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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.

Caspar Weinberger, among others, has addressed himself to these trying questions. The administration, he says, “is firmly opposed to spending for the non-necessary purposes in what we think would be a vain attempt to finetune the economy. This is another way of saying that we are not Keansian among other things.”8 Yet this simple test of intentional Keynesianism/Keansianism is hardly decisive. All the “Keynesian” governments of the postwar period would presumably argue that their public spending, military or non-military, was necessary; we are far from the lucidity of Keynes himself when he noted the prospect in 1940 that “good may come out of evil…if the United States steels itself to a vast dissipation of resources in the production of arms.”9

In 1982, one can only conclude, the administration’s fiscal policies are not very different from those that their despised predecessors might have followed. But the chosen instrument of expansion—a military buildup concentrated in engineering, science, and major weapons—may prove particularly unsatisfactory. And the administration’s monetary policy is likely to reduce the stimulus of military demand, and limit recovery elsewhere in the economy, i.e., in the other “key areas of rebound” that the Report projects for 1982: autos and housing, as well as in the “business investment” that, along with defense deliveries, is “anticipated to lead the expansion” of 1983. Keynesians in the short term perhaps—but inefficient Keynesians.

2.

What, then, of the medium term, and of the Reagan administration’s true economic philosophy as described in the Report? The first of the three main themes, concerning the government’s role in general and regulation in particular, sets out from the high theoretical ground of political and economic freedom. “No nation in which the government has the dominant economic role (as measured by the proportion of gross national product originating in the government sector) has maintained broad political freedom,” explain the authors of the Report. They then move to more refined distinctions. They concede that the economic role of government varies widely within the “free” nations, “without serious jeopardy to political freedom.”

But even in these countries, there is a “more subtle” relationship between political and economic freedom. “Expansion of the economic role of the government tends to reduce both the level of agreement on government policies and the inclination to engage in political dissent.” What are we to make of this indeed subtle calculus? That throughout much of Western Europe in the 1970s people disagreed more about public policies, but complained less? That dissent flourished in Britain, where the government’s share of gross domestic product (GDP) fell (under socialism) from 13.6 percent in 1976 to 12.2 percent in 1979? That dissent was buoyant in Mr. Carter’s United States, where the share went from 13.3 percent to 12.4 percent? But that in Sweden, where the government share of GDP increased, under a succession of more or less neoconservative governments, from 18.5 percent in 1976 to 21.6 percent in 1979, people felt more and more subdued?10

In the United States, according to the Report, the growth of government has distorted the economy in many ways. The federal government has exceeded its legitimate functions, of which the most important are to correct “market failures” and to involve itself in the provision of “public goods.” This judgment rests, of course, on a political choice of what constitutes a public good (or, in some cases, a “market failure”). And here the views expressed in the Report are indeed “historic”—by comparison not only with those of Carter or Barre but also with a consensus reaching back beyond Franklin Roosevelt to the reform movements of the 1870s and 1880s. Thus the authors consider that while national defense is a “true” public good, education is a good that “could be private,” and indeed that the public monopoly of subsidized education should perhaps be ended in the interest of “more efficient schools.” They observe that public spending leads to a regrettable reallocation of private resources: “For example, public provision of education or police services reduces the private demand for such activities.”11

The interference with market forces involved in such forms of government activity may well lead to economic inefficiency. But they are hardly novel enough to be implicated in the sudden deterioration of the American economy since the mid-1960s. The Report’s apparent enthusiasm for private bodyguard services—or other modes of the private provision of “police services”—might indeed have fallen foul of Adam Smith’s own principle of 1776 that the second legitimate expense of government, after defense, was “protecting, as far as possible, every member of the society from the injustice or oppression of every other member of it”; or of Smith’s strictures against the “very gross abuses” that follow when a person applies for justice “with a large present in his hand.” (Smith also had a faiblesse for parish schools, not to mention “public works and institutions which are necessary for facilitating particular branches of commerce.”)

It is worth noting, too, that the authors have some trouble in sustaining a consistent policy against government intervention. Thus they suggest that “tax policies that distort the allocation of inputs” can lead to greater inefficiency than “neutral tax treatment.” Yet eleven pages later they comment, without evident distaste, that Reagan’s (“historic”) Economic Recovery Tax Act of 1981 “will alter the allocation of existing capital and labor among industries,” the “allocation of new business investment,” and the composition of personal consumption.

