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The Philosophy of Reaganism

Economic Report of the President

transmitted to the Congress, February 1982
US Government Printing Office, 357 pp., $7.00

It is a relief to have at last an extensive official statement of the “philosophical beliefs and economic judgments” of the Reagan administration; one that sets out to “help both the public and our fellow economists to understand the basis, the importance, and the effects” of present economic policies. The administration has presented its economic policies as politically and intellectually “historic,” and the president’s Economic Report goes a considerable way toward justifying such pretensions.

The Report—an eight-page message from President Reagan, followed by 344 pages prepared by his Council of Economic Advisers—addresses itself unhesitatingly to a question of urgent importance: what are the causes of the “fundamental deterioration” in America’s economic performance since the late 1960s, and in particular of persisting high levels of unemployment and inflation?

Such problems are common in some form to all developed capitalist economies. The Report concedes that a “full explanation of stagflation in the United States and other countries has yet to be developed.” But the authors of the Report have little patience with the “conjunctural” explanations of economic troubles that were fashionable in the centrist governments of Raymond Barre, Jimmy Carter, or James Callaghan. External factors “such as the oil price increases of the 1970s” or crop failures explain only “a small part of the decline.” The causes of the crisis are rather to be found in the underlying development of the American political economy.

By this the authors of the Report mean, above all, the increased economic activities of the federal government. The increase in federal activity “was associated with” stagflation; it “contributed to our declining economic performance”; “in short, Federal economic policies bear the major responsibility for the legacy of stagflation.”

There are three main counts to the indictment, listed at the outset of the Report. First, increased government regulation, which has increased production costs. Second, high taxes, which have reduced incentives to work and save. Third, transfer payments for welfare and social security, which have reduced “employment of the poor and of older workers.”

To these are added a further charge, that government, because it permitted rapid growth of the money supply, “bears the most direct responsibility for the increases in inflation and interest rates.” But this indictment is concerned less with the extent of government activity than with the policies of past governments (or the Federal Reserve). The authors of the Report do not, it appears, favor deregulation of the function of creating money. They in fact rely virtually exclusively on restrictive monetary policy as a means of reducing inflation. They even observe that a main virtue of fiscal policy is to strengthen the “credibility” of monetary policy. They indict previous monetary authorities for incompetence, apparently because their policies were influenced by such nefarious government objectives as reducing economic fluctuations or paying off “obligations in cheaper dollars.” But their objection is not to the public function of monetary regulation as such.

The three main themes are developed at length in the Report. Together, they constitute an enterprise of great seriousness; a Gotha Program of political and economic conservatism; a philosophy not only for Reagan but also for the lesser conservatives from other countries who preceded or followed him into office, and who are searching, in Britain or Norway or Sweden or France, whether in power or in opposition, for a right-wing answer to the common problems of the 1980s.

1.

This high economic philosophy constitutes the interest of the Report. The reader should expect little edification about the prospects for interest rates in 1982, or for budget deficits, or for getting fired. Such matters depend, after all, on our own expectations, as the Report repeats in some eight discussions of “credibility,” “perceptions,” or “expectations.” The success of the administration’s policy, accordingly, “will depend on the extent to which it is credible in the eyes of the public.” “Any perception that the policies may soon be reversed would cause transitional costs to rise, … in short, any lack of credibility would greatly extend the period of adjustment, thereby increasing the size and duration of short-term costs.”

The Report’s short-term predictions are almost poignantly timid. “The economy,” we learn, “is generally free of impediments to expansion”—with the exception of high interest rates. Balancing the budget is a “useful and practical” rule, and “the Administration will continue to enforce a trend towards a balanced budget.” The section of the Report called “Federal Deficits in Perspective” is particularly sheepish. Federal deficits, according to 1983 budget estimates cited without comment in the Report, will amount to some $545 billion over the next six years—but this lapse “will add only marginally to the burden of the [federal] debt.” Will such deficits increase inflation? Surely not. “If added debt does raise the price level through its effect on desired money balances, this is not equivalent to continued inflation…,” and so on.

