On Nov. 6 the US economy will be sunny, but can President Reagan take the credit?
President Reagan's bid for reelection has nothing to fear from behavior of the United States economy. In two weeks, when Americans go to the polls, the economic skies will look sunny.
Does that mean reelection of the Republican candidate will be good for the United States and the world economy over the next four years? It is easy to give a partisan answer to such a question. I shall attempt here the more difficult task of examining the evidence so that readers can form their own judgments on this vital matter.
The first Reagan term was a mixed bag. When Ronald Reagan took over, the economy was in a recovery from the 1980 Carter recession: It was not a case of a disastrous economic Dunkirk.
By mid-1981 a new recession had begun. Was this because of Reaganomics or in spite of it? Although the Federal Reserve's vendetta against inflation was one important factor in the downturn, examining the evidence on how high real interest rates were becoming convinces me that an important initiating and reinforcing cause of the harsh 1981-82 recession was Wall Street's recognition of the vast structural deficit Reaganomics was creating.
Investors loved the tax breaks they were getting from the Kemp-Roth and other supply-side-economics programs. But they correctly predicted that the result would be a crowding out of private-investment borrowing by the needs of the Treasury to finance the colossal deficits. Fearing such future rises in interest rates, they prudently dumped their bonds and thereby helped bring about the realization of what they feared.
So it was Reaganomics that caused the high mortgage interest rates that choked off housing; that caused the recession slump in consumer spending on durable goods; and that forced states and localities to postpone capital projects at the same time that plant and equipment investment was stagnating.
What then brought about the eventual end of the deep and lasting first Reagan recession? Can the President at least take the credit for the recovery at the end of 1982?
A look at the record of events discredits any such claim. It was Paul Volcker and the Federal Reserve that deserve praise for contriving the ultimate recovery. From August 1982 on, the Fed indulged in a bout of Keynesian fine tuning. This time it worked. The bond market soared, bringing easy money to the responding house-construction industry. Stocks took their cue from bonds and leaped up 60 percent in the year after mid-1982.
Despite the claims of supply-siders like Arthur Laffer and Congressman Jack Kemp, it was consumers and not investors who were the first heroes of the recovery. It was a typical demand-side scenario: A rise in consumption spending, housing, and net inventory accumulation triggered the strong expansion.
Despite the theories of the school of rational expectations, when citizens recognized the huge deficits ahead, they failed to offset its tremendous public thriftlessness by a massive increase in the private saving rate. In the face of criticism by the school of monetarism, the Fed engineered a temporary sprint of the money supply, helping thereby to ensure the vigor of the initial recovery.
In summary, the novel predictions of the supply-side advisers of Ronald Reagan were falsified by the actual history of events. In accordance with conventional tenets of neoclassical economics, the tax incentives for new investment succeeded, with a lag, in producing a rise in equipment investment even in the face of unprecedented heights of the real rate of interest.
The new structural deficit gave purchasing power a boost, as defense spending multiplied and taxpayers were excused from paying out of current income for the maintained social-welfare programs.
This objective review of the past is needed to narrow down the probabilities concerning the next four years.
The public at large, which makes no pretense at deep economic analysis, is content to enjoy the Reagan luck. If only it will last indefinitely!
Reelection of Ronald Reagan, in my reading of past history and personality patterns, will imply perpetuation of the huge structural deficit. This contradicts flatly the comfortable belief that, after the election hoopla, whoever wins will have to buckle down and push through new tax-revenue programs aimed to cut the structural deficit deeply.
The President is not fooling the people in concealing the need for new taxes next year. He is fooling himself. He really does hate taxes. He regards them not as necessary evils, merely as evils - avoidable evils.
Ten years from now we shall still be experiencing large deficits, which are remaining large even in times of high employment and strong growth. An upset election of Walter Mondale would entail a stronger effort to curb the structural deficit. But once a society tastes the intoxication of on-the-cuff finance, the temptation to continue is strong.
In all likelihood, real interest rates will remain high - certainly higher than if we were not an undertaxing society. By 1985 or 1986, the already-present signs of weakness in the recovery will most probably have brought it to an end. At best a growth recession will ensue; at worst a new recession. Whether it will end in the bang of a money crunch, or in the whimper of a construction letdown, is beyond the power of economic science to predict.
For the world at large, the Reagan bout of frenzied finance is not all bad. Already it has provided stimulus for a recovery in Japan, Europe, and the third-world countries. Workers and machines abroad are able to benefit from the competitive disadvantage US industries labor under because of the dollar overvaluation that stems from the budget deficit and high interest rates.
Within a few years investors abroad will have bought back from Americans much or all of the ownership of assets abroad that we have painfully accumulated in all previous history. Prolongation of the trade deficits would result, eventually, in ever greater ownership of American domestic assets by foreigners.
Of course the President does not understand all this. Why should a layman apprehend such nuances? But if all were explained to Ronald Reagan, I doubt that he would want to alter his policy. So strong is his dislike of high government spending that he would want to continue to starve the country of tax revenue even if that entailed the cost of a large structural deficit and a low-investment economy.