Reaganomics
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The term Reaganomics, a portmanteau of Reagan and economics, has been used to describe, and decry, the economic policies of U.S. President Ronald Reagan during the 1980s. Reagan assumed office during a period of high inflation and unemployment, which had largely abated by the time he left office. It continues to be a matter of contentious political debate to what extent this was caused by Reagan's fiscal policies and to what extent it was due to external factors.
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An Explanation of Reaganomics
In a July 10, 1987 White House Briefing for Members of the Deficit Reduction Coalition, Ronald Reagan said of Reaganomics: "America astonished the world. Chicago school economics, supply-side economics, call it what you will — I noticed that it was even known as Reaganomics at one point until it started working [laughter] — all of it is fast becoming orthodoxy. It’s not just that Milton Friedman or Friedrich von Hayek or George Stigler have won Nobel Prizes; other younger names, unheard of a few years ago, are now also celebrated."
Reaganomics, free market economics and, specifically, supply-side economics have become highly politicized terms. Most will agree that Reaganomics is based on his fundamental belief in the free market, with two key ideas being the subject of much of the "Reaganomics" debate: Reagan's desire to lower taxes and to have a smaller government. Some opponents and supporters of Reagan's economic policies quote Reagan's comment that "government is the problem" as one way to appreciate this general view. On the other hand critics of Reaganomics as policy rather than articulated ideology will emphasize the fact that in fact the role of government in the economy EXPANDED because of the significant increase in defense spending under Reagan and a significant increase in protectionism (the most significant innovation being the forcing of Voluntary Export Restraints upon the Japanese auto industry).
Free market, or classically liberal (before the 1960s "classical liberal economics" was synonymous with "free" trade economics) economists, based on the tradition from Adam Smith, stress the importance of free trade based on voluntary work specialization, while the role of government in national and international policy should be focused on removing barriers to open trade. The opponents of this view go back to the opponents of Adam Smith and his followers. Smith's free market principles, put forth in the Wealth of Nations in 1776 were attacked most famously by Karl Marx, throughout his numerous works, perhaps most notably Das Kapital co-authored with Frederich Engels. In the 20th century, most Western economics scholars have preferred to criticize Adam Smith's tradition with the works of John Maynard Keynes who argued that free market economics does not offer solutions to address rapidly changing market forces in what they refer to as cycles of boom and bust.
Others note that Adam Smith himself introduced so many qualifications of the basic principles of free market economics that, according to Mark Blaug, author of Economic Theory in Retrospect these qualifications would be grist for many "socialist orations." To take one example, when Smith used the term "invisible hand" in the Wealth of Nations, the context was that he was describing businesses deciding to prefer domestic investment to foreign investment -- a rather mercantilist result of the "natural" workings of the market. ("By preferring the support of domestic to that of foreign industry, he [the investor] intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an 'invisible hand' to promote an end which was no part of his intention." -- Note in this context, that "end" is the promotion of domestic over foreign industry... (source: The Wealth of Nations, U. of Chicago Press, 1976, Book IV, Ch. 2, p. 477) A perfect 10 for 10 inspection of Principles of Economics Textbooks finds that the words "preferring the support of domestic to that of foreign industry..." are left out and only the part about seeking to "produce the greatest value" is left in to the elucidation of the "invisible hand" concept.)
During the Great Depression, Keynesian economists saw the vast numbers of unemployed workers and suggested that the government should "prime the pump" through government borrowing for job creation programs. During the New Deal, the WPA and other programs put this theory into action. Keynesian economists justified this government spending, by claiming through the multiplier effect -- one employed worker's salary will benefit 5 other workers etc. Critics argued that government, being a political entity, is an inept distributor of economic resources.
The most significant "proof" of the validity of Keynes' remedies for a depression (high government spending) was in Hitler's Germany where the depression ended in 1935 even before Germany re-armed. The huge public works program including the building of the Autobahns led to the end of high unemployment. When Keynes' General Theory was published in German in 1936, Keynes wrote a preface in which he explicitly pointed to the building of those Autobahns as demonstration of the validity of his approach.
One school of critics, the monetarists, argued that government can better stimulate the economy by manipulating the money supply. When the economy is weak, the monetarists argued that the government should lower interest rates and increase the money supply. This additional money will seek businesses and start-ups to invest in, via banks and other non-governmental means. The negative effect of an increased money supply is inflation.
[Actually most monetarists opposed any discretionary change in monetary policy -- they were in favor of a rather rigid rule in which the money supply should grow at a fixed rate per year. They argue that had such a policy been followed between 1930 and 1933, the FED could have prevented a decline in the stock of money, which Monetarists blame for the depths and length of the Great Depression.]
