The economic program of the Reagan administration, like that of the Thatcher government in Britain, manifests a conservative counterrevolution in the theory, ideology, and practice of economic policy. The aim of the counter-revolution is to shrink the economic influence of government, especially central government, relative to that of private enterprise and free markets. Three kinds of policies are at stake, concerning respectively (1) macroeconomic stabilization—the use of fiscal, monetary, and other policies affecting national production, employment, prices, and other variables of economy-wide significance; (2) economic inequality—the use of the public fisc to redistribute income and wealth; (3) resource allocation—national priorities among various public and private goods; (4) regulation of economic activities and markets. I shall speak principally about the first two categories.
I have referred to a counterrevolution, so I should remind you of the revolution to which it is the counter. That took place some thirty-five to forty-five years ago, just before and after the Second World War, in this country and in other Western capitalist democracies. Radical changes occurred in the practice of economic policy and in the theory of political economy. Live memory of the Great Depression created a broad consensus that the state must assume responsibility for maintaining prosperity, as well as for protecting individual citizens against the inevitable insecurities of life in a market economy. The New Deal in the United States and social democratic movements in Europe were the agencies of these changes. They also expanded government investment in schools, housing, transportation, and other public goods, and augmented the market power of workers, trade unions, and farmers vis-à-vis business. Over three postwar decades these changes were largely accepted by all mainstream political parties and extended by governments of various political colors. Though rumblings of discontent have been heard in increasing volume over the past fifteen years, only recently have the counterrevolutionaries gained political power.
I shall confine myself mainly to the United States and the first two issues on the agenda of the revolution and counterrevolution—macroeconomic stabilization, and redistribution of income and wealth. Two acts of Congress symbolize the revolution. The Employment Act of 1946 dedicated federal power to the achievement of “maximum employment, production, and purchasing power.” Ten years earlier, under the Social Security Act, the federal government recognized an obligation to protect individual citizens from personal economic misfortunes—workers without jobs, aged without funds, children without fathers. The New Deal had already put the federal government in the business of welfare and work relief, insurance of bank deposits and mortgages, and other “safety nets.” By 1947, then, the federal government had assumed responsibilities both to maintain general prosperity and to insure and indemnify the worst individual casualties of depression and economic change.
These really were new responsibilities. Fiscal and monetary policies were not significantly dedicated to macroeconomic stabilization before the late 1930s. In 1929-1934 both Hoover and Roosevelt raised taxes and sought vainly to balance the federal budget; they were worried about the Depression’s effect on the budget, not the budget’s impact on the economy. Throughout the precipitous decline of 1929-1932 monetary policy gave second priority to the American economy, and primary emphasis to defending US gold reserves and the gold value of the dollar—until the disasters of the winter of 1932-1933 forced Roosevelt to suspend gold convertibility and devalue the dollar. As for relief of the victims of the Depression, Hoover—a Quaker who had earned worldwide fame as a humanitarian in directing relief efforts in devastated parts of Europe after the First World War—regarded it in principle as the responsibility of private charity and local government, not the federal treasury. Roosevelt, fortunately, was a pragmatist.
Similar redefinitions of the economic responsibilities of central government occurred in other advanced democracies in the 1930s and 1940s. In Britain two wartime reports by Lord Beveridge, one on social insurance and one on full employment, set the stage for postwar macroeconomic strategy and “welfare state” legislation.
To these political developments there were important intellectual counterparts and foundations. A revolution in macroeconomics and in the theory of monetary and fiscal policy began with J.M. Keynes’s General Theory of Employment, Interest, and Money in 1936 and spread through the English-speaking world and after the war to continental Europe and Japan. This provided the rationale for the full-employment commitments of the several countries, along with guidance on how to implement them. The business cycle was no longer to be seen, as both orthodox and Marxist economists saw it, as an inevitable and functional characteristic of capitalism. According to Keynesian theory, economy-wide fluctuations in economic activity are wasteful; they can be avoided by active fiscal and monetary intervention, socalled stabilization policies.
Keynesian macroeconomics does not logically lead to any position for or against welfare-state measures. But, again in contrast to both right and left, it certainly does not say that redistribution of income and wealth by taxation and transfer is fatal to capitalism, or even damaging. In Keynes’s personal view, “The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes.” He was confident that both flaws could be corrected without sacrificing the efficiency and progressiveness of market capitalism, for which he had the same respect as his classical forebears and colleagues. Twenty years later Paul Samuelson, the principal architect of the synthesis of Keynesian and neoclassical theories that became the orthodox main current of American economics, expressed this optimistic view very clearly:
A community can have full employment, can at the same time have the rate of capital formation it wants, and can accomplish all this compatibly with the degree of income-redistributing taxation it ethically desires.
Keynes and Samuelson are saying, in other words, that an amalgam of capitalism and social democracy is both workable and robust. In contrast, both extreme right and extreme left argue that capitalism cannot afford or survive egalitarian policies.
