REAGAN and the ECONOMY REAGAN and the ECONOMY The Successes, Failures, and Unfinished Agenda Michael J. Boskin Foreword by Herbert Stein ICS PRESS Institute for Contemporary Studies San Francisco, California Reagan and the Economy Copyright O 1987 by Michael J. Boskin Printed in the United States of America. All rights reserved. No part of this book may be used or reproduced in any manner without written permission except in the case of brief quotations in critical articles and reviews. Inquiries, book orders, and catalogue requests should be addressed to ICS Press, Institute for Contemporary Studies, 243 Kearny Street, San Francisco, California, 94108. (415) 981-5353. Distributed to the trade by Kampmann & Co., New York. Book design and production by Marian Hartsough Library of Congress Cataloging-in-Publication Data Boskin, Michael J. Reagan and the economy. Bibliography: p. 287 Includes index. 1. United States-Economic policy-1981- 2. United States - Economic conditions -1981- 3. Supply-side economics - United States. 4. Reagan, Ronald. I. Title. HCl06.8.B656 1987 338.973 87-22544 ISBN 0-0917616-80-4 Contents Preface vii Acknowledgments ix Foreword xiii CHAPTER1 Introduction and Overview CHAPTER2 An Economic History of the 1970s CHAPTER3 Changing Views on the Changing Economy: The Alleged Crisis in Economics CHAPTER4 Reaganomics 1981-84 CHAPTER5 Reaganomics 1985-86 CHAPTER6 Inflation and Recession: Macro Policy in the Reagan Era CHAPTER7 Budget Policy CHAPTER8 Structural Tax Policy REAGAN AND THE ECONOMY CHAPTER9 Do Deficits Matter? CHAPTER10 The Fairness Issue CHAPTER11 Long-Term Growth CHAPTER12 Is Reaganomics Exportable? CHAPTER13 The Unfinished Agenda APPENDIX Tax Reform Proposals Notes Suggested Reading Preface Seven years ago, on the eve of the Reagan Presidency, the Institute pub- lished a broad study on the U.S. economy, edited by Michael J. Boskin. The study, The Economy in the 1980s: A Program for Growth and Stability, was undertaken at a time of great economic difficulty, perhaps the worst decade since the Great Depression. Inflation was high and rising, the average American family had seen no gain in its standard of living in six years, and taxpayers were growing restless with the rapid growth of government spending. The study presented a broad program for reform- ing economic policy, and it helped change the terms of debate on eco- nomic policy and led to the wholesale reforms that occurred in the past six years. The central thesis of the 1980 study was that much of America's eco- nomic malaise was the result of policies that perpetuated disincentives to produce income and wealth and allocate resources efficiently. To reverse this, the study proposed a combination of traditional and revolutionary policies that included slower and more predictable monetary growth, reduced nondefense spending, budget balance, fundamental tax reform, and deregulation. Seven years later, the long-run effects of the Reagan economic program are beginning to be known, but evaluating the connection between the program and its effects is a complicated endeavor, requiring a balanced perspective and careful judgment. For this task, we approached Profes- sor Boskin to evaluate the program in relation to the current state of viii REAGAN AND THE ECONOMY economic knowledge and set forth elements of the unfinished agenda. As Boskin notes herein, making this evaluation is difficult for several reasons. One problem lies in the popular tendency to correlate contem- poraneous policies and performance, ignoring the significant lags that separate them. Furthermore, economic policy is inherently political, and clear perpeaives on long-term economic growth and stability can be distorted by looking only to the next election. This was certainly true of the extravagant forecasts made by certain supply-side proponents in the early 1980s. Partisan critics are now judging the Reagan economic pro- gram against these claims; this could obscure the Reagan Administration's many achievements. Theeconomy will, as always, be an issue in the 1988 presidential elec- tion; and it is thus important that a balanced judgment be made of the successes and failures of the Reagan program. This volume represents an important, comprehensive attempt to provide such a judgment. Policymakers and the public would do well to study Professor Boskin's conc1usions as part of an ongoing effort to understand our changing econ- omy and improve economic policy and performance. Robert B. Hawkins, Jr. President, Institute for Contemporary Studies San Francisco, California August 1987 Acknowledgments The period of Ronald Reagan's presidency will be recorded as one of the most interesting in recent economic history. For economists, historians, and citizens in general, it is in many ways the most important in the United States since the New Deal days of Franklin Roosevelt. Shifting budget pri- orities from social spending to defense, de faao engineering of a new fed- eralism, cutting and reforming taxes, generating unprecedented budget deficits, disinflating