VASANTH KUMAR – MARCH 4TH, 2021
EDITOR: ALLY MINTZER
In his 2012 bid for the American presidency, Senator Mitt Romney’s core economic plan was to cut taxes by $4.8 trillion and decrease government spending by 20% to cast himself as the candidate of small government. As Romney himself stated:
“Washington’s problem is not too little revenue but rather, too much spending.”
In February 2021, Romney proposed the Family Security Act as an amendment to President Biden’s proposed stimulus package; it would provide $4,200 to every child under the age of six and $3,000 to every child between six and seventeen to lift 3 million children out of poverty and 1.2 million children out of deep poverty (family income below 50% of the poverty threshold). While funded in part by abolishing the Temporary Assistance for Needy Families (TANF) program and the child tax credit, the plan would still on net add billions of dollars to the national debt. Justifying the plan, Romney stated:
Now is the time to renew our commitment to families to help them meet the challenges they face as they take on the most important work any of us will ever do—raising our society’s children.
The contrast is stark but not unique to Romney. Across the policymaking world, the support for progressive economic policies funded by large budget deficits has experienced a seismic boost in reaction to the COVID-19 recession: higher tax credits, negative interest rates, and unprecedented levels of direct transfer payments have become politically mainstream, if not bipartisan. Austerity, once the bedrock of economic conservatism, has been relegated to the wastebasket of defunct and disfavored ideologies. And in the United States, this flavor of unbridled government support has little postwar precedent.
At the root of this ideological shock is the subtle change in how economists and policymakers discuss and compare economic beliefs and policies. While the traditional economic indicators (GDP, inflation, unemployment, etc.) have remained in favor, the discussion of these statistics has evolved from abstract notions of “fiscal responsibility” to much more visceral images of the aggregate hardship that arises from economic downturns. A new vocabulary of “economic pain” has become ubiquitous where it was once partisan, and the language of austerity, monetary discipline, and balanced budgets have lost both academic and political support in the United States. How did this happen?
Conservatism and Supply-Side Economics: 1964–1992
Scholarly praise for market mechanisms and small government is not unique to the postwar era, being a core tenet of classical liberalism since the Enlightenment. However, the most recent iteration of academic literature supporting lower government spending came with the conservative activism of Milton Friedman and the burgeoning Chicago School of economics. According to Richard McGahey’s (2010) article, “The Political Economy of Austerity in the United States,” this school of economic thought has two core theories on fiscal and monetary policy. On the fiscal side, Friedman posited that economic policies ought not to be motivated by perceivable effects (e.g. tax cuts boost GDP, social security decreases poverty) but rather by the extent to which economic power becomes concentrated in a central authority at the expense of decentralized market mechanisms. As Friedman states:
“If freedom is to be secure, power must be limited, and it must be dispersed. The most effective way simultaneously to disperse private power and to limit governmental power is to rely primarily on voluntary exchange through a free market—competitive capitalism—to organize economic activity.”
On the monetary side, Friedman developed monetarism. This theory asserted that consistent changes to the money supply, mostly independent of macroeconomic conditions, fostered the most stable inflation and unemployment levels. The consideration of the budget deficit was not just ignored, but derided. As Friedman stated in 1978 that anti-deficit conservatives were:
“… concentrating on the wrong thing, the deficit, instead of the right thing, total government spending… fiscal conservatives have been the unwitting handmaidens of the big spenders.”
The blasé attitude of Friedman to the deficit gave credence to the emergence of “supply-side economics.” Coined in 1975, supply-side theory asserted that the government mainly influenced the economy through taxes, not spending. This belief was most famously articulated by President Reagan’s economic policy advisor Arthur Laffer, who argued that the universally “optimal” tax rate existed significantly lower than its current rate. However, the original architect of supply-side economics was the Canadian economist Robert Mundell, who cited the 1971 Canadian tax rate inflation indexing policy as the first successful implementation of supply-side policies (as an aside, Mundell would also be critical in designing and implementing the Eurozone). Mundell developed a coherent supply-side thesis, an amalgam of multiple theories on exchange rates, capital flows, labor markets, etc. that asserted the universal benefit of tax cuts. Most of all, Mundell saw supply-side economics not as a political tool, but as a distinct, legitimate, academic school of thought, stating:
“It would be a mistake, however, to believe that it lacks any less of a scientific foundation than the older demand-side schools of monetarism and Keynesianism, or the new classical school. Its own academic credentials lie in the solid allocation-theoretic literature of neo-classical economics and the policy-oriented models of global monetarism and macroeconomics.”