The evidence they present is dramatic. Tax rates on new assets vary under the new law from a low of minus 11 percent in the motor vehicle industry to a high of plus 37 percent in services and trade. One consequence, apparently unanticipated by the administration, is that the 1981 Act will discriminate against precisely those industries that create large numbers of jobs. Thus the motor industry directly employed 770,000 people in 1980, compared to 810,000 in 1970. But the services and trade industries that are least favored by the Tax Act employed directly more than 38 million people in 1980, having supplied almost 12 million out of the 16.4 million new jobs created since 1970. 12

The Report is more convincing when it considers the effects of new or newly expanded government activities, notably “regulation.” There has clearly been an increase since the mid-1960s in government activities associated with the physical environment, with product safety, with occupational health and safety. This change was reflected, according to the Report, in a rather simple indicator—government “regulation” defined as “number of pages in the Federal Register“—but also in a rapid increase in the expenditures of regulating agencies, notably the Environmental Protection Agency, the Departments of Agriculture and Energy, the Nuclear Regulatory Commission.

Such activities are bound to have economic consequences. They have presumably increased the cost of producing those commodities, such as coal or electricity or automobiles, whose production or use imposes high costs on the physical environment. They may also have contributed to the overall decline in rates of growth of labor productivity in individual industries and in the economy as a whole. As the authors of the Report write, cautiously, “Capital expenditures for pollution abatement equipment (which provides no measurable output) appear responsible for a small fraction” of the decline in productivity growth. Other “possible, but less well-documented, explanations include a decline in economic efficiency associated with higher levels of distorting taxes and increased levels of government regulation.”

The environmental and social legislation of the 1960s and 1970s, and the regulations with which it has been implemented, were the political embodiment of real changes in public preferences, of increased demand for public goods such as clean air and for non-traded goods such as better working conditions. These changes have had real economic costs: both directly and as a consequence of the difficulties involved in moving capital and labor from the production of automobiles, say, to the “production” of clean air.

Conservative economists are quite right to point to such costs, and to the problems they create. Yet the conservative solution is less clear. One possibility is to find a less expensive way of producing “environmental” goods. The authors of the Economic Report appear to explore this prospect in a long and sophisticated discussion of regulation, in which they urge “increased reliance on market-like devices when appropriate government interventions are undertaken.” The other possibility is to decide that the new public preferences are simply too expensive and should be changed: either by repealing or revising the relevant legislation and regulations, or by a process of erosion in enforcing them that will be justified on economic grounds.

This more sinister possibility is also implicit in the Report, and in the administration’s policies more generally. The authors suggest that “in many areas of safety regulation, for example, the best solution would probably be to rely on market judgments about the value of safety.” Yet the main reason for safety legislation was that people wanted more safety, which the private market failed to supply. That was why their choices were expressed through the complex, discontinuous, and undoubtedly inefficient processes of political and economic compromise. Once again, the judgment about what goods are public and what markets are imperfect is based on political as much as economic philosophy.

3.

The second theme of the Report’s indictment is taxation. Taxes are bad for the economy not only because of what the government does with its tax revenues but also because of the ways in which taxes affect the economic behavior of the people and corporations who pay taxes. The main charge is that high and increasing levels of taxes in the 1960s and 1970s led people to work too little and to save too little. “Income tax progressivity,” in particular, “encourages current consumption and leisure and discourages saving for the future.”

The argument about taxes is developed at considerable length in the Report, and is linked to the view that low savings and an excessively high “rate of household consumption” are among the most important causes of the American economic “deterioration.” The administration’s view of taxes is embodied, moreover, in the 1981 tax legislation. As the Report explains, the “dominant thrust” of the Tax Act is to “provide increased incentives to household and business saving.” It has “changed the basic character of the tax system by shifting the burden of taxation away from capital income, thereby providing substantially greater incentives for capital investments and personal saving.”