After the oil shocks of the 1970s, a new economic phenomenon took hold: stagflation. Stagflation combined unacceptably high unemployment with significant inflation. Previously, the economy experienced either high unemployment and low inflation =- or even sometimes deflation, or low unemployment and rising inflation. The economy had not experienced both unacceptably high unemployment and unacceptably high and rising inflation at the same time. Stagflation meant that if one followed the Keynesian model to stimulate the economy, the government must intervene via new spending programs. The new spending is to be financed either by new taxes or borrowing. On the other hand, if one followed the monetarists, the government had to choose either to raise interest rates to tame inflation and cause further unemployment, or lower interest rates to stimulate the economy and cause further inflation.
A new school of thought gradually arose. It argued that the competitive nature of free markets (free of government regulation) made markets the best means to distribute economic resources. Businesses have to be innovative and create wealth to survive. This anti-government view saw businesses as the "goose that lays the golden eggs" and government regulation and taxes as "strangling the goose". Reagan partially agreed with this anti-government view and sought to stimulate the economy by lowering income taxes and targeting some of the tax cuts towards income from capital. Though paying lip service to reducing government spending, because of the Reagan Administration's commitment to raising defense spending, the combination of tax reductions and spending shifts within the federal government meant that much of the changes were to be financed by borrowing. Reagan argued that lowering taxes would revive the economy. When the economy revived, the increased tax revenues would be used to help reduce the deficit. Excluding military spending, he argued for broad cuts in government spending, which he viewed as a drain on the economy. Reagan raised military spending, however, as he saw the nation's defense as an integral government function, especially in regard to the Cold War.
The disagreement between "Reaganomics" and New classical economics (a modern economic theory which emphasizes that free markets self-regulate most efficiently and optimally) becomes clear with understanding Reagan's exceptional military spending. While taxes were cut and thus endorsing that element of neoclassical theory, massive military spending in the Reagan era resulted in a massive budget deficit. The 1983 deficit reached $207.8 billion, equivalent to 6 % of the economy, the highest level since the World War II era. This emphatic deficit spending violates what some people believe is neoclassical economic theory's emphasis on a balanced budget -- though in fact, most proponents of conservative economics (James Buchanan, Milton Friedman for example) emphasized balanced budgets as a means to an end -- the end being restraining government spending. Friedman in particular is quoted as saying he would rather have a $200 billion government budget financed by deficits than a $400 billion government budget fully balanced.
Absent budget balance, private actors will rationally expect, as explained by the Ricardian equivalence, for taxes to increase sometime in the future to offset this deficit, and will end up saving enough to offset any increase in consumption resulting from government spending. This argument leads many to argue that deficits represent TAX LAG. Furthermore, deficit spending is problematic under neoclassical theory because even if the Federal Reserve lowers the federal funds rate to keep interest rates low and combat this "crowding out" effect, the rational public will see the lack of credibility with this merely fiscal-policy-reactionary monetary policy.
The historical experience of Reaganomics is of a leveling off of non-defense spending after decades of increasing non-defense spending prior, increased defense spending, and large federal deficits. Nobel economist, Milton Friedman, has pointed to the number of pages added to the Federal Register each year as evidence of Reagan's anti-regulation presidency (the Register records the rules and regulations that federal agencies issue per year). [1] The number of pages added to the Register each year declined sharply at the start of the Ronald Reagan presidency breaking a steady and sharp increase since 1960. The increase in the number of pages added per year resumed an upward, though less steep, trend after Reagan left office. In contrast, the number of pages being added each year increased under Ford, Carter, H.W. Bush, Clinton, and others.
History
The large, across the board tax cuts initiated by Reagan at the start of his administration were based on principles from supply-side economics or the trickle-down effect. This was contrary to the demand-side economics of traditional Keynesianism, which tries to bring the economy to its existing full capacity by means of increasing demand, primarily through fiscal policy. In the 1970s, many on the right became critical of Keynesianism, which they claimed brought higher inflation without any gains in employment. However, true Keynesianism, which called for deficit spending during recessions and surplus saving during periods of prosperity, was rarely implemented in its totality in American politics, usually because political considerations overshadowed fiscal policy.
The early Reagan tax cuts of August 1981 embodied Reagan's supply-side economics. Economist Robert J. Gordon writes in his textbook Macroeconomics (9th ed. 2003, p. 392) that this was "the most dramatic shift in fiscal policy of the postwar era not related to the financing of wars."
