The Political Economy of Reaganomics

A Critique

Stephen Rousseas

• Publisher: Routledge
• Year: 2015
• ISBN:
  9781317273479
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

According to Stephen Rousseas, economics cannot be separated from politics. Here, he provides theoretical background and insight into the ideology of supply-side economics, commonly referred to as Reaganomics. As a Post Keynesian, Rousseas is critical of supply-side economics and the Reagan administration's attempt to counter-revolutionise the demand-side economics of the earlier twentieth century. Originally published in 1982, this title is ideal for students of Economics and Politics, as well as the general reader interested in the subject.

Chapter 1
The Crisis of Faith

I

Prevailing social theories are convenient constructions of reality which seek, more often than not, to justify whatever is by forcing the "facts" of social existence into preconceived ideological boxes. They are, when things are going well, celebrations of the status quo, and the main spokesmen for establishment theory serve as the legitimators of power and those who wield it. Immutable "laws" are propounded which "prove," on scientific grounds, that the system is just, and being just, predestined to go on forever. When things are not going too well, the theoretical guardians of the conventional wisdom tend to scold and to attribute the malfunctioning of the system to violations of sacred maxims.

Such was the state of affairs, a little over fifty years ago, with the onset of the Great Depression. It was by far the greatest challenge American capitalism had to face since the Civil War. On a black Thursday the stock market crash wiped out the paper wealth of the newly rich, and massive bank failures cleaned out the life savings of many of the not-so-rich. Real output fell by one-third, factories closed, and unemployment (as officially measured) soared to 25 percent of the labor force. According to the conventional theory of the time, it could not and should not have happened.

In its purest and most ideal form, capitalism was seen to operate within a system of competitive markets. Markets were simply the institutional arrangements within which buyers and sellers confronted each other. No single participant was big enough, either by the amount of a particular good or service he wished to purchase or the amount he was willing to sell on the market, to have any noticeable effect on price. Power was so widely diffused as not to be a social problem. All prices were determined by the free interplay of individuals in unfettered markets, and all players sought their own individual private gain in total disregard for the welfare of others or, for that matter, for the welfare of society as a whole, which was simply the algebraic sum of the welfare of its constituent parts. The market system automatically assured that the greatest public good was to be derived from the greatest private selfishness. When not tampered with, the market transformed the innate selfishness of man into a natural and unintended harmony of interests.

Such was the theoretical system that Adam Smith had wrought in 1776 when he published his monumental work, the Wealth of Nations. The individual, he wrote, "intends only his own security and...intends only his own gain, and he is in this ... led by an invisible hand to promote an end which was not part of his intention." And that unintended "end" was the social welfare, itself the by-product of the free-wheeling forces of an impersonal market system, which also seemed to guarantee an equitable distribution of the social product among all members of society. Above all, as Adam Smith's theoretical system was subsequently refined, capitalism was described as automatically tending toward full employment along a dynamic growth path. Any lapse from this ideal would be automatically corrected by built-in, spontaneous market forces. Changes in relative prices, in other words, would assure the optimal allocation and use of all resources. Short-run changes in the level of real output, and hence employment, by being ephemeral, could therefore be ignored. Capitalism, by its very nature, was in tune with the harmony of the universe. Everything was in exquisite balance. Although the "laws" of economics were patterned after those of Newton, they were different in one essential respect. Unlike the laws of the physical universe, the laws of economics could be violated, with disastrous results.

Adam Smith was not unaware of the great perils confronting freely competitive markets. "People of the same trade," he wrote, "seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices." The threat of monopoly was always lurking in the wings. Government, however, was an even greater threat to the market system than the private abuses of monopoly power. In 1876, one hundred years after the publication of the Wealth of Nations, the Political Economy Club of London met to honor the event. "One of the great dangers which now hangs over this country," warned the treasurer of the Club, "is that the wholesome spontaneous operation of human interests and human desires seems to be in course of rapid supersession by the erection of one Governmental department over another ... and by the whole term of Parliament being taken up in attempting to do for the nation those very things which, if the teaching of the man whose name we are celebrating today is to bear any fruit at all, the nation can do much better for itself." It was the role of political economy, as laid out by Adam Smith and his successors, to "reduce the functions of government within a smaller and smaller compass." The chairman of the centennial celebration reinforced the treasurer's inquietudes by stating that the primary and overriding duty of economists lay in "propagating opinions which shall have the effect of confining government within its proper province and preventing it from all manner of aggressions and intrusions upon the province and the free agency of the individual."¹ The sole function of government, it was agreed, was to provide for the national security, to enforce and uphold legal contracts, and to promote civil law and order.

II

These ideas reigned supreme—at least on the level of ideology—up to the crash of 1929. True, panics and cycles were a part of our past, but they were fleeting incidents in a rapidly growing, exuberant economy engaged in the heady process of creative destruction. Cycles were seen as temporary phenomena, an unavoidable part of capitalism to be borne in stoic silence. A leading school of economics attributed them to sunspots. There could thus be no moral public responsibility for the short-run suffering of the mass of people, and, if the poor suffered unduly, it was because of their failure to limit their daily consumption in good times in order to provide for the inevitable rainy days. For others, cycles were purely monetary phenomena attributable to a perverse elasticity of the money supply, which the creation of the Federal Reserve System in 1913 had solved once and for all—or so it was thought. American capitalism, in the 1920s, was seen by the economics profession as marching forward resolutely on a plateau of infinite prosperity. The era of Giant Capitalism in the 1910s was played down; the idealized market system continued to hold sway, at least in the minds of economists. Then came the collapse.

