Can today’s economic and political troubles be traced to Roosevelt’s misinterpretation of John Maynard Keynes’ prescriptions during the Depression? Or to Nixon’s closing of the gold window in 1971, which put the United States on a fiat-money standard? Or to Reagan’s inability to control the growth of government spending when he proposed, and Congress enacted, a massive income tax cut in 1981?
Or to the constitutional amendment allowing income taxes in 1913, along with the establishment in the same year of the Federal Reserve?
In a massive volume that melds economic history and social criticism, the former Reagan administration budget director David Stockman said yes to all of these. He found many more ways in which we went astray. Most notably, he decried the corruption of free-market capitalism by those seeking effortless profits at the public’s expense. This is the source of the book’s title, The Great Deformation.
But while Stockman put forth earnest effort recounting the history of monetary and fiscal folly in the United States, The Great Deformation is a very bad book. It is encumbered by florid prose, a tendency to rewrite history to favor Stockman’s viewpoint and a hectoring tone. Less superficially, its real fault is that it condemns the United States today as a society gone profoundly wrong. I disagree: The U.S. today is one of the best societies human history has produced, though it is in need of a few significant changes.
Stockman’s deep pessimism is not justified, and his policy recommendations are much too radical.
Stockman and Reagan
Stockman earned fame a couple of decades ago for serving in the Reagan administration, where he held the key position of budget director, and then for leaving it due to differences with the president over fiscal policy. Reagan was able to secure a major tax cut (the top income tax rate went from 70% to 28%) but not the corresponding spending cuts that he thought were needed. The result was a federal budget deficit that peaked at $221 billion, or 5% of GDP, in 1986. (For comparison, the 2009 budget deficit was 11.9% of GDP, and it did not sink below 10% of GDP until 2012.) Stockman wanted a balanced budget and resigned in protest. In his first, clumsily titled book The Triumph of Politics (1986) , he forecast an economic catastrophe due to the Reagan deficits.
We know what happened next. During the long boom of 1982-2000, real value added per hour worked, the purest measure of economic performance, increased by a cumulative total of 31% – that is, 1.5% per year.1 That’s hardly a catastrophe, and the metric understates the amount of improvement that most people experienced. The startling increase in the standard of living between 1970 and the present – housing space per capita almost doubled, motor vehicle use almost tripled and all but the poorest households came to enjoy telephones, televisions and air conditioning – occurred mostly in this boom period.
Stockman’s take on the long boom is that the observed growth in consumption was largely fueled by debt and thus unearned. But any unearned or debt-financed increases in consumption came on top of increases from the documented rate of real productivity growth. These latter increases were unquestionably earned.2 And from the viewpoint of the government, the tax cuts paid off, with growth so robust that the federal budget was in surplus from 1998 to 2001 and pretty close to it in 2007, despite the vastly expanded reach of government programs.
But Stockman, defending his Triumph of Politics thesis, rewrote history so that the long boom in real economic performance didn’t happen. It was, he says, just a boom in consumption, “a simulacrum of prosperity: a house of cards that would collapse with stunning speed and violence.”
Perhaps Stockman forgot what economic life in the U.S. was like in 1981. It wasn’t exactly a depression, but countless small businesses that had prospered for decades were driven into bankruptcy by interest rates often exceeding 20%. The Ibbotson index of the real (inflation-adjusted) total return on long-term Treasury bonds fell from a base of 100 in 1940 to 32.72 in September 1981, conveying the wealth destruction that had accrued to savers during the Great Inflation. The stock market was in shambles.
Looking beyond U.S. borders, incomes in India and China had barely budged since the Middle Ages. Now they are burgeoning. For the average person in the world, the decades since 1981 have been the most productive in history, even counting the recent recessionary years.3 For a simulacrum of prosperity, it worked well.
1. Approximate (obtained by reading a graph). This productivity growth rate was less than the historical average but a big improvement from the period just prior, as growth rates began their long climb from the lows of the late 1970s to the boom rates of the late 1990s. The productivity growth rate has since fallen sharply in the Great Recession and its aftermath, but productivity is still growing, not shrinking.
2. Stockman’s concern about unearned consumption is also subject to a caveat. Our society increasingly rewards sophisticated knowledge acquired over time, rather than the sweat of one’s brow. Households, especially young ones with children, are going to have to rely on debt more than they used to. Thus, as long as the borrower doesn’t actually default, consumption financed by private debt is earned, just not earned in the past. That is what financial markets are for: to shift consumption across time periods.
3. Stockman also faults Reagan’s budget deficits for starting the U.S. on a path to an unsupportable debt level. In hindsight, there is something to this critique. Debt buildup beyond a supportable level could not have occurred if it had never been allowed to start. But we should remember that when increasing the amount of debt one owes, the starting point matters a great deal. The Reagan deficits took the federal debt load, expressed as a percentage of GDP, from 31% in 1981 to 51% in 1989. The trend is in the wrong direction, but both levels are supportable. Increases in debt are only a problem if the trend is continued indefinitely.