CLINTON & BLAIR THE ECONOMICS OF THE THIRDWAY Flavio Romano A thesis submitted in fulfilment of the requirements forthe degree of Doctor of Philosophy School of Social Science and Policy The University of New South Wales 2004 CERTIFICATE OF ORIGINALITY I hereby declare that this submission is my own work and to the best of my knowledge it contains no material previously published or written by another person, nor material which to a substantial extent has been accepted for the award of any other degree or diploma at UNSW or any other educational institution, except where due acknowledgement is made in the thesis. Any contribution made to the research by others, with whom I have worked at UNSW or elsewhere, is explicitly acknowledged in the thesis. I also declare that the intellectual content of this thesis is the product of my own work, except to the extent that assistance from others in the project's design and conception or in style, presentation and linguistic expression is acknowledged. (Signed) Flavio Romano 2 ABSTRACT President Clinton of the United States and Prime Minister Tony Blair of the United Kingdom have both described their approach to public governance as "a third way" that is neither of the Right nor Left but new and different. Current interpretations of their Third Way are limited to the philosophical and political. Economic evaluations of the Third Way programme are lacking and it is precisely the purpose of this thesis to analyse the Third Way in terms of economic theory. Chapter 1 examines the Third Way as an economic programme. Chapters 2 and 3 examine theories of economic growth and public finance respectively. They find that the Third Way's economic programme is drawn from two very different and potentially conflicting traditions: its programme for economic growth is best described as drawing from evolutionary and endogenous growth theories whilst its programme for public finance is based on standard neoclassical theory. The potential for conflict resides in the fact that its programme for economic growth advocates increased public investment whilst its programme for public finance requires fiscal discipline. Chapters 4 and 5 analyse the Third Way's economic policy practice in the United States and the United Kingdom respectively. They find that the potential conflict between public investment and 'sound' public finance did emerge in practice and was resolved in favour of the latter, locating Clinton and Blair's Third Way within standard neoclassical theory. 3 Chapter 6 concludes by discussing whether the Third Way could have been a different programme. In particular, it discusses the Third Way's lack of a demand-side to its economic programme, such that might have enabled debt reduction through economic growth rather than solely through reliance on reduced public expenditure. The methodology this thesis adopts is to test historical practice against economic theory. It analyses the economic policies of the two-term Clinton Democratic Administration in the United States (1993-2001) and the first term (1997-2001) of the Blair 'New' Labour Government in the United Kingdom and tests these against economic theory for the purpose of drawing meaningful conclusions about the economics of the Third Way. 4 ACKNOWLEDGEMENTS I am grateful for the assistance and support extended to me by Drs. George Argyrous and Deborah Oxley, as well as to Mr Peter Gilbert of the United States Information Service in Sydney, Australia. " ... the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist." John Maynard Keynes, The General Theory ofEmployment, Interest and Money (1936) In loving memory ofAdriana and Adriano Romano © Flavio Romano 2003 5 TABLE OF CONTENTS ABSTRACT PAGE3 Acknowledgements page 5 Table of Contents page6 List of Tables page9 List of Charts page9 List of Figures page 11 CHAPTER 1: AN INTRODUCTION TO THE THIRD WAY PAGE12 The Third Way as a Public Philosophy page 14 The Third Way as a Political Strategy page 16 The Third Way as an Economic Programme page 21 Conclusion page 28 CHAPTER 2: THE THIRD WAY AND ECONOMIC GROWTH PAGE30 Evolutionary Theory page 33 Neoclassical Theory page 52 The Solow Neoclassical Growth Model page 56 Endogenous Growth Theory page 58 Conclusion page 64 CHAPTER 3: THE THIRD WAY AND PUBLIC FINANCE PAGE65 Standard Neoclassical Theory page 66 'Imperfectionist' Neoclassical Models page 79 The Changing Focus of Neoclassical Theory page 94 6 Conclusion page 95 CHAPTER 4: THE THIRD WAY IN THE USA PAGE97 Fiscal Policy page 98 Monetary Policy page 114 Investment Policy page 120 Education Policy page 135 Other Economic Policies: