Full text of Lessons from Living with Economic Policy
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7 Lessons from Living with Economic Policy 1 my w 1 riting an speaking these days consists of rem d inis cences. I have a lot to rem inisce about: I have practiced W ashington econom ics—observing an participating in the d m aking of federal econom policy—for over fifty-six years. That is ic longer th any other econom in the history of the republic. an ist The recent death of R ichard Nixon prom m to recall m pts e y experience as one of his econom advisers. That experience illus ic trates tw general points about econom policy: the lack of strategic o ic th k g about econom policy an the lim in in ic d ited consequences of policy m istakes. These points are supported by the w hole history of the past fifty years; I use the Nixon experience only because I know it best. Lack of Strategic Thinking There is little strategic th k g about econom policy: that is, in in ic h aving clear an consistent goals, having plans for achieving them d , an having a p or policy for adaptin w d lan g hen the plans are not w orking. This latter feature is alm alw m ost ays issing. Presidential adm inistrations com into office w m goals, an w plans for e ith any d ith achieving them but often the w , orld turns out different from w hat w assum inthe p as ed lans an the adm d inistrationfounders inaneffort to deal w conditions it had not foreseen, even as possibilities. ith Although I could say som positive things about w we d or e hat id 64 Lessons from Economic Policy 65 tried to do in econom policy during the N ic ixon years, w stands hat out is the big gap between w w expected at the beginning an hat as d w turned out at the end. Tw exam hat o ples of this discrepancy com e tom ind. At the tim of Nixon’s first in gu e au ration in 1969, a dom inant feature of his econom appeared to be a phobia about unem ics ploy m ent. At my first m eeting w h , in December 1968, he asked ith im m w I thought our m econom problem was. I said it w e hat ain ic as in flation an he said, “Yes, but you m , d ust w orry about unem ployment.” A second dom inant feature of N ixon’s econom at the begin ics nin of his term w opposition to price an wage controls. This g as d was, for Nixon, m th conventional R blican paternoster or ore an epu standard classical econom ics: it w a strong personal conviction. as H brief tenure as a law in the O is yer ffice of Price Adm inistration at the beginning of W orld W II h been a frustrating experience. ar ad But the unem ploym rate that h been 3.4 percent w we ent ad hen cam into office w 9 percent in May 1975. That w nine m e as as onths after Mr. Nixon’s prem ature departure fromoffice, but it w ould have been no lower if he h stayed. Insofar as the unem ad ploym rate is ent ever the president’s, that 9 percent rate w Nixon’s. as And in August 1971, Mr. N ixon, the great enem of price y controls, inaugurated the only com prehensive, m andatory price an d wage controls in Am erica’s peacetim history. These controls re e m ained m or less in effect for tw an a half years. ore o d I could list a great m reasons for this big gap between our any prom ises an expectations an the outcom We inherited w at d d es. hat the tim seemed a high in e flation rate. No one knew how m uch slow n of the econom w dow y ould be required to curb that in flation or w m hat onetary policy w ould be necessary to bring about the disin fla tion. In any case, the adm inistration d not control m id onetary policy. The course of the econom in 1970 w disturbed by a m y as ajor strike at G eneral Motors. The N ixon adm inistration h to deal w a ad ith Dem ocratic Congress that w m less averse to price controls as uch than the adm inistration w an , m as d oreover, w anted to em barrass the adm inistration for its reluctance to use controls. Later, in 1972 and 1973, there were m ajor disruptions of the w orld supply situation—Soviet crop failures, the departure of the anchovies from the P acific coast of South Am erica, and, m severe, the oil shock. ost These conditions an developm d ents ensured th the course of at 66 General Perspective econom policy during the N ic ixon adm inistration w ould not run sm oothly, no m atter w hat we d . But m point is that in our id y decisions an statem d ents we d not take m id uch account of these possible obstacles an uncertainties. Som of these conditions—such d e as the presence,of a Dem ocratic Congress—were obvious from the outset, but the possible consequences of that fact were not explored a dgiven adequate attention. Som of these developm n e ents—such as the oil em bargo—were probably not foreseeable, but the possibility of som k d of external shock, even if not that particular one, could e in have been recognized. The