goods or services where production or consumer demand is more

variable—such as exploring for oil and uranium, or making movies and high

fashion clothing—is far riskier.

Return on Equity

What stockholders risk—the amount they stand to lose if a business incurs

losses and shuts down—is the money they have invested in the business, their

equity. These are the funds stockholders provide for the firm whenever it

offers a new issue of stock, or when the firm keeps some of the profits it

earns to use in the business as retained earnings, rather than paying those

profits out to stockholders as dividends.

Profits as a return on stockholders’ equity for U.S. corporations usually

average from 12 to 16 percent, for larger and smaller corporations alike.

That is more than people can earn on savings accounts, or on long-term

government and corporate bonds. That is not surprising, however, because

stockholders usually accept more risk by investing in companies than people

do when they put money in savings accounts or buy bonds. The higher average

yield for corporate profits is required to make up for the fact that there

are likely to be some years when returns are lower, or perhaps even some when

a company loses money.

At least part of any firm’s profits are required for it to continue to do

business. Business owners could put their funds into savings accounts and

earn a guaranteed level of return, or put them in government bonds that carry

hardly any risk of default. If a business does not earn a rate of return in a

particular market at least as high as a savings account or government bonds,

its owners will decide to get out of that market and use the resources

elsewhere—unless they expect higher levels of profits in the future.

Over time, high profits in some businesses or industries are a signal to

other producers to put more resources into those markets. Low profits, or

losses, are a signal to move resources out of a market into something that

provides a better return for the level of risk involved. That is a key part

of how markets work and respond to changing demand and supply conditions.

Markets worked exactly that way in the U.S. economy when people left the

blacksmith business to start making automobiles at the beginning of the 20th

century. They worked the same way at the end of the century, when many

companies stopped making typewriters and started making computers and

printers.

CAPITAL, SAVINGS, AND INVESTMENT

In the United States and in other market economies, financial firms and

markets channel savings into capital investments. Financial markets, and the

economy as a whole, work much better when the value of the dollar is stable,

experiencing neither rapid inflation nor deflation. In the United States, the

Federal Reserve System functions as the central banking institution. It has

the primary responsibility to keep the right amount of money circulating in

the economy.

Investments are one of the most important ways that economies are able to

grow over time. Investments allow businesses to purchase factories, machines,

and other capital goods, which in turn increase the production of goods and

services and thus the standard of living of those who live in the economy.

That is especially true when capital goods incorporate recently developed

technologies that allow new goods and services to be produced, or existing

goods and services to be produced more efficiently with fewer resources.

Investing in capital goods has a cost, however. For investment to take place,

some resources that could have been used to produce goods and services for

consumption today must be used, instead, to make the capital goods. People

must save and reduce their current consumption to allow this investment to

take place. In the U.S. economy, these are usually not the same people or

organizations that use those funds to buy capital goods. Banks and other

financial institutions in the economy play a key role by providing incentives

for some people to save, and then lend those funds to firms and other people

who are investing in capital goods.

Interest rates are the price someone pays to borrow money. Savings

institutions pay interest to people who deposit funds with the institution,

and borrowers pay interest on their loans. Like any other price in a market

economy, supply and demand determine the interest rate. The demand for money

depends on how much money people and organizations want to have to meet their

everyday expenses, how much they want to save to protect themselves against

times when their income may fall or their expenses may rise, and how much

they want to borrow to invest. The supply of money is largely controlled by a

nation’s central bank—which in the United States is the Federal Reserve

System. The Federal Reserve increases or decreases the money supply to try to

keep the right amount of money in the economy. Too much money leads to

inflation. Too little results in high interest rates that make it more

expensive to invest and may lead to a slowdown in the national economy, with

rising levels of unemployment.

Providing Funds for Investments in Capital

To take advantage of specialization and economies of scale, firms must build

large production facilities that can cost hundreds of millions of dollars.

The firms that build these plants raise some funds with new issues of stock,

as described above. But firms also borrow huge sums of money every year to

undertake these capital investments. When they do that, they compete with

government agencies that are borrowing money to finance construction projects

and other public spending programs, and with households that are borrowing

money to finance the purchase of housing, automobiles, and other goods and

services.

