Huge Deficits, Weak Dollar Will Restrict Next President’s Options : Reaganomics’ Effects Likely to Be Felt for Years

Is the curtain about to fall on Reaganomics? Or will the conservative economic policies of the Reagan era be called back for an encore?

As President Reagan delivered his final State of the Union speech Monday night, that was the central domestic question facing the nation. Yet Reagan’s partisans and detractors agree that, no matter who is elected in November to succeed him, his economic legacy will remain a powerful off-stage force for years to come.

“For better and worse, the nation is on a different course than it was when Reagan took office,” said Urban Institute economist John Palmer, who has helped lead a long-term study of Reagan’s domestic policies. “What’s happened is that we’ve traded one set of problems for another.”

Strikingly Different Economy

The still-robust economy Reagan is likely to bequeath to his successor is strikingly different from the disenchanted, inflation-racked nation he inherited from former President Jimmy Carter.

After a painful 1981-1982 recession induced by Federal Reserve Chairman Paul A. Volcker to crack spiraling double-digit inflation, the economy has plowed ahead through more than five years of uninterrupted growth with only slowly rising prices.

“Our record is not just the longest peacetime expansion in history,” Reagan said in his State of the Union speech Monday night, “but an economic and social revolution of hope based on work, incentives, growth and opportunity.”

The benefits of the nation’s long economic recovery, however, have not been spread evenly. America’s heartland--where the costs of restoring reasonable price stability fell hardest on basic manufacturing workers, the oil industry and farmers--is only now beginning to emerge in better shape from the long devastation it suffered through the first half of the decade.

Poor Left Further Behind

And, although the highly educated have prospered from the economy’s continuing structural shift in emphasis from brawn to brains, many of the poor and unskilled have been left even further behind.

Indeed, Reagan never came close to delivering on the cost-free prosperity he promised at the start of his Administration. But many voters may not have noticed, because only a fraction of the American public had to bear most of the burden.

Moreover, despite the record peacetime expansion, the unprecedented accumulation of debts and other obligations to foreigners raises doubts about how long the United States can continue to borrow from abroad at acceptable interest rates to pay for the nation’s past spending spree.

“We now know what supply-side economics was all about,” C. Fred Bergsten, director of the Institute for International Economics and a former Treasury official in the Carter Administration, is fond of quipping. “The United States threw a party and the foreigners supplied the funds.”

It isn’t quite that simple, as Bergsten and other analysts acknowledge. The U.S. economy is already undergoing a profound shift--financed in part by foreign investment--from over-reliance on consumer spending to a much greater dependence on sales overseas and capital investment at home.

In his State of the Union address, Reagan proposed to sustain the shift by resisting trade protectionism. “A creative, competitive America is the answer to a changing world, not trade wars that would close doors, create greater barriers and destroy millions of jobs,” he said.

Economic Excesses

But no matter how successfully the transition to a more balanced world economy is managed, the Administration’s supporters and its critics alike acknowledge that the difficulties of overcoming the economic excesses of the Reagan era will dramatically restrict the next President’s policy choices.

“The Achilles heel of Reagan economic policy has continued to be the budget deficit,” said Lawrence Kudlow, a former Reagan Administration economist who is now chief economist at the New York investment firm of Bear Stearns & Co. “That remains the unsolved agenda item of the 1990s--no matter who is elected this year.”

Reagan remains reluctant to acknowledge his central role--by promoting an alliance of mammoth tax cuts, sharp increases in military spending and tight money to contain inflation--that allowed the federal debt to more than double to $2.3 trillion under his Administration.

“A few of us can remember when, not too many years ago, those who created the deficits said they would make us prosperous and not to worry about the debt,” Reagan said in his speech Monday evening, after seven years of pushing deficit spending far beyond boundaries his predecessors never dared to cross. “Well, at last there is agreement we can’t spend ourselves rich.”

Attracting Foreign Capital

Under Reagan, the clash between the White House’s loose fiscal policy and the Fed’s tight monetary policy helped propel the U.S. dollar sharply higher through early 1985, enabling the United States for a long while to attract capital from abroad to finance both federal borrowing and private spending.

But, with the dollar now back to post-World War II lows against many other major currencies, the next Administration no longer will have the luxury of avoiding difficult choices between higher taxes and lower government spending to free up resources to be devoted to greater savings and investment.

“The next President will be preoccupied with picking up the pieces Reagan left behind,” the Urban Institute’s Palmer said. “Even with a two-term Administration, I don’t expect anyone will have much fiscal flexibility to undertake major federal initiatives.”

Those constraints on government spending may be one of Reagan’s most lasting legacies, but it still seems doubtful--despite allegations by Sen. Daniel Patrick Moynihan (D-N. Y.)--that the White House purposely created such large budget deficits.

Perhaps even more important for the future was Reagan’s ability to marshal both liberal and conservative political forces to sharply cut maximum income tax rates by half, from 70% in 1981 down to 33% today. Equally important, Congress has indexed the tax code to inflation, assuring that inflation-driven wage increases do not drive taxpayers into higher brackets and provide a windfall to the U.S. Treasury.

Casting Long Shadow

These changes, part of a broad shift in many nations away from government intervention in the economy and toward greater reliance on free-market capitalism, are the key reasons that Reagan is likely to cast a long shadow over the next Administration and beyond.

To Jerry Jordan, that is all to the good. Jordan, chief economist at First Interstate Bank in Los Angeles, said that, when he and William Niskanen served as economic advisers to Reagan in his first term, Niskanen “used to say our biggest challenge was to avoid playing Eisenhower to the next Camelot. Despite all the difficulties and setbacks, I think much of the Reagan revolution has been institutionalized.”

The reasons have as much to do with shifts in the public mood as they do with Reagan’s accomplishments, Jordan acknowledges.

“The revolution made Reagan possible, not the other way around,” he said. “It’s the perfect example of ‘If he hadn’t existed, someone would have had to invent him.’ And that’s why much of it will remain. Because Reagan was carried forward by a broader tide toward private initiative and free enterprise that still remains a powerful force in the world today.”