Commentary

Myths About the 1980s

By William A. Niskanen
This article appeared in the .

As of October 1, seven Nobel laureates and 596 other economists had endorsed a statement opposing the Dole tax cuts. There are a number of valid reasons why economists might oppose the specific tax cuts proposed by Dole. But the statement endorsed by this group is based on a myth that the economic recovery following the Reagan tax cuts of 1981 “was demand-side growth… . No sustainable increase in growth of supply took place.” One wonders whether these economists read the statement they signed or understand the actual record of this period. The statement is wrong on both counts: in fact, the 1980s were a period of a declining growth of demand and an increasing growth of supply.

The accompanying graph [omitted] illustrates the average growth of demand and output per working-age adult (age 20 through 64) for both the 1970s and 1980s. The top line is the five-year moving average of the change in nominal GDP per adult, centered on the middle year. The bottom line is the five-year moving average of the change in real GDP per adult, also centered on the middle year. (A five-year moving average is presented to smooth out short-term cyclical changes. Both demand and output are presented on a per adult basis to adjust for changes in the growth of the working-age population.) The difference between these two lines, thus, is the moving average inflation rate.

As this graph illustrates, the 1970s—not the 1980s—were the period in which demand increased at an increasing rate. The decline in school performance, an increase in effective tax rates and an increase in the costs of regulation and litigation, moreover, reduced the growth of output. Over the whole decade real GDP per working-age adult increased at a 1.2 percent annual rate, much lower than the 2.7 percent rate in the 1960s. The combination of these conditions led to a rapid increase in the inflation rate, from 4.5 percent in 1970 to 10.3 percent in 1980. The attempt to solve economic problems by demand stimulus and micromanagement by administrations of both parties turned out to be a major mistake.

The 1980s, in contrast, reflected the effects of Reagan’s concerted policies to restrain the growth of demand and increase the growth of supply. A policy of monetary restraint beginning in late 1979 has led to an almost continuous reduction in the growth of demand. School performance stabilized. Marginal tax rates were reduced. And most federal price and entry regulations were reduced beginning in the late 1970s. These contributed to increasing the average growth of real GDP per working-age adult in the 1980s to 1.6 percent. The combination of demand restraint and supply stimulus reduced the inflation rate in 1990 to 5 percent. The Reagan administration left us with several adverse legacies, but the general performance of the economy clearly improved in the 1980s.

What explains this extraordinary disjunction between the apparent perceptions of many economists and the readily available facts on the economy? One explanation may be the residual Keynesian perspective of many older economists, based on a theory without evidence that government deficits increase total demand; the apparent reasoning is that the federal deficit increased, so therefore demand must have increased. In fact, however, the growth of demand has declined almost continuously since 1979. One might hope that this myth about the 1980s would die out, because there are few Keynesian economists under the age of 40. A more partisan explanation is more disturbing—that this group of economists could not credit Reagan with any good outcome whatever the facts or endorse Dole whatever his proposed policies. Whatever the correct explanation and whatever their deserved reputation, economists did not bring credit to their profession by signing this statement.

William A. Niskanen is chairman of the Cato Institute and a former economic adviser to President Reagan.