Savings play an important role in the lending process. For any of this

borrowing to take place, banks and other lenders must have funds to lend out.

They obtain these funds from people or organizations that are willing to

deposit money in accounts at the bank, including savings accounts. If

everyone spent all of the income they earned each year, there would be no

funds available for banks to lend out.

Among the three major sectors of the U.S. economy—households, businesses, and

government—only households are net savers. In other words, households save

more money than they borrow. Conversely, businesses and government are net

borrowers. A few businesses may save more than they invest in business

ventures. However, overall, businesses in the United States, like businesses

in virtually all countries, invest far more than they save. Many companies

borrow funds to finance their investments. And while some local and state

governments occasionally run budget surpluses, overall the government sector

is also a large net borrower in the U.S. economy. The government borrows

money by issuing various forms of bonds. Like corporate bonds, government

bonds are contractual obligations to repay what is borrowed, plus some

specified rate of interest, at a specified time.

Matching Borrowers and Lenders in Financial Markets

Households save money for several reasons: to provide a cushion against bad

times, as when wage earners or others in the household become sick, injured,

or disabled; to pay for large expenditures such as houses, cars, and

vacations; to set aside money for retirement; or to invest. Banks and other

financial institutions compete for households’ savings deposits by paying

interest to the savers. Then banks lend those funds out to borrowers at a

higher rate of interest than they pay to savers. The difference between the

interest rates charged to borrowers and paid to savers is the main way that

banks earn profits.

Of course banks must also be careful to lend the money to people and firms that

are creditworthy—meaning they will be able to repay the loans. The

creditworthiness of the borrower is one reason why some kinds of loans have

higher rates of interest than others do. Short-term loans made to people or

businesses with a long history of stable income and employment, and who have

assets that can be pledged as collateral that will become the bank’s property

if a loan is not repaid, will receive the lowest interest rates. For example,

well-established firms such as AT&T often pay what is called the bank’s

prime rate—the lowest available rate for business loans—when they borrow

money. New, start-up companies pay higher rates because there is a greater risk

they will default on the loan or even go out of business.

Other kinds of loans also have greater risks of default, so banks and other

lenders charge different rates of interest. Mortgage loans are backed by the

collateral of the property the loan was used to purchase. If someone does not

pay his or her mortgage, the bank has the right to sell the property that was

pledged as collateral and to collect the proceeds as payment for what it is

owed. That means the bank’s risks are lower, so interest rates on these loans

are typically lower, too. The money that is loaned to people who do not pay

off the balances on their credit cards every month represents a greater risk

to banks, because no collateral is provided. Because the bank does not hold

any title to the consumer’s property for these loans, it charges a higher

interest rate than it charges on mortgages. The higher rate allows the bank

to collect enough money overall so that it can cover its losses when some of

these riskier loans are not repaid.

If a bank makes too many loans that are not repaid, it will go out of

business. The effects of bank failures on depositors and the overall economy

can be very severe, especially if many banks fail at the same time and the

deposits are not insured. In the United States, the most famous example of

this kind of financial disaster occurred during the Great Depression of the

1930s, when a large number of banks failed. Many other businesses also closed

and many people lost both their jobs and savings.

Bank failures are fairly rare events in the U.S. economy. Banks do not want

to lose money or go out of business, and they try to avoid making loans to

individuals and businesses who will be unable to repay them. In addition, a

number of safeguards protect U.S. financial institutions and their customers

against failures. The Federal Deposit Insurance Corporation (FDIC) insures

most bank and savings and loan deposits up to $100,000. Government examiners

conduct regular inspections of banks and other financial institutions to try

to ensure that these firms are operating safely and responsibly.

U.S. Household Savings Rate

A broader issue for the U.S. economy at the end of the 20th century is the

low household savings rate in this country, compared to that of many other

industrialized nations. People who live in the United States save less of

their annual income than people who live in many other industrialized market

economies, including Japan, Germany, and Italy.