Employment, Competition & Trade page 141 Conclusion page 166 CHAPTER 5: THE THIRD WAY IN THE UK PAGE 167 Fiscal Policy page 167 Monetary Policy page 175 Investment Policy page 179 Education Policy page 195 Other Economic Policies: Employment, Competition & Trade page 201 Conclusion page 207 CHAPTER 6: CONCLUSION PAGE209 General Summary and Conclusions page 209 A Neoclassical Counter-critique page 220 Interpreting the Third Way page 221 Marrying Schumpeter and Keynes: A More Genuine Third Way? page224 Limitations to the Research page 232 Suggestions for Further Research page 233 7 BIBLIOGRAPHY PAGE235 8 List of Tables Table 2.1: Key Documents of the Third Way Programme page 30 Table 4.1: Clinton's 1993 Expansion of the Earned Income Tax Credit (EITC) page 103 Table 4.2: US Interest Rates, 1993-2000 page 118 Table 4.3: Student Financial Assistance under the Clinton Administration, 1993-2001 page 136 Table 4.4: Change in employment by industry, 1989-99 page 149 Table 4.5: The Distribution of U.S. Wealth and Income, 1983-1998 page 151 Table 5.1: United Kingdom Government Spending page 173 List of Charts Chart 4.1: US Federal Discretionary Spending, 1962-2001 page 101 Chart 4.2: US Federal Receipts, Outlays and Budget Surplus, 1993-2000 page 106 Chart 4.3: US Federal Government Debt, 1993-2000 page 107 Chart 4.4: US Federal Budget Surpluses and Federal Debt, 1945-2000 page 108 Chart 4.5: Annual Percentage Change in the US Consumer Price Index, 1945-2000 page 116 Chart 4.6: Annual Percentage Change in the US Money Supply (M3), 1959-2000 page 117 Chart 4. 7: Annualised Average Monthly US Federal Funds Rate, 1954-2001 page 118 Chart 4.8: US Total Public Investment for Physical Capital, Research and Development & Education and Training, 1962-2000 page 122 Chart 4.9 US Federal Expenditure for Infrastructure, 1956-1998 page 123 9 Chart 4.10: US Private Investment, 1992-2000 page 130 Chart 4.11: US National Saving, 1979-2000 page 131 Chart 4.12: US Unemployment, Inflation & Productivity, 1959-2000 page 134 Chart 4.13: US Federal Government Education & Training Expenditure, 1962-2001 page 139 Chart 4.14: US Total Federal Government Personnel, 1962-2000 page 146 Chart 4.15: US Civilian Unemployment Rate, 1950-2000 page 147 Chart 4.16: US Mean Earnings by Education, 1975-1999 page 154 Chart 4.17: US Antitrust Filings, 1991-2000 page 157 Chart 4.18: US Business Formations & Failures, 1955-1997 page 160 Chart 4.19: US Trade and GDP Growth, 1959-2000 page 165 Chart 5.1: UK Public Expenditures, Receipts and Budget Surplus page 171 Chart 5.2: UK Public Sector Net Borrowing and Net Debt page 172 Chart 5.3: Bank Of England Base Interest Rates, 1970-2001 page 177 Chart 5.4: Annual Percentage Change in the United Kingdom Money Supply (M4), 1970-2000 page 178 Chart 5.5: Annual Percentage Change in UK Retail Prices page 179 Chart 5.6: UK Gross and Net Public Investment page 181 Chart 5.7: UK Public Gross Investment page 182 Chart 5.8: UK General Government Gross Capital Formation for Education page 183 Chart 5.9: UK Total Net Government Expenditure on R&D page 184 Chart 5.10: UK General Government Gross Capital Formation for Health page 185 10 Chart 5.11: UK Public Investment in Roads page 186 Chart 5.12: UK Gross Public Investment Including PFI page 188 Chart 5.13: UK Business and Public Sector Investment page 192 Chart 5.14: UK Total Business Investment in R&D page 193 Chart 5.15: UK National Savings page 194 Chart 5.16: UK National Savings and Private Investment page 195 Chart 5.17: UK Real Public Expenditure on Education page 200 Chart 5.18: UK Real Education Expenditure by Sector page 201 List of Figures Figure 3.1: The Balanced Budget Multiplier page 88 11 CHAPTER 1: AN INTRODUCTION TO THE THIRD WAY President Clinton and Prime Minister Tony Blair have described their practice of governing the United States and the United Kingdom respectively as a "Third Way" that is neither of the Right nor Left but new and different. Use of the term "third way" to describe some style or philosophy of government is not new but has in fact been used to describe quite an eclectic range of different governments since at least the end of the 19th century when Pope Pius XII called for a third way between socialism and capitalism. It has also been used in more recent times to variously describe Sweden's "social democratic middle ground between capitalism and communism" (Reich 1999: 1), some unspecified form of social democracy between free market capitalism and centrally planned socialism, as well as by the dictators Franco and Tito to describe their own approaches (Arestis and Sawyer 2001: 2).