im plications of that possibility were not given attention either. W h a view of w we called the optim feasible path of e ad hat um the econom It w y. ould bring us to 1972 w low in ith flation w , ithout price controls, an after having passed through a brief period of only d m oderately high unem ploym ent. W also had a view of the com e bina tion of fiscal an m d onetary m easures that w ould m the econom ake y m along that path. Every few m ove onths, w hen we recognized that we were off the path, we w ould revise the path an the necessary d policy, alw to reach the sam goals. But we never prepared ays e ourselves or the pu blic for the very likely possibility that reality w ould tu out to be as far from the new path as it had been from rn the old one. As a result, w were constantly revising our policy to catch u e p w events, an the pu w continuously losing confidence inour ith d blic as policy an our forecasts. That m it im d ade possible fin to convince ally the countrythat gradualismw ouldendin flationandthat price controls were unnecessary, even dangerous. The condition of the econom y at the tim we im e posed, the controls w not terribly bad by any as standard except one: the standard of our ow prom n ises. Both in flationan unem d ploym were higher th we h been prom ent an ad ising for tw years. We could no longer convince people, probably in d o clu ing the president, that our policy of avoiding price controls was w orking. If we had recognized an insisted on the inevitable uncer d tainties from the outset, w w e ould have been in a better position to argue for patience. Moreover, our own conception of the bad consequences of price controls was abstract and academic. If we had been more conscious of the way price controls might work out, we might have been even more reluctant than we were to impose them and more successful in explaining to the public why we did not want to use them. Lessons from Economic Policy 67 As I look back to that weekend som tw e enty years ago w hen we decided to im pose the ninety-day freeze on prices an wages, I d am am azed to recall how unconcerned an ignorant we were about d w w hat ould happen next. W h a vague idea that after ninety days e ad we w ould get dow to a system of essentially voluntary exhortation n to large businesses an unions about their price, an wage behavior. d d W d not foresee that the pu w e id blic ould love the ninety-day freeze so m uch that w could not retreat from it very quickly. We d not e id foresee that we w ould be livin w the system for tw an a half g ith o d years. We d not foresee that the in l apparent success of the id itia controls w ould seduce us into excessively expansionary fiscal an d m onetary policy. W d not count on the possibility of shocks to the e id w orld food an energy supplies th w d at ould end the system in an explosion of in flation follow by the worst recession of the postw ed ar period u to that tim p e. If we h visualized that course of events, not as most probable ad but as possible, w m have resisted the im e ight position of the controls m an have explained m successfully to the public w we d ore d ore hy id that. W suffered from a tendency to regard the most probable e scenario as the only possible scenario an to neglect the im d plications of the uncertainties of our condition. This deficiency, of course, w not peculiar to the adm as inistration in w hich I served. The K ennedy-Johnson adm inistration failed to recognize the possible consequences of its policy of fine-tuning fiscal m easures com bined w arm isting businesses an unions to ith -tw d prevent inflation Members of the R . eagan teamh various assum ad p tions of w the consequences of the in l big tax cut w hat itia ould be an d found themselves struggling for seven years w the fact that none ith of these assum ptions turned out to be true. The Bush adm inistration found itself seriously em barrassed for having failed to recognize an d prepare for the possibility that its pledge of no new taxes m ight be inconsistent w its pledge to balance the budget infive years. ith Consequences of Policy Mistakes This history illustrates m first point, w y hich is the com on lack of m strategic th kin My second point is m com in g. ore forting: like hu rri canes in H artford, H ereford, an H pshire, terrible things hardly d am ever happen, at least as a result of m istakes of econom policy. The ic 68 General Perspective story of the follies of econom policy is the story of irony, of the gap ic between pretensions an outcom not a story of tragedy. d es, Most people w ould probably agree that the im position of price controls in 1971-w one of the great m as istakes of econom policy of ic the postw period. Som generally sensible observers thought that ar e the Am erican econom w y ould