Reaganomics, a success story (1)

The economic policy pursued by president Ronald Reagan was called “Reaganomics” (sometimes written as “Reagonomics” or called “supply-side economics”). This policy meant a radical rupture with Keynesianism where consumption was stimulated by massive government spending. Keynes put the emphasis of economic policy on the demand-side (consumption). Reagan, by contrast, put the accent on the supply-side (production). Keynes believed that demand would create supply, but Reaganomics started from the opposite idea, namely that supply would create demand. In this way of thinking, the supply side of the economy (the economic activity, production etc…) had to be stimulated in order to create wealth. The best way to do this was to cut the marginal tax rates on personal income. Such a tax cut would create a strong incentive to increase economic activity and would have spectacular effects on growth, investment, risk-taking and saving.

In this three-part series, we will examine Reaganomics, its critics, and what we can learn from it for today's economic problems. Belgian expert in Reaganomics Willy De Wit will be our guide.

BELGIAN ADMIRATION AND INTEREST FOR REAGANOMICS
Our non-Belgian readers may be surprised that that Belgian prime minister Guy Verhofstadt recently spoke out in favor of Reaganomics in an interview with Flemish weekly Humo. He underlined some of the concepts introduced by Reaganomics, which are taken for granted today.

When I think of Reagan, I'm thinking of Reaganomics and the Laffer curve. (Enthusiastically:) Do you remember: a tax cut could create more revenues! Reagan is dead now, but several of his ideas are now self-evident. The Flemish government lowered the estate and gift taxes. Surprisingly, the government got more income.

Few Belgians have analyzed Reaganomics in such an exhaustive way as retired financial consultant Willy De Wit from Antwerp. Recently, he gave a lecture for “FACS” (Free Association for Civilization Studies), a Flemish libertarian think tank. Loaded with facts and figures, he proved that Reaganomics did deliver results and was a success story.

CRITICS OF REAGAN'S ECONOMIC POLICY
But before summarizing the lecture of Willy De Wit, let us listen to the opponents. Numerous they are and their voices ring loud in the media. In November 2001 Mia Doornaert, a well-known Belgian journalist, wrote: “Ronald Reagan was not a great American President”. In the same leading Flemish newspaper De Standaard, Evita Neefs wrote three days after Reagan's death: "America is losing a sympathetic blockhead. He was not particularly intelligent, but extremely charming". These sentences are typical for the prejudice against Reagan and his economic policy, a policy, that - according to the opponents - made the poor poorer and the rich richer and created a huge budget deficit and a gigantic public debt. Moreover (still in the opinion of the opponents) unemployment could only be reduced by low paid McJobs, or “hamburger jobs” as they are called in Belgium.


Reaganomics is probably the only economic doctrine that made its way into a pop song. In 1985, the British group Simply Red criticized the 'antisocial' policy of Reagan in their song “Money’s Too Tight To Mention” (actually, a cover version of an original American song by the Valentine Brothers from 1982).

I been laid off from work my rent is due
My kids all need brand new shoes
So I went to the bank to see what they could do
They said: son look like bad luck got a hold on you

Money's too tight to mention
I can't get an unemployment extension
Money's too tight to mention
[...]

We're talking about Reaganomics
Oh lord down in the Congress
They're passing all kinds of bills
From down Capitol Hill - we've tried them

Money's too tight to mention
Oh money money money money
Money's too tight to mention
Cutbacks!
[...]

The popular perception of Reaganomics is clear: an antisocial policy with a curtailment of social expenses. But criticizing Reaganomics is not the monopoly of the left. Even classical (i.e. pro free market) liberals and libertarians are convinced that although Reagan stimulated the economy, it came at the cost of an enormous budget deficit.

Even George Herbert Walker Bush was initially very sceptical of the economic ideas of Reagan. In 1980 he spoke about “voodoo economics”. He changed course when Reagan chose him as running mate for the presidency.

