The damage to Brand USA needs urgent repair The twin pillars of US policy - deregulation and spreading democracy - have had their day. New ideas must

Francis Fukuyuma in the London Times of Oct 14:

October 14, 2008
The damage to Brand USA needs urgent repair
The twin pillars of US policy - deregulation and spreading democracy - have had their day. New ideas must replace them
Francis Fukuyama

The implosion of America's investment banks... the vanishing of more than a trillion dollars in stock- market wealth in a day: the scale of the Wall Street crack-up could scarcely be more gargantuan. Yet even as Americans ask why they have to pay a mind-bending $700 billion to prevent the economy from imploding, few are discussing a potentially much greater cost to the United States - the damage to America's “brand”.

Two fundamentally American ideas have dominated global thinking since the early 1980s, when Ronald Reagan was President. The first was a vision of capitalism which argued that low taxes, light regulation and a pared-back government would be the engine for economic growth. The second was America as a promoter of liberal democracy around the world.

It's hard to fathom just how badly these features of the American brand have been discredited. Between 2002 and 2007, as the world was enjoying unprecedented growth, it was easy to ignore those who denounced the US economic model as “cowboy capitalism”, but now the American economy threatens to drag the rest of the world down with it. Under the mantra of less government, Washington has failed to regulate adequately the financial sector.

Democracy was tarnished even earlier. Once Saddam Hussein was proved not to have weapons of mass destruction, the Bush Administration sought to justify the Iraq war by linking it to a broader “freedom agenda”; suddenly promotion of democracy was a chief weapon in the war against terrorism.

Restoring the appeal of the brand is as great a challenge as stabilising the financial sector. And we cannot begin until we clearly understand what went wrong.

The Reagan-Thatcher revolution caused a huge amount of pain as industries shrank or shut down. But it also laid the groundwork for three decades of growth and the emergence of new sectors such as information technology and biotechnology.Like all transformative movements, however, the revolution lost its way because it became an unimpeachable ideology, not a pragmatic response to the excesses of the welfare state.

Two concepts were sacrosanct: that tax cuts would be self-financing, and financial markets self-regulating. Before the 1980s, conservatives were unwilling to spend more than they took in in taxes. But Reaganomics introduced the idea that virtually any tax cut would so stimulate growth that the government would take in more revenue in the end. In fact, the traditional view was correct: if you cut taxes without cutting spending, you end up with a damaging deficit - the Reagan tax cuts of the 1980s produced a big deficit; the Clinton tax increases of the 1990s a surplus.

The fact that the US economy grew just as fast in the Clinton years didn't shake conservative faith in tax cuts. And globalisation masked the flaws in this reasoning for several decades. Foreigners seemed endlessly willing to hold US dollars, allowing the US Government to run deficits and enjoy high growth. That's why early on Dick Cheney reportedly told President Bush that the lesson of the 1980s was that “deficits don't matter”.

The second article of faith - financial deregulation - was pushed by an unholy alliance of true believers and Wall Street. It produced the flood of innovative new products such as collateralised debt obligations at the core of the present crisis.

Financial institutions are based on trust, which can only flourish if governments ensure that they are transparent and constrained in the risks they take with other people's money. The sector is also different because the collapse of a financial institution harms not just its shareholders and employees, but a host of innocent bystanders as well.

Signs that the Reagan revolution had drifted dangerously have been clear over the past decade. An early warning was the Asian financial crisis of 1997-98. As Thailand and South Korea liberalised capital markets, hot money started flowing in, creating a speculative bubble, and then rushed out again at the first sign of trouble.

And China and other countries began buying dollars as part of a strategy to undervalue their currencies. This meant that the US could cut taxes, finance consumption, pay for two expensive wars and run a fiscal deficit. But the mounting deficits were clearly unsustainable; sooner or later foreigners would decide that America wasn't such a great place for their money. The falling dollar indicates that we are at that point. Clearly, deficits do matter.

All this suggests that the Reagan era should have ended some time ago. It didn't partly because the Democratic Party failed to be convincing but also because, in America, less-educated, working-class citizens can swing either left or right. This group of voters will decide next month's election. Will they tilt toward the more distant, Barack Obama, who more accurately reflects their economic interests? Or stick with people they can better identify with, John McCain and Sarah Palin? It took the economic crisis of 1929-31 to bring the Democrats to power. We may again have reached that point.

The other critical component of the American brand is democracy. The problem now is that by using democracy to justify the Iraq war, the Bush Administration suggested to many that “democracy” was a code word for military intervention and regime change. The American model has also been seriously tarnished by the Bush Administration's use of torture. After 9/11 Americans proved distressingly ready to give up constitutional protections for the sake of security. Guantanamo Bay and the hooded prisoner at Abu Ghraib have replaced the Statue of Liberty as symbols of America in the eyes of many non-Americans.

No matter who wins the presidency, a new cycle of American and world politics will have begun. Which candidate is better positioned to rebrand America? Mr Obama obviously carries less baggage from the recent past, while Mr McCain may be the only Republican who can bring his party, kicking and screaming, into a post-Reagan era. But one gets the sense that he hasn't fully made up his mind what kind of Republican he is, or what principles should define the new America.

American influence can and will be restored. The US has come back from serious setbacks in the 1930s and 1970s. Still, another comeback rests on some fundamental changes. It must break out of the Reagan-era straitjacket. Tax cuts feel good but do not necessarily stimulate growth or pay for themselves; Americans must be told honestly that they will have to pay their own way.

Of course, there's a danger of overcorrecting. Financial institutions need strong supervision, but it isn't clear that other sectors of the economy do. Free trade remains a powerful motor for economic growth. If tax cutting is not a path to automatic prosperity, neither is unconstrained social spending. The cost of the bailouts and the long-term weakness of the dollar make inflation a serious threat.

The biggest change that America must make is in its politics. The Reagan revolution broke the 50-year dominance of liberals and Democrats in US politics but what were once fresh ideas have hardened into dogmas. The ultimate test for the US model will be its capacity to reinvent itself. Good branding is not a matter of putting lipstick on a pig. It's about having the right product to sell in the first place. American democracy has its work cut out.

Francis Fukuyama is professor of international political economy at the Johns Hopkins School of Advanced International Studies. A longer version of this article appeared in Newsweek