J U L Y 1 9 9 6
precedence over every other economic consideration
has captured the minds of President Bill Clinton and
his advisers. In this essay a former economic policymaker
takes a critical look at the economic logic and portentous
history behind a new orthodoxy he regards as dangerous
by Robert A. Levine
N 1925, a decade before his General Theory of Employment, Interest, and Money revolutionized thinking about economic policy, John Maynard Keynes wrote an essay titled "The Economic Consequences of Mr. Churchill." He took the then Chancellor of the Exchequer to task for having brought the pound back to the gold standard too soon after the First World War and at too high a value. Keynes predicted dire economic consequences. He was right. The British economy stagnated, resulting in years of unemployment above 10 percent even before the Great Depression. Because Britain was still central to world trade, its deflation spread deflation around the globe.
Seventy years later the world economy, now led by the United States, is on a dangerously parallel path. In the 1990s received economic wisdom has substituted for the gold standard deficit reduction as the central instrument, with zero inflation as the central goal, of economic policy.
The effects are disturbingly similar to those of the orthodoxy of the 1920s before Keynes's General Theory suggested that deliberate government deficits could be used to stimulate employment. In recent years the richest nations in the world have suffered increasing unemployment (and in the United States increasing inequality) and social unease even in good times, with worse to come when the cycle turns down.
Keynes contended that Churchill had erred because "lacking . . . instinctive judgement, he was deafened by the clamorous voices of conventional finance; and, most of all, because he was gravely misled by his experts." The same is true of Bill Clinton. In his first few months as President he surrendered the traditional liberal Democratic stress on expanding demand, leaving conventional finance in possession of the field. This not only weakened the government's ability to increase the demand for labor but also made impossible more than nominal investment in programs to improve the adaptability of job seekers to available jobs. One major reason for the President's defection was that his own experts in the ranks of academic economists and in his Administration had turned to pre-General Theory orthodoxy. Therein lies an important part of the tale that climaxed but did not end in the 1994 Republican congressional victory and the great budget battle of 1995-1996. A high point was the President's acceptance, in mid-July of last year, of the Republican goal of a balanced budget in seven years. By then the only real issue that remained was the rate of federal withdrawal from support of the economy and of those left behind by prosperity.
With balance as the sole criterion for budgeting, and zero inflation as the sole objective, what used to be called full employment has been forgotten, even though the Humphrey-Hawkins Act of 1978 still mandates it as a central national goal. The problem is one of long-term change, not recession. Even the low unemployment rates of the good times of the 1980s and 1990s almost match the highs of the 1950s and 1960s. Unemployment of six to seven percent was severe recession then; now when unemployment dips below six percent, storm warnings go up: too low an unemployment rate might be inflationary.
At the same time, inequality of earnings and income has been increasing among wage and salary earners and among American families. The rich have been getting much richer, the poor significantly poorer. And the future looks bleak to the insecure middle class, whose fearful members are tempted to blame their ills on those who are worse off than they are. Economic stimulus is not the cure for all these problems, but lacking stronger economic growth than we have had, no remedy is possible.
When the business cycle turns down again, and unemployment rises from its
already high lows, the political and social effects may go beyond grumbling and
petty meanness to expanding extremism in many areas of American life.
When the collapse of oil prices in the early 1980s made possible a return to both lower unemployment and lower inflation, the Reagan Administration tried "supply-side" economics. The resulting deficits were so huge that the Federal Reserve had to raise already high interest rates to unprecedented levels to avoid overstimulation of the economy. Supply-siders had contended that cutting tax rates would raise tax revenues, but David Stockman Reagan's budget director, knew better. He later admitted that he had deliberately used the deficits to paralyze government social spending and "dismantle" federal programs put in place since 1933.
Stockman's scheme worked. The Democratic economists of the Clinton Administration contend that although the deficits are not the fault of the Democrats, their huge presence must nonetheless dominate the Administration's fiscal policies.
Their line of argument:
Economists never have arrived at a satisfactory theory for weighting the various factors that affect investment. The cost of borrowable funds is certainly one of them, but only one. Taxation may also have important effects on investment incentives: if the returns from investment are increased by tax reduction, investment will increase. That is the central point of supply-side economics. It is a good point in the abstract, but the relative weight of the tax effect remains open to debate.