The Tax Reform Act of 1986, which had broad bipartisan support, partly implemented the principles of supply-side economics in a more moderate way. It simplified the tax code and eliminated tax loopholes.
The belief by some proponents of Reaganomics that the tax rate cuts would more than pay for themselves was influenced by the Laffer curve, a theoretical taxation model that was particularly in vogue among some American conservatives during the 1970s. Arthur Laffer's model predicts that excessive tax rates actually reduce potential tax revenues, by lowering the incentive to produce. Federal Government tax revenues did increase significantly following the tax cuts of the Reagan years; it was the dramatic increase in spending that produced the budget deficits of that era.
Before Reagan's election, Reaganomics was considered extreme by the liberal wing of the Republican Party. While running against Reagan for the Presidential nomination in 1980, George Bush had derided Reaganomics as "voodoo economics". Similarly, in 1976, Gerald Ford had severely criticized Reagan's proposal to turn back a large part of the Federal budget to the states. After the Reagan election, however, most Republicans endorsed Reaganomics, including Bush, who became Reagan's Vice President.
Support for Reaganomics
A study from the Cato Institute (a Libertarian think tank, which supports many of the premises that lie behind Reaganomics) said:
- Real economic growth averaged 3.2 % during the Reagan years versus 2.8 % during the Ford-Carter years and 2.1 % during the Bush-Clinton years.
- Real median family income grew by $4,000 during the Reagan period after experiencing no growth in the pre-Reagan years; it experienced a loss of almost $1,500 in the post-Reagan years. (source)
Laffer and Reagan were vindicated by the results of the Reagan tax cuts. Real per capita GDP increased at an annual rate of 2.6% from 1981 to 1989, after languishing at a 1.6% rate during the Carter years of 1977 to 1981. Citation: Louis Johnston and Samuel H. Williamson, "The Annual Real and Nominal GDP for the United States, 1789 - Present." Economic History Services, March 2004, URL : http://www.eh.net/hmit/gdp/
Reagan's supply-side model changed the paradigm of government involvement in the economy. Keynesian economists were at a loss to explain why the aggregate demand increases of the 1970's did not result in improved national economic performance. Likewise, they could not explain how to reverse the shift in the Phillips curve. The Reagan-Laffer-Volcker-Milton Friedman model of improving economic performance by reducing government involvement in the economy has since gained wide currency. President Clinton ran as a "New Democrat": fiscally conservative and trade-friendly. Estonia, Latvia, Slovakia, Serbia, Romania, Georgia, Ukraine, as well as Russia and Iraq have variations of the flat tax. Governor Bill Richardson of New Mexico cut personal income taxes in 2003 "to spur growth and investment". [2]
The President Reagan Information Page [3] details numerous economic statisics from the Reagan era. Highlights include the reduction of inflation, poverty and unemployment; the increase in jobs, incomes and real weatlh; increase in individual income tax receipts and overall federal receipts and an analysis of the Reagan spending proposals on the federal deficit.
Replies to this Defense
The arguments quoted above from a Cato study show the importance of not drawing conclusions from a cursory analysis of a small subset of the available data. The study calculates the average real GDP growth during a pre-Reagan period (1974-81), Reagan period (1981-89), and post-Reagan period (1989-95). The averages from the 1996 Economic Report of the President are 2.8, 3.2, and 2.1 %, respectively. Updating them from Table B-2 in the 2005 Economic Report of the President, the averages are 2.97, 3.55, and 2.37 %, respectively. In looking at all of the data, however, it appears that the economy has been following a 10-year cycle during the past several decades. There were recessions in 2001, 1990-91, 1980-82 (a double-dip recession), 1974-75, 1969-70, and 1960-61. Hence, except for the recession in the mid 70s, the recessions have come at the beginning of each and every decade. For this reason, it makes more sense to measure the average growth in GDP over 10-year periods since 1960. Doing this gives average GDP growths of 4.21 % (1960-70), 3.23 % (1970-80), 3.28 % (1980-90), and 3.29 % (1990-2000). Hence, this measure suggests that GDP growth was stronger during the 60s but was about the same in the 70s, 80s, and 90s. While not perfect, these periods more closely measure the growth during full economic cycles than those used by the Cato study.
