Goodbye Keynes, Hello Coolidge
Paying off the national debt used to be an obsession of Calvinist fundamentalists on the fringes of the Republican Party, but this year it is the boldest banner held aloft by the Democratic Party's presidential nominee. If Al Gore is taken at his word, his presidency will amass trillions of dollars in extra revenue and devote most of it to paying down the federal debt. That would represent a very conservative agenda--and an ideological sea change for the Democrats--but Gore and his economic advisers have persuaded themselves that the New Economy is real and changes everything. A conservative fiscal policy, they assert, is now the progressive thing to do. Skeptics, myself included, would say more darkly: Goodbye Keynes, hello Coolidge.
Some Gore supporters, including some liberals, wave off any criticism of Gore's strategy because they essentially don't believe it's real. They figure that either the $3.4 trillion in federal operating surpluses projected for the next decade will never materialize or the Vice President's devotion to debt reduction is simply clever positioning for the campaign. The stratagem was originated by Bill Clinton in early 1999 to stymie Republican demands for huge tax cuts, and Gore uses the issue in the same way. It also gives him protection against the "liberal big spender" label. The political benefits are real enough, but the evidence suggests that Gore is also a true believer. His advisers insist we have entered a new era, in which fueling financial markets with abundant investment capital takes precedence over major government spending programs. If the insights of John Maynard Keynes are still relevant to fiscal policy, Gore's pay-down-the-debt program could do great damage to economic prosperity.
For better or worse, Gore is the inheritor. As a candidate, he is still operating with both Clinton's people and Clinton's old strategy. The economic advisers are all veterans of Clinton's New Democrat regime, led by Treasury Secretary Lawrence Summers and Gene Sperling at the White House, plus former Treasury Secretary Robert Rubin, who's now at Citigroup; former Federal Reserve Vice Chairman Alan Blinder at the Brookings Institution; and former Council of Economic Advisers chair Laura D'Andrea Tyson, who is back at the University of California, Berkeley, as dean of the business school. One ought to add the name of Alan Greenspan, the Republican Chairman of the Federal Reserve, because Gore, like Clinton, is expected to rely on his very conservative counsel and never--ever--challenge the Fed's management of the economy.
The first problem is that economic circumstances have changed dramatically since Clinton first deployed the debt-liquidation strategy, but Gore's thinking has not. The nineties are over and the deficits are gone. Fiscal balance has been achieved, even overachieved. But Gore intends to keep on fighting the last war, establishing Democrats as the party of fiscal responsibility, and he has a new theory to justify his commitment. Eighteen months ago, the federal budget was still in deficit but heading toward major surpluses, estimated at nearly $1 trillion during the next decade. Now the projections are for $3.4 trillion in surpluses (not including $2.4 trillion in Social Security surpluses), a perennial stream of excess revenue that every year would take a bigger bite out of the private economy than the government needs. Instead of spending the extra money in ways that boost consumer demand and business profits, Gore would steadily retire Treasury bonds and improve the government's balance sheet. In his theory, this frees up capital for private investment, and that creates more jobs, better productivity. In theory, the shrinking government debt should lower interest rates for economic activity of every sort. The odd part, however, is that Gore's "new economics" implicitly accepts the same old logic that used to be called "trickle down" when conservatives proposed it. Financial capital first; the people benefit later. It's a long way from the activist government that liberals inherited from Keynes.
An enthusiastic explication of Gore's "new economics" was delivered by Larry Summers in a professorial speech on May 10 in San Francisco. "The advent of a new economy fundamentally changes the stakes involved in the choice of our nation's fiscal policy," he declared. "In a world that is rich with investment opportunities, and where investors are all able instantly to compute the implications of changes in policies five and ten years out--the importance of running a surplus and pursuing prudent policies becomes much, much greater.... Like tax cuts, reducing publicly held debt also delivers substantial direct benefits to the pocketbooks of American families: both by reducing the burden of future payments on interest and principal, and by helping mortgage holders by putting downward pressure on long-term interest rates.... The bottom line is that the more we save through debt reduction, the more that America's businesses will be able to invest in the technologies that will shape our future."
Rough translation: A tight, even austere fiscal policy of paying down debt will reassure investors about the future and also increase the supply of private capital so that market interest rates will be lower and everyone should benefit, including the humble homebuyer. This theory amounts to choosing a different "Keynesian" channel through which the government attempts to stimulate the private economy. Instead of public spending, it's the financial markets. One might ask an awkward question: If fiscal surpluses produce such benefits, why are market interest rates rising again now, when federal surpluses are also surging? The short answer, of course, is that the Federal Reserve is alarmed by the danger of too much prosperity, so it's stepping on the monetary brake, regardless of the soundness of that fiscal policy.