One can see why the Reagan program is such an inspiration to conservatives around the world. As the Gotha Program did for the socialists of 1875, it summarizes the economic and political theories of the conservative International, of the tax “revolution” which has stirred the right in Britain, Sweden, and elsewhere. And it is actually being carried out: the Wilhelm Liebknecht of neoconservatism is in the White House, having signed the Economic Recovery Tax Act and the Omnibus Budget Reconciliation Act of 1981.13

The Reagan economists’ philosophy of taxation purports, nonetheless, to reflect real economic conditions. Its value thus depends on the answers to two questions. To what extent do changes in taxation lead to changes in the supply of labor and savings? And to what extent have any such changes contributed to economic deterioration in the 1960s and 1970s?

The answer to the first question can only come from empirical investigations, which the present Report hardly cites, sticking fairly resolutely to the high ground of generalization: “In marking the decisions that determine national output and capital formation, households consider their options.” It is worth noting, however, that the “house-holds” with which the Report is concerned are distinctly prosperous ones. “Most people,” the authors write, “earn income from both capital and labor over their lifetimes. But some people may have few or no valuable things to sell, and these people will have low incomes.” The tax-related decisions the Report envisages are lofty: on the basis of anticipated tax rates, whether to “invest in durable capital, to invest in land or other tax-sheltered capital, or to consume.”

The implicit view of all Americans as inherently capitalist is not new. Tocqueville saw the “business-like qualities” of Americans everywhere, and for Engels America was the “last Bourgeois Paradise on earth,” where “everyone could become, if not a capitalist, at all events an independent man, producing or trading with his own means, for his own account.” But this may not be a useful simplification for understanding the economic behavior of most Americans in the 1980s. It is indeed the case that more than half of all American house-holds receive some income from dividends, interest, or rent. But these sources account for only 3 percent of the total money income of what the US government calls “nonaged” families—less than the 4 percent of total money income which they receive from public programs. For poor (nonaged) families, only 1 percent of income comes from dividends, interest, and rent, compared to 48 percent from public programs.14

No one would question that taxes affect the economic choices of taxpayers in general and rich taxpayers in particular. What seems possible, however, is that responses to taxes are swamped by other effects. With lower taxes, the authors of the Report write, people will have more “incentive to work more hours, or accept a more demanding job.” But can they even find such a job, with the unemployment rate at 8.8 percent for all workers, 12.7 percent for blue-collar workers, 21.5 percent for teenagers? The authors concede that tax changes will have their strongest “labor supply effects” on married women, who presumably will be encouraged by lower tax rates to find jobs. But in this case the comparable discouraging effects of high taxes were convincingly swamped by other forces during the postwar period, since the female labor force participation rate increased 1.0 percent a year in the 1950s, 1.4 percent a year in the 1960s, and 1.9 percent a year in the 1970s.15

What of the second question? Even if taxes do affect economic behavior, does this matter? The Report suggests that tax disincentives have contributed to economic deterioration by reducing labor supply and savings. Yet such effects on the supply of labor have hardly been decisive, since the civilian labor force grew about twice as fast in the 1970s as in the preceding three decades, adding more than 20 million new workers, compared to less than 30 million during the 1940s, 1950s, and 1960s. It is of great social importance that people be free to join or to remain in the labor force; and an expanding American economy may well need millions of workers in the late 1980s. But the slow growth of labor supply cannot plausibly be blamed for the economic problems of the 1970s. A simple extrapolation suggests that if participation in the labor force had been no higher in 1980 than in 1970, there would have been, with the same civilian population and employment, 5.6 million fewer people unemployed in 1980. If unemployment remained at its actual 1980 level, with 1970 labor force participation, productivity (real GNP per employed person) would have grown at 1.4 percent a year during the 1970s, instead of its actual rate of below 0.8 percent per year.

The argument about taxes and savings is far more important, since it is at the heart of the entire Reagan program. Yet here again, the real economy is peskily intrusive. A low savings rate can lead to economic problems—notably slow economic growth—if it results in a low rate of investment. (It seems unilluminating to speculate whether the Reagan economists believe that savings determine investment, or investment savings….) The US has virtually the lowest investment rate of any OECD country, lower even than Britain’s. But this rate was in fact no lower in the 1970s than it had been in the earlier postwar period. Gross private domestic investment—according to statistics taken from the appendix to this Report—amounted to 15.9 percent of GNP in the 1950s; 15.5 percent in the 1960s; and 15.9 percent in the 1970s.

