Thirty Years of Bad Economic Policy
How to undo thirty years of bad economic policy
Conventional wisdom in America today holds that high levels of taxes and government spending diminish America’s prosperity. The claim strikes a deep intuitive chord, not only among those on the Right, but also among many on today’s Left. Indeed, the antitax credo has become so obvious to so many over the past thirty years, and rolls off the tongues of policymakers from both parties with such fluency, that one would think evidence needn’t even be gathered to support it. “Closed case: tax cuts mean growth,” wrote former Tennessee Republican Sen. Fred Thompson, as if there could be no alternative argument.
Republican followers of Ronald Reagan remain the most ardent supporters of the anti-big-government idea. But many Democrats only partially disagree. To the conventional Democrat today, tax increases and increased government spending should be minimized or, better still, avoided. That is partly simple electoral calculation—holding any other position is considered politically self-destructive—but it has also become a matter of belief, as Democrats have revised their traditional views and made deficit reduction their primary government objective.
This ideological revision was accomplished over a decade ago. President Bill Clinton successfully raised taxes on better-off Americans in 1993, but with the express purpose of reducing the federal deficit, not developing new social programs. The Democratic Leadership Council (DLC), which Clinton helped found in the mid-1980s, continued to urge Democrats to tread lightly regarding tax increases and the new social programs that require them. The triumph of Republicans in the 1994 congressional elections reinforced the perception that American public opinion had turned against government, and in his State of the Union address of January 1996, Clinton proudly announced that “the era of big government is over.”
Strategically, the Republicans had won. Thus, even though Clinton had hundreds of billions of dollars of budget surpluses to bestow in the late 1990s, he left federal spending on transportation, education, and poverty programs below the levels reached (as a proportion of GDP) under his Republican predecessors, Bush and Reagan. And despite the reduction in growth of military spending made possible by the end of the cold war, Clinton generally resorted to tax credits for funding his social goals, whether providing help for the working poor or programs to expand health insurance, retirement savings, and an affordable college education. Such an approach fit neatly into the new conventional wisdom that bigger government was a danger to prosperity, reflecting the ascendant ideology of greater reliance on free markets. “Market incentives” became the new buzz phrase among middle-of-the-road Democratic economists. The approach also had the great virtue of not requiring a tax increase to support a social program. But in fact it was costly to government; tax revenues were lost.
Meanwhile, with Clinton’s encouragement, Wall Street hadn’t had such a friendly response from Democrats in anyone’s memory. The dominant new faith in markets motivated broad federal deregulation. Under George W. Bush, the laxity of federal oversight has taken an obvious toll—most notably in the credit crisis of 2008, but also in areas such as food and drug safety, airline traffic and safety, and tragically in the aftermath of Hurricane Katrina. Yet few Democrats acknowledge how much they themselves contributed to a weakened regulatory attitude in the United States. Jimmy Carter was a sincere believer in deregulation, and along with airline and trucking deregulation (which were arguably sensible), he gave financial deregulation a decided push. And under Clinton, much of the New Deal regulatory apparatus designed to restrain financial market excesses was formally and proudly eliminated.
And so centrist Democrats joined with Republicans to produce an ideological turning point, one that moved the nation to adopt an antigovernment faith. “We know government doesn’t have all the answers,” Clinton said in that 1996 State of the Union address. But had anyone ever suggested that government did have all the answers? By citing this straw man, Bill Clinton joined those who painted the government with a broad brush of ideological disapproval—and he brought the Democratic Party with him.
In assessing the triumph of antigovernment ideology over the past quarter-century it would be hard to overestimate the importance of the Nobel Prize-winning University of Chicago economist Milton Friedman. Friedman’s rise to prominence was remarkable. In the 1950s and ’60s, he was widely considered an extremist, albeit a well-schooled, intelligent, and articulate one. The frigid initial reception to his classic free-market book of 1962, Capitalism and Freedom, reflected the progressive attitudes of the Kennedy-Johnson years. But in later years Friedman pulled the entire mainstream profession unexpectedly in his direction. By the 1970s, his book had become a bestseller, and his anti-big-government apostasy had become gospel to many, exerting powerful influence over theorists and policymakers alike.