the economy, continuing deregulation, adding ten mil- lion jobs while structural changes in the labor market continued: all this and more occurred during the Reagan era. Some of the outcomes were the result of President Reagan's policies; some occurred independent of, or in spite of, them. Changes in the economy, economic policy, and analyses of the rela- tion between them moved at a breathtaking pace, stirred by the powerful message and sense of redirection and values the President enunciated. New economic theories were combined in interesting proportions in a sort of recipe economics in order to market certain parts of the President's pro- gram. Each of these theories contained elements of truth, but none of them was sufficient to describe the actual performance of the economy or to prescribe economic policy in all its important dimensions. These policies are fundamental to an understanding of our economy, the role of government in it, and the future opportunities to improve eco- nomic performance while maintaining personal freedoms. Because of this, I decided under the urging of A. Lawrence Chickering of the Institute for Contemporary Studies to try to write a non-technical, accessible volume x REAGAN AND THE ECONOMY placing Reaganomics in perspective. My intent throughout this volume is to assist the reader in understanding the economic and intellectual back- ground to Reaganomics, to recall the vast array of policies- including some policy reversals- that were proposed, enacted, or rejected, and to describe the economy's performance, with some emphasis on assessing what role economic policies had in achieving that performance. I have attempted to remain as detached as possible for someone who feels strongly about the various issues involved, has conducted much research on them, and has been an adviser and consultant to many involved with them, including the President, the Treasury, the Senate Majority leader, and members of both parties on key committees in both houses of Congress (such as the House Ways and Means Committee, Sen- ate Committee on Finance, Budget Committees, and the Joint Economic Committee). I have deliberately avoided elaborating on the roles of specific individuals in all but the few instances in which it was necessary to do so. I believe that what is important is the policies proposed and adopted, the alternatives that were available, and the outcome. Many persons far more important than I devoted countless hours to the making of the eco- nomic policy. Regardless of which side of the issue the person was on, or whether they were in the executive or legislative branch of the govern- ment, I do not doubt their sincerity in doing what they viewed was best for the country, at least as they saw it. I owea great intellectual debt to the numerous scholars whose work is mentioned in this volume, as well as to countless others whose research has influenced my thinking. To those with whom I disagree, I can only say that I have attempted to incorporate your theories and findings to the best of my ability. It is inevitable that in a society as complex and diverse as ours, with an economy whose performance must be measured in many dimensions, points of view will differ despite attempts to examine common evidence. I have attempted to convey a bit of the flavor of those disputes through- out thisvolume, although that is not my primary purpose. I mention where one might find an alternative point of view and summarize it briefly, and refer those who would like to pursue the subject to original sources. This is not meant to be an academic treatise. The material presented is not tech- nical, and requires little more than the ability to read a chart or table and bear with a small amount of the economics jargon used in the popular financial press in order to follow the arguments and to make up one's own mind. I firmly believe that understanding this era in our history-this set ACKNOWLEDGMENTS xi of attempts to restructure the role of government in our economy and the major economic disruptions and achievements of the times-is vital if we are to pursue sensible policies in the future. That will not guarantee an economy free of future problems. We have not seen the last recession in the United States or in the world economy. Reigniting inflation will always be a temptation for politicians. Sluggish productivity growth and declining international competitiveness are not exclusively a phenome- non of the period of the over-valued dollar. Maintaining the dynamism, flexibility, and decentralization of decision-making in our economy will require more than an ideological predilection toward such features. It will require a careful understanding and evaluation of the achievements such approaches have to offer our citizens. It is in this spirit that this volume was produced. For sharing that concern and vision, and providing invalu- able guidance and editorial assistance, I would like to thank the staff of the Institute for Contemporary Studies, in particular its Executive Direc- tor, Mr.