The only forthright predictions are those dealing with military spending. The authors of the Report clearly have high hopes for the stimulating effects of increased defense spending, which they see as a “key area of rebound” for the economy in 1982. Defense spending will again “lead the expansion” in 1983, even though its effects have “not yet become particularly evident in statistics of work in progress.”

Yet the authors also see serious economic costs resulting from the military buildup. Murray Weidenbaum—the chairman of the Council of Economic Advisers and the principal author, presumably, of its Report—is among the leading academic experts on the economic effects of military spending. The Report is commendably outspoken in its account of military economics. In the short term, according to the Report, the economy “has ample slack to accommodate” the beginning of a military expansion. But as the economy recovers, problems will appear.

The military expansion planned for the 1980s will differ from earlier booms in that it is highly concentrated in certain kinds of military spending, namely weapons procurement and research and development. Estimates in the 1983 Budget suggest that these kinds of military purchases will increase 16 percent a year in real terms from the 1981 to the 1985 fiscal year (FY). Other military outlays, of which the most important are payments to soldiers and civilian government employees, will increase only 5 percent a year.1 As the Report says, the planned increase in procurement and research “exceeds the 14 percent [real] annual rate of increase that occurred during the three peak years of the Vietnam buildup.”

The new pattern of military spending, as the Report shows, will “add to pressures on the durable goods manufacturing sector” which supplies most, although not all, of the goods and services bought with outlays for defense procurement and research.2 These pressures “may increase relative prices in at least some of the affected industries.” Increased demand may “produce delays in the delivery of military goods.” And there “may be some temporary crowding out of private investment,” which depends, like military procurement, on equipment produced by durable goods industries. A civilian electronics firm, for example, may find that the specialized machines it needs have all been ordered by defense contractors. In short, “some problems may arise.”

The only relief offered is modest. The authors explain that in the defense industries, unlike competitive private industry, “the function of encouraging efficiency is largely performed by DOD [Defense Department] analysts of contract negotiations and administration.” The next few years, they conclude, “will therefore increase the challenge to DOD administrators.” Did Professor Weidenbaum—erstwhile scourge of “the close, continuing relationship between the military establishment and the major companies serving the military market”—allow himself a small smile as he wrote or read these lines?3

The details of the administration’s projections for defense spending cannot be taken as a reliable guide to the future, particularly as they proceed toward the statistical Eldorado of fiscal years 1985 and 1987. Consider, for example, the assumptions about military inflation. The “President’s Budget” price assumptions published by the Defense Department—on which the Report apparently relies in its predictions of “real purchases of defense durables”—suggest that the annual inflation rate for defense purchases from industry will be only 8.3 percent in FY 1982, and will thence decline gently—as the military buildup gathers momentum—to 5.3 percent in FY 1987. Yet the actual inflation rate for defense purchases of durable goods increased during FY 1981 from 10.9 percent in the first quarter to 12.2 percent in the second quarter, 13.1 percent in the third quarter, and 14.3 percent in the fourth quarter.4

There are other confusions. The Economic Report—which seems a sort of Gutenberg Bible of economic sobriety compared to much of the output of the Office of Management and Budget and the Defense Department—provides in the space of seven pages two different estimates of federal spending not only for 1987 but also for 1981. It also appears to anticipate a rapid decline in military retirement pay—which might interest the Veterans of Foreign Wars—to a level in 1987 $5 billion below that estimated by the Defense Department.5

It is clear nonetheless that the military stimulus from which the administration expects so much in 1982 and 1983 will have serious economic costs. The Report indeed says forebodingly that “monetary and budget policies can offset the impact of a large increase in government spending for national security”—i.e., that any positive “Keynesian” effects of increases in military demand on demand elsewhere in the economy can be compensated for by restrictive monetary policies and further cuts in nonmilitary public spending.