Looking back, Friedman wrote in the preface to the 2002 edition of Capitalism and Freedom that people’s experience with government expansion had convinced them his economic philosophy was right. In truth, what really boosted the conservative movement were not Friedman’s insights (which were simplistic), but the damaging hyperinflation of the 1970s—which he and others misleadingly attributed to government spending. The causes of inflation in the ’70s were far more complex than the growing money supply—the factor that Friedman emphasized, linking it to growing federal spending. Yes, rising government budget deficits can contribute to inflation, but other equally or more prominent causes in the ’70s included an eightfold hike in oil prices, bad crop supplies worldwide, a sudden downshift in productivity growth not anticipated by any economist, and a fall in the value of the dollar. As for the size of government, federal expenditures in the first half of the ’70s were only one percentage point higher as a proportion of GDP than in the first half of the ’60s—yet annual inflation rose rapidly in the early ’70s, while remaining low in the early ’60s. And what of the budget deficits that horrified Americans in the ’70s? Even in the worst years of the decade, deficits as a proportion of the economy were no larger than during the worst years of George W. Bush’s administration in the early 2000s, when inflation was mild.
In sum, Friedman offered little evidence that big government was the root of the problem. But his argument about the dangers of government proved politically effective, and by the late ’70s most of America was convinced. In 1980, Ronald Reagan, channeling Friedman’s ideas, campaigned by appealing to America’s nostalgia for an artificial laissez-faire past. This Reagan-Friedman mythology remains with us more than a quarter-century later. Running for the Republican presidential nomination in 2008, Mike Huckabee, former governor of Arkansas and an admirer of Reagan, put the myth simply: “The greatness of this country has never been in its government,” he said in a speech before the New Hampshire primary. “Any time the government gives something to us, they first have to take something from us.”
How did America become a nation that does not believe it can afford to do what it once did, let alone what has to be done today? How did the wealthiest nation in history come to believe it is not wealthy? The nation today remains shackled by a pessimism that it does not even acknowledge. This antigovernment, can’t-do attitude goes back to Ronald Reagan, who ironically promised a “new morning in America,” even as he ushered in the age of limits he accused Jimmy Carter of creating. With Reagan, slow wage growth and high unemployment became accepted, as pundits like Robert Samuelson of Newsweek told America that the fast wage growth of the 1950s and ’60s was a historical aberration. In fact, had the Reagan spirit of government distrust prevailed throughout American history, the free primary and high schools of America would probably not have been built, the highways would have remained an uncoordinated and inadequate maze, minorities would not have been as readily included in the economy, GIs would not have been subsidized to go to college, and on and on.
Free-market ideologues tell us all this would have occurred anyway—just more efficiently. But look what has happened to America over the past thirty-five years when their ideology has been ascendant. Today, America has no free and high-quality day care or pre-K institutions to support its two-worker families, and both work and family are undermined as a consequence. College has become far more expensive, and attendance is now bifurcated by class, with the privileged attending the elite colleges that garner the best jobs for their graduates. The nation’s transportation infrastructure is decaying and inadequately modernized to meet either energy-efficient standards or global competition. America has not responded to a new world of high energy costs and global warming. The nation’s health-care system is out of control, providing often inadequate quality care at very high prices. Its financial system, progressively deregulated since the ’70s, broke free of government oversight entirely in the past fifteen years, triggering rampant speculation that caused severe damage. And average incomes have remained nearly flat all along.
These facts amount to conclusive proof that the ideology of the past quarter-century has failed. And yet, under the influence of this ideology, many Americans still see government as an intrusive force, and remain unaware or deliberately forgetful of its many past accomplishments. If their lives feel pressured, it is because of social programs adopted by government, not government’s failure to act. Instead of demanding new institutions to cope with the rising two-worker family, Americans simply worked more. A life of family strain, inequality, and insecurity has become accepted as inevitable; indeed, it is even thought to be a strength of America. This was Reagan’s Trojan horse. Disguised as an ethic of personal responsibility that promised to make everyone better off, what he really sent in was a plan to reduce help to most Americans, while benefiting an increasingly privileged upper tier.