One of the great axioms of our existence is: What is, is possible, even if a theory says that it is not. A corollary is: And if it is possible and does exist, then it is the theory that has to go, not the real world. Conventional market theory, however, held on. It argued that nothing was wrong with the theory; it was the real world that was out of whack. The "laws" of economics had been transgressed, the economy was living in sin, and the wages of sin are retribution. We were being punished for our evil ways. Apply the antitrust laws, break up the unions, take the government out of the business of running the economy, and market forces would quickly move us back to the natural level of full employment. With flexible market prices, flexible wages, and no governmental interference with market forces, adjustments in relative prices would result in the reallocation of resources needed to restore full employment. The policy recommendations followed logically from the supporting theory, but they were politically naive. No elected government was about to take on big business and big labor at the same time. Apart from political considerations, such policies would further wreck the economy by trying to go back to something that had never existed in the first place, except in the mythology of the underlying theory.

The Great Depression could not be denied. It was there in all its black majesty and it was not just another transient rainy day. It was a storm that threatened the very survival of the system and there was no new theory to provide a quick fix; Keynes's General Theory (1936) came later. With rejection of the naive policy nostrums of conventional theory, the political response in the United States was a pragmatic groping for solutions which led to that amalgam of policies called the New Deal. Its public works projects, its relief for the poor, its civilian conservation program for unemployed youth, the National Recovery Act (NRA), and the establishment of a social security system—all these gave some measure of hope to a dispirited nation. The federal budget went from a $737 million surplus in 1930 to a $4.5 billion deficit in 1936. The public debt, in the process, more than doubled. It went from $16 billion in 1930 to $34 billion in 1936. By 1940 it had reached $43 billion, a phenomenal amount for its time and one that led to repeated warnings of bankruptcy and impending disaster. Yet, in retrospect, the New Deal did too little rather than too much. After a slow recovery, the U.S. economy dropped sharply once again in 1937. It began its full recovery only in 1939 with the onset of World War II in Europe, and with the direct involvement of the United States in 1941.

As World War II was coming to an end and victory seemed assured, the old fears resurfaced. As a warning to its corporate subscribers, Leo Cherne's Research Institute of America predicted (on expensive linen paper) 11 million people unemployed in the immediate postwar period. The Pabst Blue Ribbon Beer Company announced a competition, with a $25,000 first prize, for the best 2,000-word essay on how to avoid sliding back into the mass unemployment of the prewar period. The National Planning Association was established in Washington and it quickly recruited a staff of professional economists to work on a national plan for the postwar reconversion of the economy. The British White Paper of 1945, for the first time in modern history, proclaimed the government's responsibility to provide for full employment in the postwar world, and in the United States the Employment Act of 1946 committed the federal government to the maintenance of maximum employment, full employment being too controversial for the U.S. Congress. And in the late 1940s the United Nations convened a Committee of Experts (Nicholas Kaldor, Arthur Smithies, John Maurice Clark, Pierre Uri, and E. Ronald Walker) to propose National and International Measures for Full Employment. Governments (particularly the United States) were to be held responsible for the overall high-level performance of their economies, which was to be assured by the adoption of appropriately stabilizing fiscal measures. It was on this basis that we entered the postwar period with some trepidation but armed with the new Keynesian theory for managing aggregate demand. Government was to compensate for the occasional market failings of the capitalist system, with special emphasis on the "free" market's failure to provide for full employment.

Keynesian economics gathered momentum in the postwar period and quickly provided, ex post facto, the intellectual rationale for the earlier pragmatic policies of the New Deal. In a stagnant economy operating at considerably less than full employment, government expenditure and tax policies were to be used to stimulate aggregate demand. Personal income tax cuts would increase disposable income. Consumption expenditures would increase as a result, which, in turn, would stimulate private investment and output. Business tax cuts, on the other hand, would work more directly to spur investment by providing the additional cash flows businessmen needed to finance their capital outlays—thereby moving the economy closer still to full employment. On top of this, government expenditures in the form of public works would provide jobs for the unemployed and pump additional purchasing power into the economy via the construction of dams, roads, city halls, schools, hospitals, and other forms of social capital. Finally, governmental transfer payments in the form of relief for the unemployed would alleviate human suffering in the interim until the economy could get moving again.

The government's impact on output and unemployment would be primarily through the government budget. Its tool would be an expansionary fiscal policy and deficit financing, and its role would be compensatory—temporarily filling in the gap between actual private outlays and the amount of aggregate demand needed to achieve a full-employment economy. Monetary policy, in this scheme, was to play a lesser role. In the 1930s and the immediate postwar years, the banking system was awash in a sea of liquidity, and it was recognized that additional bank reserves could not of themselves stimulate an increase in the demand for loans without the prior play of fiscal policy.