WILLY DE WIT: REAGONOMICS SAVED THE ECONOMY
In the sixties and seventies, Keynes' economic theory was applied on a large scale. Keynes developed his ideas in the deep economic recession of the thirties, with its high unemployment. Keynes argued that governments should stimulate aggregate demand by massive spending and infrastructure works in order to invigorate the economy. Through the “multiplier” effect every dollar spent by the government would create a multiple in income. Unemployment would vanish, the tax base would broaden, and the budget deficit would disappear, Keynes argued. But during the oil crisis of the seventies, it became clear that Keynesianism did not work. Higher public spending did not resolve unemployment. On the contrary, unemployment increased in line with the increase of government spending. Moreover, unemployment and inflation appeared simultaneously, a fact which could not be explained by the dogmas of Keynesian thinking. The only thing they were able to do, was to give it a name : “stagflation”, which meant that we had a combination of creeping inflation, recession and unemployment. During the Carter years, inflation was at a staggering 13%. Huge interest rates were necessary to fight it. The interest rate on credit facilities reached the unbelievable level of 21%. The drama was complete when taxes were increased to fight both inflation and government deficits. During the Carter years, the top marginal tax rate on personal income rose to the insane record level of 70%. Experts dit not know how to agree on any economic policy. They simply had no solution!

THE FUNDAMENTAL FLAW IN KEYNESIAN LOGIC
A lot of recent studies indicate that an increase in public spending (as advocated by Keynes) does not stimulate the economy. The main reason is that money that could otherwise be spent efficiently by the private sector, is instead siphoned off for pork-barreling public works, very often with little or no return. Money to pay for deficit spending must come from somewhere else and, as usual, it is the taxpayer who must pay. The fundamental flaw in Keynesian logic is that it hardly makes sense to tax money away from productive people, thereby reducing their rewards, so as to spend it on unproductive goals. Some call it robbing Peter to pay Paul. The United Kingdom, home of Keynesianism, experimented with this medicine for years - only to get sicker and sicker, until Margaret Thatcher stopped it. A more recent example is Japan. This country has provided one of history’s best demonstrations that the Keynesian demand stimulus is a deeply flawed economic philosophy. Despite huge government outlays, the Japanese economy is still wallowing in the slump that has afflicted it for more than ten years. This point of view is confirmed by a recent study (based on multiple regression analysis) from Flemish independent think tank WorkForAll. According to their analysis of the relationship between economic growth and the size of governments in 16 European countries, the two main causes leading to poor growth performance are excessive government spending and a demotivating tax structure, which put a heavy burden on work, income and profit.



Moreover, many influential economists have come to the conclusion that the multiplier effect does not exist. See Paul A. Samuelson (“Economics", edition 1973, page 229), Harvard's Robert J. Barro (“Macroeconomics”, third edition page 301) and “The Wall Street Journal", November 3, 1992 : ( “Keynes is still dead”)

STAGFLATION BECAME RECESSION, EXPANSION FOLLOWED
Four young economists (Paul Craig Roberts, Robert Mundell, Norman Ture and Steve Entin) and a journalist (Jude Wanniski) convinced Reagan to completely reverse the economic policy of that time. Their point of view was that high marginal tax rates were a disincentive to produce, to take risk, to invest and to save. In their opinion this “economy of discouragement” had to be transformed into an “economy of encouragement”. The reasoning was as follows: people are producing because it pays to do so. Consumption alone will not result in increased production when the incentives to do so are not there. When tax rates are raised, people reduce their participation in taxed activities, such as working, risk taking, saving and investing. When tax rates fall, people increase their participation. Fortunately, Reagan understood this logic immediately. Few people know that Reagan had a major in economics, which he obtained at the Eureka College (Illinois) in 1932. The economic theory he was taught was untouched by Keynesian thinking and, as a consequence, very appropriate to the problems of the eighties. Reagan followed the advice and took action. The top marginal tax rate of 70% was lowered in two phases: to 50% with the “ERTA” (Economic Recovery Tax Act of October 1, 1981) and in a later phase to 28% (The Tax Act of 1986). These tax cuts created 18 million new jobs in 8 years, lowered inflation to 4.3% and cut unemployment from 9.7% to 5.4%. One of the longest and strongest economic expansions since World War II had begun, with an average annual growth rate of 3.5%. But the first two years (1981 and 1982) were lost for Reagan. Fed chairman Paul Volcker fought inflation with a tight monetary policy and high interest rates. The Reagan administration urged Volcker to decrease monetary growth by a maximum of 50%, in order not to kill the tax cut program. But as the Federal Reserve is totally independent, Volcker cut money growth by 75% in 1981. The recession became even worse, and unemployment rose further. But after inflation had been defeated, money growth resumed and the Reagan expansion took shape.

In part 2 of this series, we will look at some popular criticism of Reaganomics: the rich got richer and the poor got poorer, employment grew through crappy jobs, and everything came at the cost of a huge public debt. Willy De Wit will prove with figures and facts that these allegations are simply not true.



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