At the height of the 1990s economic boom—a period of unprecedented growth—capitalism American-style seemed triumphant. After sluggishness in the 1970s and 1980s, productivity in the United States had risen sharply, to levels that exceeded even those of the boom following World War II. Globalization was in full swing, and in ways that redounded distinctly to the good of this country. The North American Free Trade Agreement (NAFTA) and the so-called Uruguay Round of international trade negotiations promised to bring untold benefits to our economy. The flow of capital to emerging markets had multiplied sixfold in just over six years—a remarkable increase, driven by the search for ever higher returns. U.S. representatives at G-7 meetings and elsewhere boasted of our success, preaching to the sometimes envious economic leaders of other countries that if they would only imitate us, they, too, would enjoy such prosperity. Asians were told to abandon the model that had seemingly served them so well for two decades but was now seen to be faltering. Sweden and other adherents of the welfare state appeared to be abandoning their models as well. The U.S. model reigned supreme. There was even talk of a radical New Economy, in which incomes would soar and the very idea of a business cycle would be relegated to history.
There is no question that the nineties were good years. Jobs were created, technology prospered, inflation fell, poverty was reduced. I served in the Clinton Administration from 1993 to 1997, and all of us who were involved in U.S. economic policy during those years benefited from a happy confluence of events. We eagerly claimed what credit we could for the prosperity; the American people, wanting to believe that the economic good times were a matter not just of luck but, rather, of good management, willingly gave credit to those responsible for shaping economic policy, in the hope that under the continued stewardship of such policymakers this prosperity could be prolonged.
But the recession of 2001 showed that even the putative best of economic management could not insulate the economy from downturns, and that the business cycle was not dead. The bursting of the stock-market bubble showed that New Economy rhetoric contained more than a little hype. And the Enron, Arthur Andersen, Merrill Lynch, and Adelphia scandals presented another side of American capitalism. Now the economy is setting new kinds of records: WorldCom's is the largest bankruptcy in history; the fall in the stock market is the largest in decades. As the market has plunged, those who confidently ploughed their savings into stocks have found their retirement incomes in jeopardy.
It would be nice for us veterans of the Clinton Administration if we could simply blame mismanagement by President George W. Bush's economic team for this seemingly sudden turnaround in the economy, which coincided so closely with its taking charge. But although there has been mismanagement, and it has made matters worse, the economy was slipping into recession even before Bush took office, and the corporate scandals that are rocking America began much earlier.
The history of the 1990s needs to be rewritten. How are we to assess that decade in light of what we are seeing today?
For seven years, from 1993 to 2000, I was in a position to observe closely what was going on in Washington, first as a member of the Council of Economic Advisers, later as the chairman of that body (a Cabinet-level position), and then as the chief economist and senior vice-president of the World Bank, in the tumultuous years of the global financial crisis and the faltering transition of Russia and the other formerly Communist countries to a market economy.
I could see what effects individual players can and can't have on the behavior of the economy. We in the Clinton Administration took office at the right time. Some of what happened was the consequence of forces set in play well before: Investments in high technology finally began to pay off, leading to increased productivity. Income inequality declined, owing in part to a change in the "education premium" (the difference in income between those with and those without a college education), which in turn was due to ordinary market forces of supply and demand. Some Clinton policies—including increased support for Head Start, an effort to compensate for the disadvantages of some of America's poorest children—will make a difference in the future, but that difference won't show up in the data for years. Future administrations will be the beneficiaries of the wise policies instituted by the Clinton Administration.
Of course, even if the long-term productivity increases were partly attributable to longer-term forces predating the Clinton Administration, its policies were pivotal in the recovery (though for reasons that were quite different from those often cited by Administration officials). The Fed deserves credit for not spoiling the boom—and it had the potential to do so. The inflation-fearing Fed could have slammed the brakes on the economy too hard, by raising interest rates too high, bringing the boom to a premature end—as it had done several times in earlier decades. Chairman Alan Greenspan's good sense prevailed over the fears of the inflation hawks on the Fed's board, and for this Greenspan should be praised.
But at the same time, the groundwork for some of the problems we are now experiencing was being laid. Accounting standards slipped; deregulation was taken further than it should have been; and corporate greed was pandered to—though not to the extremes taken by the Bush Administration. The U.S. economy will pay the price for years to come. Many of the mistakes were debated during my time at the White House; it sometimes seemed that we were arguing mainly over the soul of the Democratic Party. But those debates were also about the future of the U.S. economy.
Any story of the economic boom of the nineties has to begin with the recession that preceded it, in 1991—a recession brought on in part by the long-overdue bursting of the 1980s real-estate bubble. This bubble was caused primarily by the tax giveaway of 1981 and by the poorly designed financial-sector deregulation carried out under Ronald Reagan. The infamous savings-and-loan debacle—in which the U.S. government had to bail out banks devastated by nonperforming real-estate loans—dearly cost not only the federal budget but also the economy. In its aftermath new banking regulations were put in place, and the flow of capital dried up—as did, in a slowly unfolding way, the economy itself. The Fed failed to recognize the underlying source of the problem. It lowered interest rates, but not quickly enough. The economy went into a recession that was described by many as short and shallow, but it didn't feel that way to those who lost their jobs. Indeed, a closer look at the data shows that the downturn was serious; as measured by the gap between the economy's potential and its actual performance, it was as bad as the average postwar downturn. Bill Clinton was to benefit from this and other economic miscalculations—in ways that go well beyond his election (which itself owed much to the faltering economy).
"In recent years economists have begun to question the previously unchallenged notion that the economy had a 'natural rate' of unemployment...."
When Clinton took office, according to the conventional wisdom, he became convinced that before committing substantial government spending to important social programs, he had to restart the economy—and to do that he had to reduce the federal budget deficit. As a result of Reagan's tax cuts and the increases in expenditures that both his Administration and Congress had pushed for, the deficit had soared to close to five percent of the gross domestic product. Though Clinton had to trim his own ambitions, he did the right thing and cut the deficit. Interest rates came down, and the recovery began.