Personal savings also contribute only part of the funds available for domestic investment: less than a third in the 1970s, with the balance coming from business “saving.” The authors of the Report indeed contemplate an ingenious way of finding funds for investment from sources other than personal (or corporate) savings. The solution, not likely to endear the administration to America’s allies, already restive at high US interest rates, is to seduce savings from countries that save more: “Some saving could also come from abroad.” As the authors continue, discussing the effects of US government borrowing on private investment, “If international credit flows respond sufficiently to only slightly higher interest rates, significant crowding out of US private investment may be prevented.”16

The most conclusive objection to the Reagan view of savings is, finally, that personal savings have declined only slightly in the 1970s. Personal savings accounted for 6.8 percent of disposable (after tax) personal income in the 1950s (still according to the Report’s statistical appendix); for 6.9 percent in the 1960s; and for 6.6 percent in the 1970s.17

In their main discussion of tax policy and economic growth, the authors of the Report conclude that “creating an environment in which households choose to save a larger share of their income is of paramount importance.” Yet their argument about savings turns out to be exceptionally disingenuous. They do not concern themselves-for understandable reasons-with the household or personal savings rate. Instead they describe a sharp increase in the 1970s in what they call the “household consumption rate.” This is defined as “household (private sector) consumption divided by the difference between net national product (NNP) and total government consumption,” and it is assigned the major responsibility for a decline in the 1970s in the “net saving rate” (defined as “NNP less household and government consumption, divided by NNP”). As households “consumed” more, the argument goes, the nation saved less. 18

The fate of the “household consumption rate” is so central to the Report’s analysis that it deserves further investigation. Household consumption itself has changed very little as a share of NNP, going from 69.5 percent in the 1950s to 68.1 percent in the 1960s and 69.4 percent in the 1970s, as can be deduced from the main table (5.2) in which the concept is presented. The change in the “household consumption rate” must thus depend largely on changes not in the numerator but in the denominator of the expression, namely NNP less total government consumption. This denominator, according to the Report, is equivalent to the “total disposable income” of the “private sector” because “the private sector must pay for the government’s current consumption either now or in the future.”

Here things become much more murky. Earlier in the Report, the authors have explained that they define government “consumption” as government purchases of goods and services except for purchases of durable goods and structures, which constitute government “investment.” (Table 4.1. At this initial stage, to their credit, they do utter a word of warning: “in practice, therefore, statistics that allocate government purchases between consumption and investment must be viewed with caution.”) Now, in their analysis of savings and growth, they have removed government consumption from the denominator of the “household consumption rate,” while leaving in place, as part of NNP, government “investment” (along with other miscellaneous and unspecified terms, presumably including an item representing “the rest of the world”).

This arithmetic turns out to transform the sense of the argument. For government “investment,” as defined in the Report, consists in large part of defense purchases of durable goods, i.e., weapons, whose “future benefits,” as the authors earlier concede, “cannot be captured in GNP.” And these purchases for defense “investment” have changed dramatically as a share of gross and net national product. Defense investment—our calculation is still based only on tables 5.2 and 4.1 of the Report—amounted to 5.0 percent of NNP in the 1950s; to 2.9 percent in the 1960s; and to 1.5 percent in the 1970s. So the denominator of the “household consumption rate” contains a term that has declined very rapidly over time, for reasons having nothing to do with savings or household behavior.

If we remove defense purchases from “disposable income,” along with the other forms of government consumption subtracted in the Report—because the private sector “must pay for” defense just as for nonmilitary public consumption—we arrive at a quite different and less dramatic pattern of change in the three postwar decades.19 The “household consumption rate,” on this amended definition, goes not from 81 percent in the 1950s to 82 percent in the 1960s to 86 percent in the 1970s, but from 86 percent to 85 percent to 87 percent; the “net national saving rate” instead of declining from 16 percent to 15 percent to 12 percent goes from 11 percent to 12 percent to 10 percent. The authors of the Report end their discussion of economic growth with the assertion that “to achieve higher national savings rates it is important to lower the household consumption rate.” Neither rate can justify the conclusion that changes in household savings have been of central importance to economic performance.