But even the direct effects of increased military demand may prove disappointing. Expenditure on procurement, at least initially, creates fewer jobs than does expenditure on personnel.6 These jobs are also concentrated in industries—aircraft, communication equipment, ordnance—which employ disproportionately many workers, such as engineers, from groups with low unemployment rates; and disproportionately few from groups with high unemployment, such as the young black women workers of whom 40.8 percent, according to the appendix to this Report, were unemployed in December 1981. The military expansion may provide relatively far fewer jobs than earlier such booms, above all for unemployed workers. And its longerterm economic effects may of course be even more serious—as growing military demand takes an increasing share of output from the durable goods industries on which much of the economy’s prospects for long-term growth and innovation depends.7

The military economy, in sum, poses many problems for the Reagan administration. Will the defense buildup help the economy? If so, should its benefits be negated by other restrictive policies? And—a tricky question of economic epistemology—how is it possible to tell that Mr. Reagan is not a Keynesian? The administration is running large budget deficits in a recession. It believes that the economy has sufficient (aggregate) “slack” to accommodate increased government demand without seriously increasing inflation. In a period of recession, the Report suggests, “a given deficit can be financed with less pressure on interest rates than during a period of growth.” The previous military buildups of the postwar period—with the exception of the missile boom of 1961—came at times when the economy was already growing rapidly. But Mr. Reagan, the first military Keynesian, may be spending his way out of the recession of 1982.

  1. 1

    Budget of the United States Government, Fiscal Year 1983 (US Government Printing Office, 1982), p. 5-10, National defense outlays for FYs 1981-1985. Estimates of outlays “in real terms” based on “inflation rate assumptions” given in Caspar W. Weinberger, Secretary of Defense, Annual Report to Congress, Fiscal Year 1983 (US Government Printing Office, 1982), p. B-2.

  2. 2

    The Report defines “purchases of defense durables” as “research and development and procurement of major weapons systems.” This bizarre identification does not correspond to conventional usage. With its procurement and research outlays, the Defense Department makes purchases from industries other than “durable goods industries” including business services and chemicals; it buys commodities other than durable goods—such as research services—even from durable goods industries; it buys durable goods with other parts of its budget, notably “operations and maintenance.” The difference between the two measures is substantial. Actual “defense purchases of durable goods” amounted to $37.3 billion in the 1981 fiscal year (according to the authoritative series, based on actual commodities purchased, which is published monthly by the Commerce Department in its Survey of Current Business). But military outlays for procurement and research amounted to $50.5 billion in that year.

  3. 3

    Murray Weidenbaum, American Economic Review (May 1968), vol. LVIII, no. 2, p. 428.

  4. 4

    Implicit Price Deflators for Government Purchases of Goods and Services by Type,” US Department of Commerce, Survey of Current Business, Table 7.14B (1981, various issues).

  5. 5

    These pages provide an instructive view of the statistical foundations—the seething statistical cellar—on which the administration’s predictions repose. Thus we learn on page 85 that between 1981 and 1987 “military spending (including military retirement) will rise from 5.6 percent to 7.8 percent of GNP, and from 25 percent to 37 percent of total Federal spending.” This suggests that federal spending accounts for 22.4 percent of GNP in 1981, and 21.1 percent in 1987. But the figures given on page 79 are 23.0 percent in 1981 (this is also the Budget figure) and 19.7 percent in 1987.

    What of military retirement? Table 4.2 on page 83 of the Report shows defense spending excluding military retirement accounting for 22.2 percent of federal outlays in FY 1981 and 35.4 percent in 1987. This information, together with that on page 85, yields a share of military retirement payments in federal outlays of 2.8 percent in 1981 and 1.6 percent in 1987. The 1987 level of payments would thus be $15.7 billion in current dollars (according to estimates for 1987 federal outlays given on page 3-21 of the 1983 budget): But the Defense budget in its “long-range forecasts” (page B-3) estimates 1987 military retired pay at $21.1 billion. …

  6. 6

    This is so, among other reasons, because workers and engineers in defense industries are paid more than Defense Department soldiers and civilians, and because part of procurement outlays take the form of profits.

  7. 7

    See Emma Rothschild, “Military Expenditure and Economic Structure” (Independent Commission for Disarmament and Security Issues, October 1981, to be published later this year).

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