There is considerable debate about why the U.S. savings rate is low, and

several factors are often discussed. U.S. citizens may simply choose to enjoy

more of their income in the form of current consumption than people in

nations where living standards have historically been lower. But other

considerations may also be important. There are significant differences among

nations in how savings, dividends, investment income, housing expenditures,

and retirement programs are taxed and financed. These differences may lead to

different decisions about saving.

For example, many other nations do not tax interest on savings accounts as

much as they do other forms of income, and some countries do not tax at least

part of the income people earn on savings accounts at all. In the United

States, such favorable tax treatment does not apply to regular savings

accounts. The government does offer more limited advantages on special

retirement accounts, but such accounts have many restrictions on how much

people can deposit or withdraw before retirement without facing tax

penalties.

In addition, U.S. consumers can deduct from their taxes the interest they pay

on mortgages for the homes they live in. That encourages people to spend more

on housing than they otherwise would. As a result, some funds that would

otherwise be saved are, instead, put into housing.

Another factor that has a direct effect on the U.S. savings rate is the

Social Security system, the government program that provides some retirement

income to most older people. The money that workers pay into the Social

Security system does not go into individual savings accounts for those

workers. Instead, it is used to make Social Security payments to current

retirees. No savings are created under this system unless it happens that the

total amount being paid into the system is greater than the current payments

to retirees. Even when that has happened in the past, the federal government

often used the surplus to pay for some of its other expenditures. Individuals

are also likely to save less for their own retirement because they expect to

receive Social Security benefits when they retire.

The low U.S. savings rate has two significant consequences. First, with fewer

dollars available as savings to banks and other financial institutions,

interest rates are higher for both savers and borrowers than they would

otherwise be. That makes it more costly to finance investment in factories,

equipment, and other goods, which slows growth in national output and income

levels. Second, the higher U.S. interest rates attract funds from savers and

investors in other nations. As we will see below, such foreign investments

can have several effects on the U.S. economy.

Borrowing from Foreign Savers

The flow of funds from other nations enables U.S. firms to finance more

investments in capital goods, but it also creates concerns. For example, in

order for foreigners to invest in U.S. savings accounts and U.S. government

or corporate bonds, they must have dollars. As they demand dollars for these

investments, the price of the dollar in terms of other nations’ currencies

rises. When the price of the dollar is rising, people in other countries who

want to buy U.S. exports will have to pay more for them. That means they will

buy fewer goods and services produced in the United States, which will hurt

U.S. export industries. This happened in the early 1980s, when U.S. companies

such as Caterpillar, which makes large engines and industrial equipment, saw

the sales of their products to their international customers plummet. The

higher value of the dollar also makes it cheaper for U.S. citizens to import

products from other nations. Imports will rise, leading to a larger deficit

(or smaller surplus) in the U.S. balance of trade, the amount of exports

compared to imports.

Foreign investment has other effects on the U.S. economy. Eventually the

money borrowed must be repaid. How those repayments will affect the U.S.

economy will depend on how the borrowed money is invested. If the money

borrowed from foreign individuals and companies is put into capital projects

that increase levels of output and income in the United States, repayments

can be made without any decrease in U.S. living standards. Otherwise, U.S.

living standards will decline as goods and services are sent overseas to

repay the loans. The concern is that instead of using foreign funds for

additional investments in capital goods, today these funds are simply making

it possible for U.S. consumers and government agencies to spend more on

consumption goods and social services, which will not increase output and

living standards.

In the early history of the United States, many U.S. capital projects were

financed by people in Britain, France, and other nations that were then the

wealthiest countries in the world. These loans helped the fledgling U.S.

economy to grow and were paid off without lowering the U.S. standard of

living. It is not clear that current U.S. borrowing from foreign nations will

turn out as well and will be used to invest in capital projects, now that the

United States, with the largest and wealthiest economy in the world, faces a

low national savings rate.

MONEY AND FINANCIAL MARKETS

A Money and the Value of Money

Money is anything generally accepted as final payment for goods and services.

Throughout history many things have been used around the world as money,

including gold, silver, tobacco, cattle, and rare feathers or animal skins.

In the U.S. economy today, there are three basic forms of money: currency

(dollar bills), coins, and checks drawn on deposits at banks and other

financial firms that offer checking services. Most of the time, when

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