The Economy and the Deficit
Economists' difficulty with predictions was confirmed once again at the beginning of 1983. Time reported that people on its Board of Economists were beginning to feel like Vladimir and Estragon in Waiting for Godot; they kept thinking the recovery ought to arrive, but it hadn't for so long that they were beginning to wonder if it ever would.[20] Pessimism was mainly based on a belief that high interest rates would "shackle consumer spending and business investment." Surveys of business plans showed no intention to increase investment. Business Week commented:
The sobering experience of the past two years suggests that executives and investors must be prepared for a world quite different from that of the standard forecast—but it also leaves scant guidance about whether the surprise is more apt to be pleasant or unpleasant. Since unemployment and underemployment are so high, there is clear potential for a surge in growth at least as swift as the postwar average. But if the Administration and Congress fail to cut the budget deficits and the Fed returns to stricter adherence to monetary targets, there is also the potential for yet another—and worse—bout with recession.[21]
This conventional wisdom about deficits sounded sensible, but, after the Fed turned to tighter money and the deficit continued, the economy boomed anyway.
Martin Feldstein's first economic forecast for the Reagan administration was fairly pessimistic. He predicted GNP growth of 3.1 percent, inflation of 5 percent, and year-end unemployment of 10.4 percent.[22] The CEA, overcorrecting for 1981's overoptimism, thus ensured that it would not be criticized for trying to make the administration look good. But two wrongs do not make a right. That projection also increased the pressure for action on the deficit. Asked in an interview about the forecast, President Reagan replied, "I just can't help but have an optimistic feeling that the recovery may just be better than we think."[23]
Reagan's suspicions were quickly confirmed. In January unemployment started dropping. Feldstein told the president that GNP growth might be more like 5 percent than 3.1.[24] BY mid-February there was little doubt that the recovery had finally arrived.[25]
By late May 1983 the economy was looking ever better, unless you were among those union workers whose wage contracts were calling for actual reductions. Some policy makers, such as Henry Wallich of the
Federal Reserve Board, were beginning to fear that the economy would overheat. Beginning in May, the Federal Reserve moved toward a policy of tighter money. By late June, the Commerce Department was reporting second-quarter growth at an 8 percent rate; business profits were soaring.[26] Walter Heller had been keeping a list of adjectives applied to the recovery. At the year's beginning they included "weak, wobbly, puny, pokey, measly, muted, and miserable." At midyear they had become "rapid, robust, snappy, surging, brisk, bullish, and a barn burner."[27]
Throughout 1983, the economy kept growing beyond expectations. "There's one way we can tell our program is beginning to work," crowed the president. "They don't call it Reaganomics anymore."[28] By October, industrial production had rebounded to an all-time peak.
Unemployment, which had languished near 10 percent, finally fell to 7.2 percent by December.[29] By a number of indicators, mid-1984 was another watershed, with growth slowing markedly to a rate of roughly 2 to 3 percent per year from that time to the end of 1985.
Everyone should have been happy, right? Wrong. Lots of people were miserable. Policy and the overall trends of the economy together seemed to be creating an "unbalanced" recovery; people at the wrong end of the seesaw did not like it one bit. Recovery in 1983 left manufacturing below 1981 levels. Construction was also weak. Industries that had done relatively well during the recession attained new heights during the recovery: wholesale and retail trade, finance, insurance, real estate, and services. The big losers were the heavily unionized blue-collar industries, such as steel and autos, that were vulnerable to foreign competition, or those, like airlines and trucking, that suffered under deregulation.
These differential effects fed a suspicion that, underneath the cyclical movements of interest rates, prices, wages, and unemployment, "something else was going on." That something else might have involved the changing position of America in a global economy, or it might have been the beginning of a new phase of the industrial revolution. The economic age of the automobile, petroleum, and steak might be giving way to that of the personal computer, Electronic Fund Transfer, and croissants. There were signs aplenty of such a broad change—from Sears' metamorphosis into a financial-services supermarket, to the ATM machines that were replacing tellers in banks, to the unemployment remaining in the old middle-American cities of Toledo, Detroit, South Bend, Flint, Gary, and Youngstown.
