When Theory, Real World Collide
Times are hard for economists and the diminishing band of corporate leaders and public officials who endeavor to heed their advice and hearken to their prophecies.
At midyear, many forecasters foresaw a strong second half and a flourishing 1987. Some were even more euphoric. Yale’s William Nordhaus last April confided to the New York Times that the country was embarked on a historic boom, premised upon falling oil prices, the declining value of the dollar, Wall Street euphoria and the impact of Gramm-Rudman on the federal deficit.
Salomon Bros.’ celebrated pessimist, Henry Kaufman, foresees a continuing flow of foreign investment--particularly Japanese--substantial enough to finance the federal deficit, open foreign-owned factories and support securities and real estate markets.
Far be it from this confused practitioner of the baffling science to quarrel with these and other eminent practitioners, among them Alan Greenspan, former President Gerald R. Ford’s economic adviser, and Nancy Teeters, now vice president for economics at International Business Machines and recently a member of the Federal Reserve Board. But the optimism that they share seems at odd variance with the statistical indicators.
Unemployment, well into the fourth year of an unusually protracted expansion, refuses to decline for more than a month at a time below 7%, a figure that in the past was high enough to signal a recession and alarm Congress and the White House. Factory operating rates are low. Energy, farming and manufacturing are disaster areas. For large numbers of employees, real wages have been declining, even when men and women retain factory jobs. Those who have lost factory jobs in most cases now work at much lower wages in the service sector.
Inequality Continues to Grow
By almost any measure, inequality is growing. Between 1980 and 1984, the income share of the poorest one-fifth of Americans declined to 6.1% from 6.8%. The winners were in the top one-fifth--moving up to 38.9% from 27%.
If we define the middle class as the large group of people whose incomes fall below $18,900 (the Bureau of Labor Standards’ low budget standard for 1986) and $46,800 (the start of the agency’s high standard), it is a shrinking group. Since 1978, twice as many families have fallen below the $18,900 marker as have broken into the $46,800-plus quasi-plutocracy. Consumer debt creeps ominously upward as families struggle to maintain living standards.
The “wealth” created by the stock market boom can disappear even more quickly than it has been created, whenever--and for whatever reasons--speculative sentiment turns bearish. During the giddy ascent of the Dow Jones industrial average, Wall Street seemed to be fixated upon the excitement of mergers and the prospect of lower interest rates to the neglect of sagging productivity, indifferent corporate profits, the simmering international debt crisis and a foreign trade deficit unalleviated by nearly a year of currency readjustments. That few mergers improve profits or performance is a conveniently ignored bit of economic experience.
The last two weeks suggest that Wall Street sentiment has, at last, caught up with economic reality.
The theorists are at least as confused as their data. A few intransigent supply-siders still are heard in the land, occasionally in Business Week magazine and routinely in the Wall Street Journal. But the failure of the 1981 “supply-side” tax cuts either to spark a genuine investment boom or avert swelling federal deficits has turned the doctrine, always intellectually fragile, into an ideological curiosity.
Alas for the monetarists and their appealing vision of an economy uniquely responsive to changes to M1 (or some other money supply measure). The supply of money, however defined, has been growing far more rapidly than economic activity. Moreover, inflation has been declining, not rising according to monetarist doctrine.
One of monetarism’s truest believers, Council of Economic Advisers Chairman Beryl W. Sprinkel, concedes that “it’s a problem. Nobody knows where we are going.” After all, how can the influence of money upon other variables be evaluated if nobody knows how to define and measure money?
Loosening of Credit Spurred Rebound
Keynesians emerge from the doctrinal debacle in somewhat better repair than do the supply-siders and monetarists. One can plausibly explain continuing expansion in conventional fiscal and monetary terms.
The Federal Reserve’s loosening of credit and downward pressure upon interest rates in the late summer of 1982 started the country’s rebound from severe recession. The combination of major tax cuts and a defense procurement boom fueled consumer spending while producing large deficits. Freshmen students of economics might be encouraged by real-world illustration of the efficacy of Keynesian analysis of aggregate demand, if their instructor happens to be using Samuelson and Nordhaus or some other Keynesian text.
Prudent Keynesians should refrain from celebration. Nothing in their doctrine contemplates an expansion dependent upon a continuing flow of foreign investment. This late in a model Keynesian expansion, factory operating rates should be far higher and unemployment much lower than they are now. The federal budget should be in surplus, or at the very least in balance, instead of threatening again to rise as federal tax collections disappoint expectations.
Designed for a closed economy, Keynesian macroeconomics less and less adequately explains a world economy agitated by enormous capital flows, wide oscillations in oil and other commodity prices and pervasive political instability.
I am too old to change careers. But our world appears to be better understood by astute students of global politics than by the most powerful of econometric models and any single economic theory. Politicians who ignore economists may be wise in their generation.
