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The Future of Reaganomics

by William A. Niskanen

December 7, 1988

The author was a member of the President's Council of Economic Advisers between 1981 and 1985. This article is abridged from a paper which he will give at the Institute of Economic Affairs conference "Reaganomics and Beyond", QE2 Conference Centre, London SW1, on December 8.

William Niskanen assesses the legacy of Ronald Reagan

Reaganomics was the most ambitious attempt to change the course of US economic policy since the New Deal. The consistent and distinct theme of this programme, in Ronald Reagan's words, was that "only by reducing the growth of government can we increase the growth of the economy." The four key elements were:

In direction, if not in magnitude, Reagan delivered on each of these promises.

General economic conditions are also quite favourable. The current recovery is now in its 73rd month, the longest peacetime recovery in US history. The unemployment rate is now the lowest for 14 years and both the inflation rate and long-term interest rates have declined about 6 percentage points since the end of the Carter administration.

This is a substantial record, for which Reagan deserves credit. In the end, however, there was no Reagan revolution. Although the growth of federal spending was reduced, the federal budget share of GNP, until recently, continued to increase. Although tax rates were reduced more than anticipated, some of this reduction was financed by shifting taxes tot the future (via the deficit) or by increasing the taxes on new investment. Some deregulation was offset by a net increase in trade restraint. Moreover, the failure to reform the remaining government role in several industries left a high rate of bank failures, a large future bill to close insolvent banks which are still operating, increasing air traffic congestion, and the prospect of some reregulation. There is still no consensus on rules for the conduct of monetary policy and although economic recovery has lasted longer than usual, average economic growth in the 1980s has been about the same as in the 1970s. A Reagan revolution would have reduced both the number of lawyers in practice and the price of property in Washington; I need not remind you what happened.

In the absence of any significant change in the institutions, incentives, and constraints of federal policies, the achievements of Reaganomics could be reversed in one term of the Bush administration, although this is not likely. The future of Reaganomics will depend critically on how its major adverse legacy - the still large federal deficit - is resolved. Sustained budget restraint is necessary. The normal problem of constraining the growth of government spending will be compounded by the bills now coming due for expensive weapons systems, the closure of insolvent banks, and for repairing and replacing the government's nuclear material facilities. Reducing the deficit either by tax rate increases or by reinflation, however, would reverse these successes.

How much of Reaganomics will survive? I am moderately optimistic. The reduction in marginal tax rates has become the symbol of tax reform, both in the US and abroad, and is unlikely to be reversed. Mr. Bush made an unusually strong commitment against tax increases and proposed selective reductions in tax rates and the tax base. The contribution of "supply-side" economics will survive long after the phrase disappears from political discourse.

Similarly, the reduction in inflation is not likely to be reversed. During the 1970s, politicians in many countries claimed that inflation was out of their control - blaming whatever external condition provided a temporarily plausible explanation. However, the reduction in inflation in most advanced countries during the 1980s demonstrated that inflation is primarily a monetary phenomenon which can be reduced by sustained monetary restraint. This will make it more difficult for politicians to reinflate, again long after the term "monetarism" disappears from political discourse.

The main remaining problem is that there is no consensus on a rule for the conduct of monetary policy. More specifically, we expect our central banks to do too much. My primary immediate concern is that the central banks will take the Louvre Agreement on exchange rates too seriously, increasing the instability of domestic demand in an attempt to reduce the instability of exchange rates. My primary longer-term concern is that we have delegated on of the most important government roles to unelected central bankers, without clear rules on monetary policy.

On other issues, the future of Reaganomics is much less clear. Mr. Bush has proposed increased spending for education and the environment and a variety of small tax preferences that will reduce the revenue base. Moreover, he will probably be forced to approve part of the agenda of the congressional Democrats to gain approval of administration initiatives. The still-large federal deficit will constrain new proposals for spending increases or tax cuts but is likely to divert the demands for special benefits into mandates on employers, selective trade restraints, and other regulation.

The major domestic opportunity of the Bush administration will be to consolidate the Reagan economic programme. The major risk is continued stalemate, similar to the last two years of the Reagan administration. Although Mr. Bush won by a substantial margin, the Democrats, with a quite different agenta, increased their margin in both Congress and the states. Residual bitterness about the Bush campaign may have reduced the potential for bipartisan cooperation. In effect, Mr. Bush will have to prove his mandate by early successes.

The primary reason why Reaganomics did not prove to be a revolution, however, is that there has not yet been a fundamental change in the perceptions about what the federal government should and, more importantly, should not do, at least among elected officials.

Ronald Reagan offered a vision that represents the best of the American heritage - a US of opportunity, tolerance, and caring. But his reluctance to face hard choices left Americans with some major new problems and an electorate which is still vulnerable to those who promote the competing vision of an expansive state.

The most distinctive characteristic of this century has been the pervasive growth of government. Reaganomics may prove to be only a temporary pause in this progressive loss of liberties. A more general sense of outrage about the contemporary role of government, one or more constitutional amendments, and new leaders who share Reagan;s vision are probably necessary to protect and extend history's most notable experiment - the American revolution.

This article originally appeared in the Financial Times on December 7, 1988.