Many politicians wanted to ride the wave. A new breed of Democrats popped up in Congress, if not among the public. These advocates of high tech were dubbed "Atari Democrats" after the Silicon Valley maker of video games. The computer was all the rage; Time even chose that machine as its 1982 "Man of the Year."
Whatever was happening, it was not good for labor. Unemployment
did come down, but its slide stopped at a level well above the rate during any previous expansion. Those who were unemployed had been out of work for a long time—an average of 20 weeks in 1983, compared to 15.8 weeks in 1976 (also a first year of recovery from deep recession).[30]
As unemployment stayed fairly high, wages failed to grow. Real wages had fallen from average weekly earnings of $183.41 (1977 dollars) in 1979 to $168.09 in 1982, mostly due to the 1979–1980 inflation. The low inflation recovery that the administration promised, and (after unexpected vicissitudes) delivered, did little to redress the wage loss.[31] In 1984 real, nonfarm business compensation remained below its 1977 level. Where, the obvious question is, did the rest of national product go? Most went to increasing employment and a growing population; the rapid growth in 1983–1984 had to accommodate more workers before wages could increase. The money did not go to the profits of manufacturing industries. Some went into the profits of service industries such as wholesale and retail trade.[32] Much went to bond holders and other savers due to the higher interest rates. Whether they held government or other debt, people and institutions who had money to lend could benefit most from a recovery that combined high interest rates and low wage growth. In nominal (that is, inflated) dollars, personal interest income doubled from 1979 to 1984, while overall wages rose by less than 50 percent and manufacturing wages by only 30 percent.[33]
This transfer of income from wage earners to rentiers had begun under Carter. The Reagan administration's tax and spending policies directly paralleled these wider economic trends, but we cannot judge how much they contributed to them. Tax policies, such as the failure to adjust personal exemptions in the 1981 tax bill, exacerbated by social security contribution increases, meant that those people who saved less because they earned less also benefited least from the tax cut. Decreased taxes on interest income (such as the 1981 top-rate reduction and capital-gains reduction) also favored interest earners over wage earners, as did the budget deficits (to the extent they increased interest rates).[34]
The trend began with pressure on union wage rates from more basic movements in the political economy. The power relation between labor and management had, by 1982, been dramatically changed. The effect is described by the CEA's 1985 economic report: "Some recent union wage settlements have involved an actual reduction in wages or fringes, a relaxation of work rules, or wage freezes. Concessions have occurred in previous recessions, but the scale of recent concessions is unprecedented."[35] The unions' problems explain why the AFL-CIO, battered by events under first a Democratic president who barely knew them and then a Republican who opposed them, determined that they would pull out all the stops in 1984 to have a friendly president.
Nominal interest rates came down, but real interest rates stayed high,
reaching 7 percent. There are as many possible explanations for interest rate behavior as there are political positions that stand to benefit from explanations. None are entirely persuasive. The administration's favorite explanation was that higher prospective, after-tax return on investment, caused by the 1981 tax changes, made businesses more willing to pay high real interest rates.[36] Changes in financial markets associated with deregulation, formal and informal, may have enabled businesses and individuals to demand a higher price for the money.[37] The most common explanation, however, was that big deficits increased the demand for money, and the Federal Reserve reduced its supply. The causes might not have had the presumed effect, but they did exist. After June 1983 fiscal policy, for the first time in our story, became loose; monetary policy once again became tight.[38]
The Federal Reserve insisted that, in order to prevent inflation, monetary policy was tight because fiscal policy was loose, thus blaming deficits for both sides of the pressure on interest rates.[39]
High interest rates favored lenders and borrowers who had profits high enough for the tax advantages of interest deductibility to come into play. High interest rates were very bad for debtors—that is, farmers, young families who wanted to buy houses, and thus the housing industry. They were very bad for Latin American nations. And they were not much help to the federal government, whose debt service costs grew steadily.
To summarize, a consumer-led recovery that began in December 1982 accelerated particularly in mid-1983, maintained rapid growth for an unusually long time into 1984 due to business investment, and then slowed to a pace that was either "moderate" (per Republicans) or "sluggish" (per Democrats) by mid-1984. In the aggregate, the recovery resembled Ronald Reagan's promise of inflation-free expansion. But an unusually large number of people weren't along for the ride.