This a a follow-up to yesterday’s post about the fact that shifting norms and institutions meant that productivity gains were no longer shared with workers from the 1970s onwards, leading to rising inequality. There seems to be a prevailing myth that somehow the free market reforms initiated by the Reagan administration– cutting top marginal tax rates, crushing unions, curbing welfare, deregulation etc– led to superior economic outcomes. This is dogma among Republicans in particular. And many Catholics are claiming that this period has led the Church to modify its criticism of capitalism, from being regarded alongside socialism as one of the “twin rocks of shipwreck” by Pope Pius XI to being embraced by Pope John Paul II in Centissimus Annus. I don’t mean to single out Joseph Bottom here, but he perfectly encapsulates this view in this quote:
“What the Reaganites believed was that a healthy economy can bring about new sources of finance—an economic truth that the riches of one person does not necessarily mean the poverty of another, but, in fact, the creation of new wealth can benefit the whole of society and advance the common good. Centesimus Annus recognizes this truth, and yet, at the same time, it rests on the foundation of the great Leonine teachings….”
I’ll ignore the fact that this group is patently mis-interpreting Centissimus Annus in its zeal to align Catholicism with free market economics. What I want to address in this post is something more fundamental: the analysis is wrong. As I showed in yesterday’s post, the period from the 1970s onwards saw very little movement in median wages, the best measure of middle class living standards. It is not the case that the creation of wealth benefits society as a whole and advances the common good if we ignore the distributional implications. But here’s the rub: wealth did not increase that much during this era.
In the early 1970s, productivity growth slowed down dramatically. If you look at the standard measure of non-farm productivity, you will see a solid expansion of 2.8 percent a year on average between 1948-73. Between 1973-95, it slowed down to 1.4 percent, and rose again to 2.7 percent in the decade since 1995. If instead we look at Dean Baker’s more appropriate concept of “usable productivity”– the amount of productivity available for wages– the comparison is even more stark. After rising by 3.1 percent a year on average between 1948-73, it fell to 0.9 percent in the 1973-95 period, and rose again to 1.8 percent after 1995; the increase still fell short of the earlier juggernaut. What this shows is that even if wages had been shared, worker’s living standards would not have been able to rise to the levels as during the postwar period. Put simply, the pie stopped growing rapidly.
What happened? This is much debated, and I don’t really want to debate the full range of causes here. Suffice it to say that there two major global supply shocks in the 1970s (from oil prices) that had the effect of lowering growth and raising inflation. That was classic stagflation. The problem was compounded by an inappropriate policy response; weaned on naive Keynesian, and never having faced a shock of this magnitude, policymakers responded by loosening monetary and fiscal policy– pumping out money and running up deficits. But, as they quickly learned, that won’t work in a supply shock and all you get is more inflation, combined with skyrocketing interest rates. Welcome to the 1970s.
What happened in the next quarter century was that macroeconomic stability was gradually restored. Let’s start with monetary policy and the Volcker recession of the early 1980s. The problem is that once high inflation expectations become ingrained, and feed through to contracts, it becomes very difficult to squeeze inflation out of the system. The only way to do it was through a severe recession, which is what happened. It was paying the price for the mistakes of the 1970s.
Fiscal policy discipline was not restored until the Clinton administration; in fact, the deficit kept increasing under the Reagan administration. It was only through the combination of Greenspan and Rubin that the fiscal-monetary nexus managed to secure low inflation, and low interest rates. In other words, we were back to the stability of the postwar world, but it took a quarter century.
Notice what’s missing in this story: any discussion of the Reagan “reforms”. If these policies had worked, we would have expected a supply boost. That never materialized, as witnessed by the lousy productivity growth. Instead, the Reagan boom– beloved of the supply side crowd– was simply an aggregate demand response to a very severe recession. It was just a course correction, not an expansion in the pie. The pie only expanded again after 1995, and even then, not to the extent a generation earlier. Clinton, of course, was lucky: his terms of office coincided withe the tech boom which boosted productivity. But macroeconomic stability provided the groundwork.
So what about the tax cuts and the other stuff? Not so much. Tax cuts for sure had some effect on aggregate demand, but the effect of supply is minimal. We need to remember that during the height of the boom in the postwar period marginal tax rates were high and unions were strong. During the weaker growth period, marginal tax rates were low and unions were weak. There difference lay not so much in the size of the pie, but in its distribution. Put another way, it is really hard to justify policies that redistribute income upwards, but do not increase growth.
Ad-Free & Subscriber Log-In