Presidential Economics: Different Drummers but the Same Sorry Tune

Listening to the rhetoric of various presidential aspirants in recent weeks has led me into a kind of retrospective on Reaganomics. Seven years ago, we ushered in a brand new Reagan Administration, full of vigor and new ideas. The Carter Administration had been pretty thoroughly discredited in its waning months and we could hardly wait for the change.

Supply-side economics was to have its day in the sun; the dawn of Reaganomics was at hand. An economic strategy was shaping up that promised to be more bold and dramatic than anything since the Kennedy/Johnson Administration and its New Economics of the early 1960s.

Here we are again, seven years later, at the approaching Gotterdammerung of this Administration and things don’t look much different than they did in 1980 (or in 1968, for that matter). The Reagan Administration is also looking a bit worn and frazzled, and it, too, is scandal-plagued and under increasing attack on several fronts. (Iran seems to have replaced Vietnam as the latter-day “gotcha” for presidents.)

Supply-side economics is looking a bit dated and we seem increasingly impatient to get on with whatever changes may lie ahead. Perpetual presidential campaigns tend to grate on one’s nerves after awhile. But before we’re swept up with “new” economic ideas for the ‘90s (actually, the problem seems to be a lack of new ideas), it might be instructive to compare the premises with the product of these two ambitious economic campaigns: the New Economics of the ‘60s and the Reaganomics of the ‘80s. In doing so, I find that there’s really nothing new under the sun. It’s mostly a matter of packaging, labels and emphasis and, in both cases, there was a good deal of wishful thinking involved, to put it mildly.

The New Economics of the ‘60s was based on the concept of full employment, later relabeled “high employment” because the word “full” had a limiting sound to it. Essentially, it was felt at the time that we could spend ourselves into budget balance; i.e., the more the government spent, the faster the economy would grow, producing such large gains in tax revenues to more than offset the spending and eventually produce a budget surplus as we approached full employment.

In short, the idea was to boldly increase spending (and cut taxes) and assume that revenues would grow to cover it because there were unused resources on the demand side of the economy. This argument, of course, applied only when the economy was operating below full employment. Trying to increase demand beyond that would result only in higher wage and price inflation. At the time, there was general agreement that we could reduce the unemployment rate to 4%, maybe less, before the economy would start to run into that kind of trouble. The theoretical underpinning for this trade-off between unemployment and inflation was popularly known as the Phillips Curve.

In contrast, the original notion of Reaganomics was to cut revenues, especially income taxes, rather than try to cut spending because, first, you couldn’t spend what you didn’t have (wanna bet?) and, second, because there were unused resources on the supply side of the economy that would be called forth by a reduction in the tax burden. These resources would be put to work, through higher saving and private investment, to generate faster economic growth and rising federal revenues that would tend to offset the revenues lost through tax reduction.

Optimal Taxation

In other words, instead of assuming that growth induced by spending would balance the budget (the old approach), Reaganomics assumed that growth induced by tax cuts would balance the budget. The trade-off between federal tax cuts and economic growth was drawn from what came to be known as the Laffer Curve of optimal taxation.

Unfortunately, the correct identification of where on the Laffer Curve (the “in” curve of the early ‘80s) counterproductive tax rates begin proved about as elusive as trying to identify where on the Phillips Curve (the “in” curve of the early ‘60s) was true full employment.

Right to Be Nervous

In retrospect, it would appear that in both cases we were playing a bit of a shell game except that our attention was switched back and forth from the spending side to the revenue side of the budget. Neither approach worked quite the way it was supposed to.

Yes, we did get some benefits from both but the promised result of lower budget deficits proved to be a chimera. Here we sit with the worst budget calculus in peacetime history--at what may be the peak of a business cycle! The world has a right to be nervous. This Administration’s fiscal policy ran aground on the same shoals that bedeviled its predecessors: It could not stem the expansion of federal spending.

Spending is the problem, everyone agrees. But no one on either side of the aisle has been able to figure out a solution that does not somehow involve yet more spending.

Beyond that, the big question in my mind after seven years of supply-side economics is, what happened to all that saving that was supposed to gush forth once tax rates were sufficiently reduced? The facts are that the nominal dollar volume of personal saving has shrunk to the point where it’s no higher than it was 10 years ago! This despite the fact that nominal GNP is 14 times larger.

Business saving continues to rise, albeit recently at a snail’s pace. When this is combined with large federal government deficits, we find that the volume of total gross saving in the U.S. economy has been virtually stagnant throughout the years of the Reagan Administration.

Propensity to Import

As a direct or indirect consequence of the ongoing fiscal rupture, foreign capital inflows have been required to offset the lack of domestic saving to finance continued economic and employment growth, growth that has been the envy of the world. Unfortunately, that growth has carried with it a high propensity to import other countries’ products.

The continued lack of a solution to the internal saving deficiency, accompanied by the bulging trade and current account deficits, finally combined to bring down the U.S. dollar. The dollar, on a trade-weighted basis, has now dropped back to where it was when the Reagan Administration began seven years ago.

In the meantime, the ratio of debt to gross national product in this country has reached levels not seen since the early 1930s. And almost every sector--consumers, business and government--has contributed to this result.

To say that we have stretched to maintain our living standards is an understatement. As a result, options to change the course of destiny are few and far between. Fiscal policy is trapped in gridlock and monetary policy is limited by global monetary conditions.

If we add to this the very real prospect of economic volatility, even recession, in an election year, there could very well be a public reaction against laissez-faire government policies and a demand for more government involvement in all kinds of things. In other words, we may have passed the inflection point of what, by comparison, might be called relatively “cheap” government.

At the moment, these prospects are only a possibility, not a probability. But the nature of the political issues and the intensity with which they will be pursued depend heavily on what happens to the economy and the financial markets between now and November. And, at this juncture, that is anybody’s guess.