The administration’s tax policy is directed explicitly to increasing household saving. One of its main objectives is to increase both saving and investment by “switching away from taxes on capital income to some other tax base, such as wages or consumption.” “I cannot emphasize strongly enough,” Professor Weidenbaum has said, “that this is not a consumption-oriented tax cut of the standard stop-and-go variety that became so popular over the past two decades. This is a tax cut which deliberately seeks to encourage productive saving…”20

But changes in household savings, as we have seen, contributed only modestly to economic problems since the 1960s. What President Reagan calls “the people’s tax cut” is a tax cut for savers, and for earners of capital income. The Gotha Program of the conservatives is reduced, in the end, to a less than complex philosophy: redistribute income to people with a high propensity to save—who happen to be rich people—and hope that their high spirits or their thrift will in some manner inspire economic growth.

4.

The third theme in the Reagan economic philosophy is the evil effects of “transfer payments” covering social security and welfare. Some of the economic arguments in the Report will already be familiar: that the taxes required to pay for transfer payments interfere with the free market; that the payments themselves “maybe have strong allocative effects within the economy.” The political arguments advanced are also not unexpected: it is “a basic tenet of the Administration that income redistribution is not a compelling justification in the 1980s for Federal taxing and spending programs.”

The most serious economic argument about transfer payments is that people who receive social security and welfare payments have a reduced incentive to work. The Report alludes with evident dismay to the fact that only 20 percent of men over sixty-five work, compared to 46 percent in 1950. It commiserates with “typical welfare recipients, namely single mothers with children,” for the high marginal tax rates they face if they should find work.

Such disincentives constitute a real social problem, and one with which any progressive government would be preoccupied. Social programs that contribute to isolating the poor and the old from the “normal” labor force can cause misery and waste. A more just society would provide more jobs for old people who want to work, and more opportunities to learn new skills. But the strictly economic effects of a reduced supply of labor—as in the case of tax disincentives—are nevertheless hardly decisive. The economic problems of the 1970s would probably not have been less had the US enjoyed a larger supply of unskilled workers, or workers with obsolete skills. In other countries, governments are in fact more perturbed by the oversupply of older workers—the Mauroy government in France, for example, appears to contemplate a policy of reducing unemployment by incentives to make people retire at sixty, and punitive “disincentives” to keep them idle. (The Reagan economists may of course anticipate that the flux of millions of underprivileged workers into the labor market—disinherited recipients of transfer payments—would reduce wages and increase labor discipline. This prospect is not cited in the present Report as one of the economic benefits of “welfare reform.”)

A second economic cost of transfer payments is that they “absorb resources” through their “administrative costs.” A third is that transfer payments could lead recipients to change their “savings behavior.” People may well save less if their minds are not concentrated by the threat of destitution; transfer payments certainly constitute a modest redistribution of national income away from people—rich people—who save on a lavish scale. But overall savings “behavior,” as was clear from our look at the taxation count of the Reagan indictment, has changed rather little in the postwar period, and can bear little of the blame for present troubles.

A final argument, mentioned in passing in the Report, is that transfer payments “may change the composition of the demand for goods and services.” This is presumably taken to be disagreeable in itself, although one might surmise that the kinds of commodities that poor people buy (necessities, including the output of older consumer-goods industries) are at least as likely to stimulate economic recovery as are the commodities bought by the rich. (Caspar Weinberger, curiously enough, has examined this complex point of economic theory in his “Keansian” speech. Transfer payments, he explains, “generally go to non-durable consumer goods. These have a lower investment component and a lower multiplier effect.” Military spending, by contrast, is a sort of Stealth aircraft of fiscal strategy: “You aren’t really adding substantially to your deficit when you add defense spending because the spending is frequently, if not matched, at least approached by the increased revenue that is generated by the defense expenditure.”)21

The economic arguments about transfer payments are the weakest in the entire theory of economic deterioration spelled out in the Report. But the political passions of the theorists are compensatingly strong. At one point, the authors of the Report observe that the main objective of foreign aid should be “to help those poorer countries which, for reasons beyond their control, have not been able to improve their standards of living.” Some of America’s own poor, too, are truly innocent and truly needy. But the authors appear to have little appetite for the “argument based on benevolence,” according to which “many people prefer not to live in a society in which there is poverty.” The innocent poor must be helped to become economic adults (just as poor countries “mature” from subsidized loans to market loans): “the long-term cost of paternalism may be to destroy and individual’s ability to make decisions for himself.”