For the moment, leave aside the question of whether this New Economy theory adds up. The crucial point is that once its conservative premises are accepted, they influence Gore's entire agenda. His approach mimicks the incrementalism of Clinton, not the big and fundamental ideas that liberal Democrats had hoped to see once federal deficits were eliminated. Gore began the 2000 campaign as a fiscal conservative and used Bill Bradley as his foil, denouncing Bradley's moderate version of healthcare reform as irresponsible. Subsequently, as new budget projections pumped up future surpluses enormously, Gore loosened his wallet a bit. He began committing modest sums to a growing list of standard liberal concerns--various tax credits for education, families, healthcare and other matters. His one big and original proposal is a major subsidy to help finance private savings accounts for middle- and low-income families, which could become an important first step toward ameliorating the growing inequality of wealth.
On the whole, however, Gore and his advisers remain skeptical of big ideas and new departures that involve government intervention. During the Clinton years, for instance, the number of Americans without health insurance grew from 38 million to 44 million. One of the acknowledged causes is welfare reform; another is the steady growth of temp jobs without benefits. When I asked Laura Tyson why advisers were unwilling to propose a major reform, she said it wasn't clear what, if any, intervention might work. So they agreed that market forces should be allowed to play out, while modest steps are taken on the margins to help poor families get or regain coverage (George W. Bush has a similar, though smaller proposal). The notion that government should confront the labor market and push businesses to assume a larger responsibility for their workers wasn't on the table.
The commitment to market forces is likewise reflected in Gore's views on globalization. He now promises that any new trade agreement in his administration must include strong provisions for labor rights and environmental protections. But one recalls that this is the same promise Clinton made in 1992 and repeatedly violated in numerous trade agreements, most recently with China and Vietnam.
What Gore himself truly believes (or fully understands) is unknowable, of course, but he certainly wants to sound fervently committed to the importance of endless surpluses. Earlier this year, his enthusiasm led him into what any economist (including his own advisers) would recognize as a gaffe. Gore told the press that if recession were to develop, he might have to cut spending to maintain a balanced budget. The New York Times reported Gore's promise to raise taxes in a recession to defend the surpluses. The idea of doing either is economic nonsense, since both would deepen a recession. The idea is a political nonstarter, in any case, since even the flintiest right-wingers would oppose it. Numerous inquiries to the Gore campaign about whether these remarks have ever been retracted went unanswered.
The big question about Gore's conservative bookkeeping is whether the economy could stand it. In olden days, when Democratic economists were liberals, they would have explained the negative "fiscal drag" that an overly austere fiscal policy exerts on economic growth--undercutting incomes and profit by sapping aggregate demand. The unfolding fiscal circumstances are unprecedented for at least the past seventy years, and some dissenting economists foresee grave danger if Gore were actually to implement what he is promising. Indeed, L. Randall Wray of the Levy Institute and the University of Missouri, Kansas City, argues that in the process of gradually eliminating the "structural" deficits created by the Reagan era, government has overcorrected and created the opposite problem--"structural" surpluses that persist regardless of the business cycle. The government's own projections seem to confirm this, he observed. Growth is expected to be somewhat slower on average in coming years, and recession is anticipated to occur at some point, yet the huge surpluses endure year after year. Since the government will be collecting perennial surpluses of revenue, the private sector--businesses and especially families--will be compelled to borrow more and more to maintain the aggregate demand needed to sustain growth. Indeed, Wray said, that already seems to be happening. This year, while the government is flush with extra cash, the household savings rate has fallen to zero. The danger of running huge structural surpluses (much like the deficits of the eighties and nineties) is that once this condition is embedded throughout government by tightening or eliminating the spigots for spending, it may prove difficult to reverse quickly. If an economic contraction develops, fiscal surpluses would shrink but might continue for several years, Wray warned. If so, the government's fiscal policy would be inadvertently feeding the recession, not stimulating a recovery. One can see the danger, Wray suggested, by looking at Japan's miserable decade. In the late eighties Japan was astride its own fabulous financial bubble, and its government was running huge budget surpluses. After the bubble burst, Japan's government responded hesitantly and Japan's surpluses persisted for three or four years, dragging the economy into a severe deflationary recession. The central bank lowered interest rates to nearly zero, but it didn't help. Private firms had been deeply damaged, and consumers were too frightened to spend. Japan is still struggling.
It can't happen here, we are assured, because the government could respond swiftly and restore deficit spending, that is, unfashionable Keynesian pump priming. Maybe so, but once politicians have embraced a new faith, it is often hard for them to grasp that reality contradicts their convictions. In the meantime, the Gore posture is like Clinton's. He would count on the Federal Reserve to steer the economy wisely and, if the worst happened, to lower interest rates smartly to revive a failing economy. Come to think of it, that's what Herbert Hoover relied on too.