|
|
|
|
Map of Middle East |
CIAO DATE: 8/01
The Seventeen-Year Boom
On The Issues
March 2000
The current economic expansion, which officially dates from 1991, is better viewed as stretching back to 1982. (The only hiatus occurred after Iraq invaded Kuwait and precipitated a spike in oil prices and two quarters of contraction in the U.S. economy.) The seventeen-year boom was triggered by a series of policy decisions that let markets do their work of tying risk to reward throughout the economy.
Bill Clinton takes credit for what is now the longest peacetime economic expansion in U.S. history. But when historians look back, they will date the current expansion from 1982-not 1991, when the last, brief recession ended, and certainly not 1993, when Mr. Clinton took office.
It was in late 1982 that a sea change occurred in the American economy. True, this seventeen-year expansion was briefly interrupted by two successive quarters of economic contraction in 1990-91, the shortest period that meets the definition of recession. But in terms of economic performance, government policy, and effect on the thinking of professional economists, the 1980s and 1990s form a continuous era radically different from what preceded it. How this expansion ends will no doubt shape economic performance, policy, and philosophy in the new century.
The power of this seventeen-year expansion is as impressive as its durability. The level of real per capita consumption has risen 36 percent. Almost 35 million jobs have been created. The Dow Jones Industrial Average has risen thirteen-fold. Economic optimism reigns supreme.
The mildness of the 1990-91 recession underscores just how powerful the process that began in 1982 has been. The recession coincided with the Iraqi invasion of Kuwait and the Gulf War. Oil prices spiked. The banking system was being restructured, a painful process that has crippled other countries' economies. Either of these shocks would have been enough to cause a severe recession in years past. Both together induced only a mild downturn a decade ago.
The economy also shrugged off the deliberate tightening of fiscal and monetary policy. By 1990 the Federal Reserve had already raised interest rates almost 400 basis points to cool the economy. The combined effects of bank restructuring and monetary tightening cut the rate of money growth to its lowest level since World War II. In addition, Congress and President Bush had agreed on a very sharp fiscal tightening program, which contemplated cutting the cyclically adjusted deficit to 1.7 percent of gross product from 3.2 percent.
What Sparked the Boom?
Obviously, something started in the 1980s that energized the economy like never before. What was it? Markets simply were allowed to work. The change began with an intellectual shift among economists, which was followed by important changes in both public policy and private-sector practice, helped along by the information-technology revolution.
In the 1970s economists began moving away from the "modern mixed economy" model that grew out of the New Deal, World War II, and the Cold War. That regime reached its intellectual zenith in John Kenneth Galbraith's 1967 book, The New Industrial State. The central feature of the old model was not competition but countervailing power among business, labor, and government.
The new view challenged the old in four major ways. First, in the 1970s the "capture theory" of regulation challenged the regulatory regimes that dominated many major American industries. Economists came to see that stockholders, workers, and consumers weren't benefiting from a cozy set of deals between entrenched corporate management, labor bosses, and a permanent bureaucracy. Successful deregulatory experiments in transportation served as a model for other industries, including finance and energy.
Second, economists came to understand how high marginal tax rates stifle creativity and entrepreneurship, while largely failing to raise revenues. Capital gains tax rates were reduced in 1978, and ordinary income tax rates were cut in 1981 and 1986.
Third, old macroeconomic theories were discredited. Economists came to see "supply side" management of both inflation expectations and the supply of labor and capital as at least as important as "demand side" management of spending power. Milton Friedman's lonely voice gave way to a chorus, and the Reagan administration translated it into policy.
Fourth, the field of finance underwent a revolution. The concept of systematically parsing financial risk into component parts and selling those parts to individuals willing to assume the risks has remade our capital markets in just over a quarter century. It made possible the triumph of shareholders over previously entrenched management by creating a vibrant market for corporate control.
New Economic Era?
Does this all mean we're in a new economic era? Perhaps. But neither the laws of economics nor the fundamentals of human nature have changed. It is useful to reread the economic commentaries of the 1960s, when the last "new economic era" dawned. The hubris of that period's intellectuals and policy makers led directly to the policy blunders of the late 1960s and 1970s. A stock market that had risen almost continuously-to 1000 in early 1966 from 170 in late 1946-was about to enter a sixteen-year period of no nominal increase and a 66 percent decline in inflation-adjusted terms.
The intellectual faith we now have in markets provides hope for the future but also holds a risk. Markets are not perfect, even though they beat any alternative form of economic decision making. They do so because they unite the concepts of risk and reward. They put economic decision-making power in the hands of the person who will suffer if something goes wrong. This concentrates the mind of the decision maker, forcing him to focus on the business at hand. It also diffuses power among many decision makers.
As in the 1960s, the greatest risk we face today is hubris. Already we hear demands that ever more of the economic rewards prosperity has generated should stay in Washington for use by politicians, not the people who earned the money by risking their time and capital. After seventeen years of almost continuous prosperity, it is easy to think that the inherent risks in economic life have vanished and that prudence is pass'. Politicians naturally come to think that society can afford the luxury of having more resources allocated for political rather than economic uses.
Since the Industrial Revolution, economic history tells a story of unprecedented and amazing progress. That progress is steady when viewed over generations, but not when viewed quarter to quarter. Our present prosperity was brought to us by intellectual and political leaders who questioned conventional wisdom, who did not despair at the travails of the moment, who knew that free individuals, not politicians, would create wealth and make the economy grow.
If things continue to go well, will our leaders keep that faith and discipline? If things go wrong, will we think that markets have failed and elect politicians who promise quick fixes if only we give them more power and money? When and how will the present expansion end? How will our politicians respond? The answers to those questions will shape our economic fortunes for decades to come.
Lawrence Lindsey holds the Arthur F. Burns Chair at AEI. A version of this article appeared in the Wall Street Journal on January 27, 2000.
Email this citation