The authors of the Report are collectively aware, despite their vision of the asset-rich household, of the real economy in which millions of Americans live. There are glimpses, throughout the Report, of the underworld in which “about 23 million people” do not have public or private health insurance; in which “the number of people receiving unemployment compensation was 41 percent of the total unemployed”; in which the average dole for the compensated unemployed “is about one half of take home pay.” The authors understand, for example, that “a worker may become physically disabled” and that “individuals generally do not like the risk of losing their ability to earn income.”

But such realities justify no more than the most limited interference in the (imperfect) market for disability insurance. There is only, as far as I can tell, one moment of genuine emotion in the entire Report, when the authors’ passions are stirred beyond market principles. They are discussing the leasing provisions of the 1981 Tax Act (conditions which so reduce tax revenues that they are apparently opposed in their present form by the Business Roundtable, the American Business Conference, and the National Association of Manufacturers).22

In the dark days before the 1981 Act, according to the Report, “firms with temporary tax losses (a condition especially characteristic of new enterprises) were often unable to take advantage of investment tax incentives. The reason was that temporarily unprofitable companies had no taxable income against which to apply the investment tax deduction….” It was a piteous contingency for the truly needy entrepreneur. But all was made right with the Tax Act. Social security for the disabled incompetent corporation: the compassionate soul of Reagan’s new economy.

5.

What remains, after this expedition through economic premises and political conclusions, political premises and economic conclusions, of the Reagan administration’s bold explanation for the economic crisis of the 1970s and 1980s? The argument about the costs of environmental legislation is, I believe, of great economic importance. But it is one that has less to do with “government” and “regulations” than with the consequences of a relatively sudden change in people’s preferences: the sort of “distress” that according to Ricardo follows “sudden changes in the channels of trade,” whether associated with war, new taxes, or “the tastes and caprice” of consumers.

The other arguments concerning government explain virtually nothing about present economic problems. They amount to little more than a macroeconomic veil of modesty for the administration’s political objectives: to redistribute income and well-being toward the rich and away from the poor; to redistribute health and education and security toward much the same people who would already have enjoyed them before the Second World War, or before the New Deal, or before the Gotha Program.

All of this is not to say that Reagan’s policies may not, in the end, resolve at least some of America’s economic problems. The expectation of the Reagan administration depends, as we wrote here fourteen months ago, on “some unknown Republican inspiration, some elixir of indigenous capitalist expansion.”23 This spirit was not forthcoming in 1981; it may reveal itself during the “medium term” of the administration’s fiscal and political counterrevolution.

But any economic “recovery” under the Reagan regime will involve economic and social misery. It will threaten a further collapse in employment, as women workers, government workers, workers in service industries join the unemployed from the industries first affected by high interest rates. Its cuts in public spending will hurt the poorest and the weakest. It will delay still further any resolution of the real social contradictions of modern mixed economies, some of them identified in the present Report, and others foreshadowed in the Gotha parties’ faith in the “State”—contradictions all the more important to the extent that public and private “markets” for health or education may constitute the last best hope for a capitalist expansion in the 1980s and 1990s.

A recovery stimulated by Reagan’s policies would not be founded on any change in the underlying causes of the economic crisis, which the Reagan philosophers understand no better than the rest of us. It would rely, rather, on the darkest spirits of capitalists. ” ‘Discipline in the factories’ and ‘political stability’ are more appreciated by the business leaders than profits,” wrote Michal Kalecki in 1943, describing the opposition of business to government policies of full employment which might have guaranteed stable profits.24 The businessmen of the Reagan recovery would invest out of the purest euphoria. They have been feeling more and more rotten at the thought of taxes and welfare mothers and occupational safety and equality; they felt less rotten about defense procurement; they believed in the counterrevolution of the 1980s. What is at stake, in the “historic” Reagan program, is not the credibility of the administration’s monetary policy and of its tax cuts for savers—it is the moral credibility of conservatism.

  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).

  8. 8

    Remarks by the Honorable Caspar W. Weinberger before the Economic Club of New York, October 27, 1981. Office of the Assistant Secretary of Defense (Public Affairs), News Release No. 493-81.

  9. 9

    The United States and the Keynes Plan,” The New Republic, July 29, 1940, in The Collected Writings of John Maynard Keynes, vol. XXII (Cambridge University Press, 1978).

  10. 10

    Statistics for gross domestic product by kind of economic activity, including “producers of government services,” taken from OECD, National Accounts of OECD Countries 1960-1979 (Paris, 1981), vol. II, Tables 2a.