Prior to the war, the Temporary National Economic Committee (TNEC) in Washington had held hearings on the failure of the economy and published volumes describing interlocking corporate directorships and monopolistic restraints on trade. By the onset of the postwar period, the market system had been discredited and the end of laissez-faire proclaimed. It was no longer believed that there was a natural tendency of capitalism to move toward full employment. Indeed, as viewed within a Keynesian framework, capitalism could well rest at a chronic level of underemployment indefinitely. Theories of secular stagnation abounded, and an increased role of government was seen as the only way out of the morass. This was the state of affairs when World War II broke out. It was left to the postwar period to build on the Keynesian foundation and to refine its policy tools to their highest "fine tuning" degree of "perfection" in the Kennedy administration—until Keynesian theory itself came onto hard times in the 1970s.

III

For the most part, the postwar period was an economic success. The fear of another Great Depression was replaced by a series of mild, short-lived recessions. The trend of real output, real wages, and productivity was upward and inflation, by current standards, was a relatively minor problem. Everyone was a Keynesian, including the Republicans, or so Walter Heller said at the end of his tenure as chairman of Kennedy's Council of Economic Advisors. Then came the 1970s and the problem of stagflation—low growth accompanied by high unemployment and inflation. Keynesian economics itself was now on trial.

A retrospective on the postwar period was held in 1980, on the occasion of the sixtieth anniversary of the influential National Bureau of Economic Research (NBER). At its conference on The American Economy in Transition,² participants were asked to review the overall postwar performance of the American economy from the point of view of their specialties.

The year 1980 was not a good one. The economy was once again in serious trouble. Echoing the treasurer of the Political Economy Club of London in 1876, Martin Feldstein, a leader of the current counterrevolution and host of the conference as director of the NBER, attributed the poor performance of the American economy to government interference. The worm had turned. "There can be no doubt," he wrote, "that government policies ... deserve substantial blame for [our] adverse experience" (p. 3). Government regulations, income transfer and social insurance programs, and the inhibiting tax effects on capital accumulation had sapped the vitality of capitalism.

Feidstein's views, however, were hardly reflected in the other papers presented at that conference. Instead of a return to "the years of chaos and depression," the postwar economy, according to Benjamin Friedman, had "entered an era of stability and prosperity" with not only a higher average growth rate in the postwar years "but also a smaller variability of that growth" (pp. 11-13). The "categorical imperative" of postwar policymakers, in the opinion of the late Arthur Okun, was the avoidance of the Great Depression, and in that, he argued, they had largely succeeded. The business cycle had indeed been tamed, or at least brought within politically tolerable limits. This newfound stability, moreover, was greater than at any other time. "The standard deviation of real GNP around its growth trend," wrote Okun, "was about one-fourth as large as it had been in 1900-45, and only half as large as in the 'golden age' of 1900-16, 1920-29." Whereas expansions averaged twenty-six months and contractions twenty-one months from 1854 to 1937, the postwar expansions had an average duration of forty-eight months with contractions compressed to an average of eleven months. "This quantum jump in stability," said Okun, "must ... be credited to public policy. It was made in Washington," and it was "the compositional shift" to a larger public sector GNP share that constituted "the largest single stabilizing element." The growth of government transfer payments was another factor contributing to the marked reduction in cyclical instability. Although the postwar record of macroeconomic policy "in dealing with relatively minor accidents ... is mixed," Keynesian monetary and fiscal policy was eminently successful in avoiding catastrophe. To Okun, the success of postwar economic policy was to be measured "not in dollars of real GNP, but in the survival of United States Capitalism" (1980, pp. 162-63, 168, italics supplied).

Okun's assessment of the postwar performance of the U.S. economy was reinforced by Alan S. Blinder's analysis of the postwar distribution of income. From 1947 to 1977 "real consumption per capita increased by more than 80 percent." At the same time "the basic necessities of life—food, clothing, and shelter—commanded ever decreasing shares of the consumer budget." The net result was a drastic improvement in "the average level of economic well-being" as well as in its content (p. 433). The increasing levels of per capita real income, however, did not affect the distribution of income which remained virtually unchanged, with a Gini ratio³ ranging from a low of .40 to a high of .42, with the mean smack in the middle at .41. Although there was little change in the postwar distribution of income, it was "noticeably more equal than the distribution of 1929" (p. 435). Despite this improvement, however, the United States continues to have a higher inequality of income distribution than many other industrialized countries and has the dubious distinction of competing with France for the worst among the Organization for Economic Cooperation and D...

Table of contents

• Cover
• Title
• Copyright
• Original Title
• Original Copyright
• Dedication
• Contents
• Preface
• Chapter 1: The Crisis of Faith
• Chapter 2: Classical Supply-Side Economics
• Chapter 3: Demand-Side Economics
• Chapter 4: Monetarist Supply-Side Economics
• Chapter 5: Supply-Side Praxis
• Chapter 6: The Great Confession and Its Aftermath
• Chapter 7: The Threat of Delegitimation