In the world of conservative activism, supply-side economics became the gospel. Americans for Tax Reform (ATR), a large activist organization founded by Grover Norquist, adopted the general catchphrase of “starve the beast,” representing government tax and excess spending cuts. As Norquist vividly put it:
“I don’t want to abolish the government. I simply want to reduce it to the size where I can drag it into the bathroom and drown it in the bathtub.”
The political manifestation of this neoliberal ideology occurred when Ronald Reagan was elected in 1980. On the surface, his primary economic goals were to combat inflation and unemployment, motivated by the belief that welfare, government spending, and loose monetary policy were singularly responsible for stagflation. However, the core plank of his enacted platform was tax cuts, which were justified in the goal of freeing American “entrepreneurial spirit.” The political results are clear: after the passages of the Economic Recovery Tax Act in 1981 and the Tax Reform Act in 1986, the top-bracket income tax rate decreased by 42 percentage points, and the corporate tax rate decreased by 14 percentage points. Notably, over the course of Reagan’s presidency, national debt increased by 15.8 percentage points to 38.1% of GDP with no major federal programs or agencies abolished.
Austerity and the Washington Consensus: 1992-2008
After 1992, a new language defending small-government policies emerged. Distinct from the ideological stance of Friedman or Mundell, the justification for government spending reductions came to fall under the purview of “austerity.” Whereas full-blooded conservatives were motivated to reduce the aggregate size of government on principle and were singularly focused on decreasing taxes, austerity’s core goal was the reduction of the budget deficit. The eventual result was that conservatives adopted a paradoxical platform: reduce taxes to control big government, and reduce government spending to preserve the integrity of big government.
The roots of academic and intellectual opposition to an increasing national debt stock lie with Franco Modigliani, who, in 1961, provided an early model for understanding the effects of debt on the economy. According to Modigliani, the national debt was “worth the cost” if it increased the national capital stock, that is, if debt was used to improve future productivity.
A second key argument developed and dispersed within academia was the concept of “r-g”. Indicating the real interest rate (“r”) and the trend growth rate (“g”), this model’s focus on interest payments on the national debt was clear and intuitive: if “r” exceeded “g,” (r-g > 0), then the total stock of national debt owed was unsustainable and would increase exponentially. If “g” exceeded “r,” (r-g < 0) then the total annual output would eventually “keep up” to sustainably service debt payments. This simple model stressed the importance of interest servicing over the total stock of national debt.
While the threat posed by the national debt has evolved as federal borrowing patterns, exchange rates, and the natural real interest rate has changed over time, these models proved invaluable to economists’ initial understanding of the peripheral effects from national debt. However, the introduction of such theories also resulted in a loose, vague, and now derided collection of policy recommendations known as the “Washington Consensus.” The consensus opposed the long-term expansion of welfare programs and government spending beyond short-term recessions and catastrophes. The policies were most forcefully applied by the International Monetary Fund and World Bank in forcing policies of privatization, monetary contraction, and, most of all, austerity on already indebted developing nations.
In the United States, as the debt-to-GDP ratio ballooned under Reagan and real interest rates surged (and subsequently peaked) in the 1990s, concerns over American national debt arose and the ideas behind the Washington Consensus trickled into discussions on domestic economic policymaking. The deficit reduction platform came to the national stage in full force with Ross Perot’s 1992 campaign for President. While Perot received only 18.2% of the popular vote, Perot’s proposal to eliminate the national debt in five years (including tax increases, decreases in national spending on defense and other sectors, and a fierce opposition to the trade deficit and free trade agreements like NAFTA) remained popular. Conversations on the national debt ultimately dominated Clinton’s presidency. Pressure from technocratic deficit hawks, such as his economic advisor Robert Rubin, forced him to balance the national budget. This resulted in a 61.2% reduction in government spending during his presidency, mostly concentrated in defense, Medicare, Medicaid, and Social Security. Not only had Clinton achieved a budget surplus, but the entire national debt was projected to be paid off by 2009.
By now, however, conservative politicians and economists developed a paradoxical language with little relation to the theories of Friedman, Mundell, and Modigliani. Allegedly concerned about the role of a bloated government in interfering with efficient market mechanisms, the ideology supported large tax cuts, deregulation, and the retreat of the government from public economic life. The economists John Cochrane and Nobel laureate Edward Prescott exemplified this stance in a 2009 ad in the New York Times:
“Notwithstanding reports that all economists are now Keynesians and that we all support a big increase in the burden of government, we the undersigned do not believe that more government spending is a way to improve economic performance … To improve the economy, policymakers should focus on reforms that remove impediments to work, saving, investment and production. Lower tax rates and a reduction in the burden of government are the best ways of using fiscal policy to boost growth.”