The absurd levels of remuneration on Wall Street are the leading example of a nation deluded by this ideology. These windfall sums are the result, we are told by some policymakers (and even serious scholars), of a natural process of the free market in a modern economy, and justified by the alleged contributions Wall Street professionals make to the economy. Incredibly, such pronouncements continue to pour forth despite a growing list of financial calamities: a savings-and-loan scandal that cost hundreds of billions of dollars; a stock market crash in 1987; an international financial debacle in 1997 and 1998; corporate scandals led by Enron in which employees lost life savings in the early 2000s; and a deep credit crisis due to insupportable prices for houses in 2007 and 2008—all undergirded by an extraordinary shift of the annual national income to the top 1 percent of earners.
Perhaps the current crisis will bring about serious change; as we go to press, the people are choosing a new president, and opinion surveys reflect a deep dissatisfaction with the economy. But the response may be too late and too little, with reforms that are poorly designed and administered. In truth, what we need is not merely this or that reform, but a different way of seeing the bigger picture: a reversal, a vision that helps us uproot the pessimism about government that was a cornerstone of the Reagan Revolution. For we now know the following: If federal, state, and local governments were to absorb 35 percent of GDP in America, rather than the current roughly 30 percent, the additional spending—if well-channeled—would not inhibit growth or undermine entrepreneurial spirit, productivity, or prosperity. Government absorbs much more in other nations whose prosperity is at least as robust as ours. In European nations, government spending absorbs about 40 percent of all spending, and standards of living are high. If government programs are managed well, they will on balance enhance productivity. A rise to 35 percent will raise approximately $700 billion a year to provide protections to workers, finance social programs, maintain an adequate regulatory presence, and raise significantly the level of investment in transportation, energy, education, and health care. And most if not all of this $700 billion can be paid for with higher taxes.
Even if we lower our sights to a more politically practicable additional 3 percent of GDP for new government programs, the nation would have more than $400 billion a year with which to work. Four hundred billion dollars a year could make Social Security entirely solvent, with no further reductions in benefits; provide universal pre-K education to America’s three-to-five-year-olds; and leave $50 or $60 billion to be shared with state and local government to improve education. Or we could set aside $30 to $50 billion a year to fully fund two years of tuition for all college students. Thirty billion dollars a year could also go a long way toward repairing and updating transportation infrastructure, making it far more energy-efficient. Indeed, some competent scientists argue that we could transform the nation from fossil fuel to solar energy for only a little more than that per year.
Over time, of course, the ideological pendulum swings, and what to many in America today look like pragmatic limitations on spending and on the proper role of government—or simply like responsible fiscal management—will very likely someday be seen for what they truly are: the reflection of a deep pessimism, a rise in power of vested interests seeking tax cuts and special benefits, and a tragic shirking of responsibility. Of course, boldness in government does not mean that the right choices will always be made. (The war in Iraq serves as a supreme and tragic reminder of government activism gone awry.) But in business we tolerate wrong choices—and a lot of waste—in order not to suppress the “animal spirits” of private enterprise. It is time to understand once again that we must encourage experimentation and boldness in government as well as in business. History emphatically tells us that the results can be constructive—and, more to the point, that unrestrained business is not enough to preserve prosperity and equal opportunity.
Growth itself, without a serious and all-encompassing response from government, will simply not guarantee a prosperous and free society. The evidence is all around us. Business, remarkable in many ways, has in significant measure become abusive of workers again. Meanwhile, social and public goods are neglected to the point of tragedy. But a fearful nation reads its history poorly. For a long time now we have been exhorted to look backward to minimal government, rather than forward to pragmatic change; and we have let ourselves be convinced that as a nation we are in financial straits, rather than rich and privileged. Writers alarm the public merely by telling it how large government is, when in reality a complex economy requires such a government in order to function. Modest policy change will not be adequate in the face of this willful misreading of history. What we require now is not the safety of the political center, but one of those remarkable political thrusts into unproven, risky, and even occasionally radical social territory that make America vital. Given where we are, the pendulum cannot swing back far enough or fast enough.
Copyright © 2009 by Princeton University Press. Printed by permission from The Case for Big Government by Jeff Madrick, to be published next month.