Perhaps the most important determinant of investment, however (so most economists of the 1950s and 1960s held), is the demand for products produced by new plant and equipment. If, for example, demand for automobiles is expected to increase, Ford or Honda may invest in a new plant. Whether Honda will do it in Honshu or in Ohio is a question that suggests that economic policies must increasingly be considered on the international level. Regardless, market demand remains a crucial factor in determining investment. And fiscal policy contributes directly to market demand. If the economy is operating at less than full employment, then increased government spending or tax reduction or both can increase demand for goods and services and consequently increase investment in capital goods to make products to supply the demand.
Which economic policies will best increase productivity and growth thus remains
an issue much more open than is suggested by current orthodoxy. President
Clinton, Senator Bob Dole, Federal Reserve Chairman Alan Greenspan and
Vice-Chairman Alice Rivlin, point in one direction: balance the budget to
reduce competition for investable funds. Some very respectable economists but
few politicians, in the United States or elsewhere, point the other way:
increase investment by increasing demand.
The popular analogy is to a spendthrift family borrowing to live beyond its means. That analogy is dubious, for three reasons.
First, even thrifty families borrow for long-term purposes, many of which -- their children's education, for example -- may be expected to increase future income. A substantial part of federal spending is similar: it is investment to increase future national income. Indeed, more than half of the states' constitutions require balanced operating budgets, but they separate out capital budgets to allow borrowing for long-term investment projects.
Second, some government functions fall outside the family metaphor: if federal deficits can have major effects on employment and other crucial economic indicators, then national requirements for growth and stability may supersede the simple morality of balancing income and outgo.
Third, few families go broke because family members are borrowing from one another. Most federal borrowing is from citizens or institutions that are part of the American family; less than a quarter of our national debt is owned by foreigners. For that reason, although deficits burden our children with debt, debt also provides a good many of our children with such assets as government bonds, representing the ownership of that debt. The national debt is now about two thirds of the GDP. At the end of the Second World War it was greater than the GDP, but postwar prosperity worked the ratio down. What threatens our children now is not the debt, most of which they will owe to themselves. Rather, it is economic policy aimed at achieving slow growth at best, which will severely constrain their chances of finding good jobs.
Even if the analogy between federal and family budgets is a poor one, however,
controlling spending is a valid and politically compelling goal. Advocates of
fiscal stimulus need to dissociate themselves from any idea that all spending
is good. Any proposed program that questions the current exclusive emphasis on
budget balancing must equally insist on close examination of each government
expenditure. That should include porky public works, entitlements, both
individual and corporate welfare, and "tax expenditures" -- loopholes in personal
and corporate taxes that, for bad reasons or good (for example, low-income
housing), attempt to achieve the same purposes as appropriated expenditures.
The current budget battle shows how difficult it is to do this in the face of
entrenched interests. Both the Administration and the congressional Republicans
have made brazen exceptions for special interests, even as they exchange
rhetoric over budget-balancing purity.
In the American political dialogue, going beyond the parroted slogans of a balanced budget is unlikely until the November election. It may also be unlikely afterward, no matter what the outcome of the election. If so, the United States can probably continue on the current economic course, at least for a while. Yes, inequality will increase and insecurity grow. But the economy will also grow, and if the rising tide is no longer lifting all boats, not many are being left in the mud.
Sooner or later the tide will go out. The real and deep danger is that if the economic cycle turns toward sharp recession, and if balanced-budget deficit-bashing remains the order of the day, either by constitutional amendment or by rigid budgetary enactment, then we could be back in 1932.
History tested then-prevalent economic theories in the 1920s and 1930s, and
those theories failed their tests. The economic imbalances and orthodoxies of
the 1920s led to the Great Depression, and that in turn opened the door to
Nazism and to war. Economic theorists and, more important, economic
decision-makers ignore such experience at great peril to the world.
Copyright © 1996 by The Atlantic Monthly Company. All rights reserved.
The Atlantic Monthly; July 1996; The Economic Consequences of Mr. Clinton; Volume 278, No. 1; pages 60-65.