never be the sam an that we w e d ould never get back to free m arkets. But that d not turn out to be the id case. We d go through some foolish experiences, like the drow id ning of baby chicks allegedly because of the price controls, and having to w in line for gasoline. W d end u w a recession, but ait e id p ith recessions are a com on part of our econom history. The 1974m ic 1975 recession w not m worse th our average. And we d as uch an id have an exceptional rise of output an em d ploym in 1972, w ent hich we m not have h w ight ad ithout the controls. M any people w ould agree that the deficits of the R eagan an d Bush adm inistrations were a m ajor m istake of econom policy. But ic it is h now to point to any substantial dam they did. Econo ard age m ists w say that the deficits depressed private investm an ill ent d slow dow long-term grow but w ed n th, hen we try to estim the ate size of this effect, it seems to be quite sm all. H do w explain this apparent fact that we can have so m ow e uch folly w so little resulting dam ith age? I w suggest an explanation by ill referring to three quotations. Adam Sm the fount of a w ith, ll isdom said, “There is a great , deal of ru in a nation.” He m in eant, I believe, that a nation is a sturdy, flexible institution, reflecting the private decisions of m illions of in ivid als, an that the follies of governm do not m disturb d u d ent uch the n ation conditionunless the follies are exceptionally great. al A second quotation is less elegant but m pointed: “Econom ore ic policy is random w respect to the perform ith ance of the Am erican econom but th God there isn’t m of it.” That revelation d y, ank uch id not com fromthe fount of a w e ll isdombut fromme; it suddenly cam e to m ten years ago as a sum ary of m experience in forty-six e m y years of W ashington econom The fact is that most of the things ics. that we regard as big issues are really sm relative to the size of all the Am erican econom y. The th quotation is, to me, the most interesting. Axel ird Oxenstiem, chancellor of Sw eden 350 years ago, said: “Behold, m y son, w howlittle w ith isdomthe w orld is governed.” For a long tim e, I thought he w saying that the w as orld is governed badly because it Lessons from Economic Policy 69 is governed w so little w ith isdom I now believe that he m have . ay been saying that even a little w isdom is sufficient to govern the w orld—that the w orld can be w governed w ell ithout m w uch isdom . That idea should be fam iliar to econom ists. Thanks to Adam Sm w believe that good perform ith, e ance of the econom does not y depend on the w isdom of the in ivid al actors in the econom W d u y. e have an institution, the m arket, that produces good results even though the in ivid als m not be very wise. The institutionw d u ay innow s out the follies of the participants. That, we suppose, is w Adam hat Sm m ith eant by reference to the Invisible H and, although since he put the in itials of those w ords in cap letters he m also have ital ay been speaking of God. But we generally reject, or at least overlook, the possibility that an Invisible H and controls governm to prevent the follies of our ent governors from resulting in tragedy. I recently read the First Inaugural Address of George W ashington an w surprised to fin d as d himsaying this: “No people can be bou to acknow nd ledge an adore d the Invisible H w and hich conducts the affairs of m m thanthose en ore of the U nited States.” I do not know w hether George W ashington ever read The Wealth of Nations. Alexander H ilton, w helped W am ho ashington as a speech w riter, m have done so, an that m be the connection ay d ay between Sm ith’s Invisible H d an W an d ashington’s. Clearly, W ashing ton w referring to God, as Sm probably w also. But W as ith as ashing ton like Sm w probably also referring to institutional arrange ith as ments that yielded good results w ithout great dem ands on either the w isdom or the virtue of in ivid als. In Sm d u ith’s case, the institution w the free m as arket. In W ashington’s case, it m have been the ay structure of governm ent, starting w the Constitution in w ith hich he an his contem d poraries placed so m uch faith. The Invisible H and m have been the guidance an lim ay d itation placed on the policies of governm by the division of functions am the federal govern ent ong m ent, the states, and the citizens; the balance of powers am the ong branches of the federal governm ent; the room left for the play of diverse factions an interests; an the assurance of freedom of d d discussion an the com d petition of ideas. This m be the Invisible ay H and that despite the lack of strategic th kin about w in g hich I have com plained saves us from extrem an persistent errors of e d governm ent. (June 1994)