  11. 11

    The authors of the Report are also concerned with the definition of market failures. Thus they write that “observed differences in safety conditions among workplaces, for example, are not sufficient evidence of a market imperfection, because employer and employee knowledge of these conditions may lead to compensating differences in wages and employment conditions.”

  12. 12

    US Department of Labor, Employment and Earnings, March 1971 and March 1981.

  13. 13

    The German Social Democratic Workers’ Party, led by Liebknecht and August Bebel—later founders of the Second International—merged with the General Association of German Workers at the Gotha Unity Congress of May 19, 1875. The “Gotha Program”—which called, among other things, for universal suffrage, public elementary education, and a uniform progressive income tax—was the major document of the economic and political philosophy of social democracy. It was bitterly criticized by Marx and Engels for its implicit economic theory and for including such “bourgeois liberal” demands as “freedom for science” and “freedom of conscience.”

  14. 14

    US Department of Health and Human Services, Social Security Bulletin, Annual Statistical Supplement, 1980, page 62. Shares of money income for nonaged households, families with head under age 65, 1978. According to this Supplement, 21.3 million “nonaged” Americans were poor in 1978 (p. 61).

  15. 15

    Here and in what follows, all statistics are taken from the statistical appendix to the present Report. We also follow the practice adopted in the text of defining the decade of the 1970s as lasting from 1971-1980, the 1960s from 1961-1970, and so on.

  16. 16

    This flow of foreigners’ “savings” would presumably be offset—as the Report does not point out—by an increase in US imports of goods and services. Gross investment is of course only one measure of national investment. Economists concerned with paucity of US investment also cite the decline in “net private domestic investment” (gross investment less capital consumption allowances) as a share of GNP: from 6.6 percent in the 1950s, to 7 percent in the 1960s, to 6 percent in the 1970s. Some decline is however to be expected in a decade which included two recession years when the ratio of net to gross investment fell sharply.

  17. 17

    As a share of total personal income, i.e., before tax, personal saving declined from 6.0 percent in the 1950s and in the 1960s to 5.6 percent in the 1970s. This particular series gives a clear illustration of how important is one’s choice of time period. As mentioned above, we follow the Report in defining the decade of the 1970s as lasting from 1971 to 1980. If it were defined as lasting from 1970 to 1979, then saving as a share of total personal income would go from 6.0 percent in the 1950s to 5.8 percent in the 1960s and 5.9 percent in the 1970s. (1980 was a very bad year for savings, and 1970 was a rather good one.) As a share of disposable personal income, saving would be 6.9 percent in the 1970s, up slightly from 6.7 percent in the 1960s, and 6.8 percent in the 1950s.

  18. 18

    Net national product, NNP, is equal in US national accounting conventions to gross national product (GNP) less “capital consumption allowances with capital consumption adjustment.” If NNP were, say, 1,000, household consumption 700, and government consumption 140, then the “household consumption rate” would be 700/860 or 81 percent. The “net saving rate” would be 160/1,000 or 16 percent. The Report’s two “rates,” it should be added, are somewhat eccentric in terms of conventional national accounting procedures.

  19. 19

    In the example from the preceding footnote, assume that “defense investment” accounts for 50 units out of NNP. Subtracting this from the denominator of the “household consumption rate” would yield an amended rate of 700/810 or 86 percent. Subracting the same 50 units from the numerator of the “net national saving rate” would lead to an amended saving rate of 110/1,000 or 11 percent. These proportions correspond approximately to the actual figures for the 1950s.

  20. 20

    The Economic Outlook,” address by Murray L. Weidenbaum before the Society of American Business and Economic Writers, May 5, 1981.

  21. 21

    Caspar Weinberger, remarks before the Economic Club of New York, op. cit. Any differential multiplier effects of course depend not on investment but on the propensities to consume of workers in military and consumer goods industries. (“Accelerator” effects have different consequences.) Workers in military industries probably consume less of their income, because they earn more, but also pay more taxes.

  22. 22

    New York Times, March 4, 1982.

  23. 23

    Reagan and the Real America,” New York Review, February 5, 1981.

  24. 24

    Political Aspects of Full Employment,” in Michal Kalecki, Selected Essays on the Dynamics of the Capitalist Economy 1933-1970 (Cambridge University Press, 1971).

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