Simultaneously, economists and policymakers pushed indefensible and unacademic theories on the national debt. An infamous paper by Carmen Reinhart and Kenneth Rogoff (2010), which argued that a debt-to-GDP ratio of greater than 90% stymied growth, was touted as definite proof that deficit reduction was necessary (until significant errors in key calculations required Reinhart and Rogoff to publish formal errata). Commenting on the paper’s assertion that austerity policies boosted business confidence, the economist Robert Pollin argued that attempting to quantify the positive effects of austerity in abstract concepts like “business confidence” is fairly indefensible. Nevertheless, the rhetorical power of such arguments, no matter their limitations, has given an authoritative air to tax cuts and austerity alike.
The Slow Recovery: 2008–2015
Bolstered by such arguments, austerity materialized in full force during the Great Recession. Unlike previous recessions, government spending during the aftermath of the Great Recession was significantly lower. In truth, the Bush and Obama presidential administrations spent an unprecedented $983 billion on tax rebates, job creation, and relief to combat the slack in aggregate demand and unemployment through the 2008 Economic Stimulus Act and 2009 American Recovery and Reinvestment Act. But the 2010 election of a Republican Congress crippled the recovery effort. In 2011, Congress passed the Budget Control Act to increase the debt ceiling and cap discretionary spending; at the time, the CBO had already estimated that the act would reduce GDP by 1%.
The result was that the United States experienced the slowest economic recovery in postwar history. Whereas the post-recession periods of 1976-78 and 1983-85 experienced rapid “V-shaped” recoveries with an excess of 5% GDP growth, the post-Great Recession growth rate averaged between 2-3% until 2016. The CPI inflation rate, which had already plummeted from a pre-recession level of 3.84% in 2008, was barely registrable at 0.12% in 2015. In December 2015, the unemployment rate was 5.0%, still significantly above pre-recession levels.
The slow recovery jump-started a reckoning in attitudes among economists towards the necessity of robust fiscal policy to curb recessions. The economist Jason Furman termed this reckoning the “New View,” an updated iteration of Keynesian economics that factored in the decades-long decline in the natural real interest rate. The “New View” economists advocated for a strong demand-focused fiscal policy, funded by large deficits during both the immediate recession and extended recovery, were vital to maintaining trend growth.
Still, however, there is no consensus among economists. Reputed economists such as Lawrence Summers and Olivier Blanchard have shared concerns over the effect of the scale of large general stimulus in “overheating” the economy. Yet other economists have mostly resolved that the costs of inaction and the possibility of another slow recovery outweigh the potential harm of “overshooting the bound” on stimulus.
Perhaps the greatest revolution in economic attitudes towards fiscal policy has come from conservative politicians, as Senator Mitt Romney’s significant change in perspective illustrates. Fundamentally, the support for stimulus among Americans is near universal and bipartisan: 78% of Americans, 90% of Democrats, and 64% of Republicans support direct stimulus payments. Public opinion’s consistent pressure on elected officials to provide stimulus resulted in the largest stimulus package in American history, the CARES Act, which was significantly more progressive than the Economic Stimulus Act of 2008, the last stimulus package to pass with Republican support. The CARES Act was twenty times larger, and expanded unemployment benefits, rental assistance, direct universal stimulus checks, and small business aid.
Whether the shift in academia and politics away from austerity rhetoric will last is unknown. After all, conservatives have supported large stimulus before: Bush’s Economic Stimulus Act received bipartisan support, and despite its small size, prioritized veterans and beneficiaries of Social Security and Medicaid. A year later, only three Republican senators voted for Obama’s American Recovery and Reinvestment Act. Conservative support for stimulus today may be purely conditional on the party of the president.
While Republicans may continue to campaign on a paradoxical platform of austerity, tax cuts, and increased defense spending, the average economic relief/stimulus policy has definitively swung progressive regardless. The growing prioritization of stimulus over debt, sparked by the failure of austerity in the post-Great Recession recovery, is more mainstream than ever. Meanwhile, the prominence of conservatism and austerity in both academia and policymaking has degraded significantly since their heyday. Only time will tell whether the austerity playbook’s fall from grace will remain permanent.
Featured Image Source: The Wall Street Journal
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