The postwar era, especially its first twenty-five years, appeared to justify the optimism of Keynes and Samuelson. In no other period of similar length have productivity per worker and living standards grown so fast, or aggregate production and employment advanced so steadily, or world trade expanded so greatly. The last ten years have been disappointing compared to the 1950s and 1960s. But we should not lose perspective.
The main source of disappointment and disillusionment with the revolution was the stagflation of the 1970s—the combination of high inflation and high unemployment. Even during the era of their apparent success, Keynesian policies for full employment and countercyclical stabilization aroused chronic anxieties about inflation. Indeed the principal advocates themselves, beginning in the 1940s, warned that full employment, removing the wage discipline exerted by unemployment and the threat of layoffs, might not be compatible with price stability. Some of them foresaw the need for direct restraints on wages and prices to reconcile the two goals. The economy would have a “secular” or long-term bias toward inflation, they observed, if wages and prices rose freely in expanding industries, and during economy-wide booms, but fell slowly if at all in declining sectors and during short recessions.
Moreover, inflationary bias was exacerbated by social welfare legislation, extended and expanded as it was by postwar administrations and Congresses of both parties, most dramatically beginning with the Great Society programs of the late 1960s. Social insurance dulls to some degree the incentive to seek and accept employment, especially the less remunerative or attractive jobs.
Probably more important were developments that fall under the fourth of my initial classifications. The Rooseveltian political coalition opened old-fashioned interest-group politics to large groups that previously had been excluded. Like all governments, our federal government has always catered ad hoc to private business interests with political clout, as our history of tariffs, “internal improvements,” land grants, bank charters, and subsidies amply ilustrates. Beginning in the 1930s trade unions gained federal protection for organizing and bargaining. Wages, hours, and conditions of work became subject to federal standards. Farmers were not only subsidized but organized into federally administered cartels. The promotion of monopolistic powers for unions of workers and farmers was justified by J. K. Galbraith and others as “countervailing” the monopolistic powers of big business, to the benefit of the society as a whole.
This dubious proposition was never congenial to liberal Keynesians devoted principally to full employment and diminished inequality. In any event, these countervailing powers increased inflationary bias. Workers, unionized or not, had more power to gain wage increases in booms but resist cuts in downturns. Agricultural price supports diminished the downward trends and cyclical declines of food and materials prices that contributed so much to price stability in the 1920s and earlier.
Nevertheless, the inflation record of the United States was very good until the late 1960s. That deficit financing of the Vietnam War then overheated an economy already operating at capacity was no surprise to any economist, Keynesian, monetarist, or classical. That inflation accelerated during the 1970s, in spite of monetary policies that triggered three recessions, in spite of unemployment higher than in the two previous decades, is the great disappointment to theory and policy that set the stage for the counterrevolution. Many observers would explain the stagflation by the series of external shocks, unprecedented in their severity, that hammered the world economy during the 1970s: the depreciation of the dollar after Nixon proclaimed it inconvertible into gold in 1971, the worldwide commodity shortages and speculative booms in 1973, the two big OPEC shocks, 1973-1974 and 1979. Others blame over-stimulative monetary and fiscal policies in 1972-1973 and 1977-78. The controversy is far from being resolved, but the Reagan administration is sure of its diagnosis: the disappointments of the 1970s were the inevitable outcome of mistaken policies followed throughout the postwar decades.
To the revolution that took place some thirty-five to forty-five years ago, Reaganomics is, like Thatcherism in the UK, the political and ideological counterrevolution. Just as Keynesian theory inspired the revolution, so a wave of professional reaction to the synthesis of Keynesian and neoclassical doctrines that became orthodoxy in the 1960s sustains the counterrevolution. In both instances, of course, there are many divergences among economic theory, popular ideology, and actual policy. Nonetheless, in both cases, a common tide of opinion floods academic journals, popular media, political rhetoric, Congress or Parliament, and the guiding philosophies of president or prime minister. Rightly or wrongly, the revolution is blamed for the “stagflationary” disappointments of the 1970s, the high rates of unemployment, inflation, and interest, the depressed stock market, the slowdowns of productivity growth and capital formation. The old doctrines and policies, new forty years ago, are discredited, replaced by new doctrines and policies, old forty years ago.
Respecting stabilization, the new doctrine is that active fiscal and monetary intervention—characterized or caricatured as “fine-tuning”—is the problem, not the solution. The government should forswear countercyclical policies and let the market economy stabilize itself, as it will, given confidence that government policies will be stable. Thus the central bank should tie itself, or be tied to, a fixed-rate rule of monetary growth, independent of the state of the economy. Likewise federal tax and expenditure legislation should not be responsive to business conditions. Various proposals to make macroeconomic policies blind to cyclical fluctuations, including constitutional amendments to require annual budget balancing and to restrict government expenditure and monetary growth, are currently before the country and the Congress and are viewed benignly by the Reagan administration.