An even more surprising result comes from looking more closely at real median family income. The Cato study states that it experienced no growth during the pre-Reagan period, grew by $4,000 (1994 dollars) during the Reagan period, and shrunk by almost $1,500 dollars during the post-Reagan period. Looking at recent census data, real median family income did grow a mere $55 (2003 dollars) from 1973 to 1981, grew $5,740 from 1981 to 1989, and shrank $335 from 1989 to 1995. However, Figure 2 in the Cato report shows the reason for this. During the Reagan period, the author is measuring very nearly from a trough to a peak in family earnings. This means that the pre-Reagan period is measuring TO a trough and the post-Reagan period is measuring FROM a peak. In fact, real median family income has been reaching a peak about every ten years since about 1969. It reached peaks in 2000, 1989, 1979, and 1969. Measuring the growth every ten years since 1969 gives growths of $5,426 (1969-79), $3,025 (1979-89) and $4,887 (1989-99). Incidentally, the growth from 1959 to 1969 was $11,539. Hence, over the four decades since 1959, this measure gives the growth of real median family income during the Reagan decade to have been the lowest, not the highest.
Much of the liberalization (telecoms, break up of AT&T, air travel etc.) that many claim helped to reinvigorate the American economy was initiated in the 1970s under President Carter and received broad bipartisan support. For example, deregulation of the airlines was initiated under the leadership of Alfred Kahn in 1978. It can also be argued that liberalization has increased the amount of insecurity suffered by the average citizen, while encouraging wage cuts, the decline of unionization, the rise of profits, and the like.
Reagan's tax policies were accused of pushing both the international transactions current account and the federal budget into deficit and led to a significant increase in public debt. Advocates of the Laffer Curve contend that the tax cuts did lead to a near doubling of tax receipts ($517 billion in 1980 to $1,032 billion in 1990), so that the deficits were actually caused by an increase in government spending. However, Historical Table 1.3 in the 2006 U.S. Budget shows that revenues had likewise doubled (or better) during every decade since the Great Depression. They went up 506% during the 40's, 135% during the 50's, 108% during the 60's, and 168% during the 70's. At 96 %, they nearly doubled in the 90s as well. Furthermore, according to Historical Table 2.1, the receipts from individual income taxes (the only receipts directly affected by the tax cuts) went up just 91 % during the 80's. Meanwhile, receipts from Social Insurance, which is directly affected by the FICA tax rate, went up 141 %. This larger increase was largely due to the fact that the FICA tax rate went up 25% from 6.13 to 7.65 % of payroll. Reagan also signed into law six other tax increases from 1982 through 1987, (The Tax Equity and Fiscal Responsibility Act (TEFRA), The Highway Revenue Act, the Deficit Reduction Act of 1984, the Consolidated Omnibus Budget Reconciliation Act of 1985, The Tax Reform Act of 1986, and the Omnibus Budget Reconciliation Act of 1987). Hence, the increase in revenues in the 80s was no larger than other recent decades and a portion of that increase was arguably due to tax increases enacted during the Reagan administration, not from stimulus provided by supply-side cuts.
In addition, old-fashioned Keynesian economics has argued for many decades that any fiscal stimulus helps "pay for itself" by increasing aggregate demand and gross domestic product and lowering unemployment. These forces automatically raise tax revenues and lowers transfer payments such as unemployment insurance. No supply-side effects are needed to understand this story. David Stockman, a key player in selling the Reagan administration's supply-side "pay for itself" claims to Congress, admitted in a 1981 Atlantic Monthly article in that the 1981 tax cut "was always a Trojan horse to bring down the top [tax] rate" for the wealthy.
The disinflation had been initiated by Fed chairman Volcker before Reagan assumed office. An anti-inflation monetary policy program had been begun by Fed Chair Volcker in the latter days of the Carter administration, but it took awhile to take hold, so that inflation was still near a historical peak around the time of the 1980 elections. In fact, instead of helping restore prosperity, Reagan's budget deficits threatened Volcker's monetary policy by encouraging concerns that the U.S. government might decide to inflate away America's rapidly growing debt, and made it more difficult for the Federal Reserve to earn confidence in the sustainability of its low-inflation policies.
A recession occurred in 1982, his second year in office. Almost no one blames this on the Reagan administration. Instead, it was central to Volcker's campaign against inflation: applying either the Phillips Curve or the NAIRU theory, high unemployment (almost 10 % of the labor force in both 1982 and 1983) undercuts inflation. Reagan benefited from the fact that Volcker relented (shifting to more expansionary monetary policy) after inflation had largely been beaten. Further, the sudden fall in oil prices around 1986 helped the economy attain demand growth without inflation in the late 1980s.
The job growth under the Reagan administration was an average of 2.1% per year, which is in the middle of the pack of twentieth-century Presidents.
External links
Proponent Think Tank Papers:
The President Reagan Information Page
PBS Commanding Heights: The Battle for the World Economy
Topics From WWW.EconLib.Org: