One of the great disappointments of recent decades is that Democrats have more or less swallowed whole the underlying economic theories of their Republican rivals. They are now as fearful of government spending and taxes as their counterparts, and they have no economic theory to justify their social programs. To the contrary, many now agree that social programs are invariably a cost to the economy because they reduce growth by sucking funds from private capital markets. What makes Democrats different is that some argue that they are a cost the nation should gladly bear.
In fact, an analysis of why economies grow that is less ideological and truer to history yields a different attitude toward public policy. The strength of internal demand–that is, the home markets for goods and services–is a central source of economic growth, and has been at least since the Middle Ages. And good social programs ultimately help modern economies grow by keeping domestic markets strong.
I am not merely talking about Keynesian stimulus here, which is at last making a comeback. In order to keep the recession from worsening, we should be extending unemployment insurance, channeling money to cash-strapped cities and states and giving a tax cut to middle- and lower-income workers by rescinding the Bush tax cuts for the rich. But more important for the long run, it is again time to understand that high wages and more equal incomes can help the nation grow over time. Social programs–from the minimum wage to earned-income tax credits to the public investment that supports transportation infrastructure, educational equality and high-quality childcare–can be central to economic growth as well as to social justice.
Even liberal economists forget these fundamentals of growth. A common claim among them these days is, “We are all Keynesian in the short run and supply-siders in the long run.” Supply-side economics mainly emphasizes national savings, support for technology and getting government out of the way.
Economists did not always think this way. Twenty-five years ago, some, like Nicholas Kaldor of Cambridge University, argued that large markets were a key to growth. In other words, the demand side matters in the long run, too. In fact, this is a page right out of Adam Smith. You might be able to make 200 times as many pins in a day as you divided the tasks and specialized the labor, but you would not bother, Smith wrote, unless you had a thriving market in which to sell them. Industrialization made the size and growth of the market even more important. Economies of scale were simply extraordinary, with a mass market that devoured standardized products; the costs of producing everything from steel, oil, automobiles and radios to chewing gum and breakfast cereals fell fastest in the nation with the largest market, the United States. The Internet era is making economies of scale only more potent.
Demand-side economics lost favor for two reasons. One is that it was carried too far. By the 1970s, wages were probably too high compared with profits. Two, beginning with the Vietnam War, and then the oil shock of the 1970s, increasing demand fueled inflation more than it did real growth.
Now the pendulum has swung too far toward the supply side. Supply-side ideas did not bring America back in the late 1990s. Rather, new technologies met a vast market that was at last growing again, in part due to a looser Federal Reserve policy that reduced interest rates. And one of the key factors that drove the nation’s economy to boom were economies of scale from complex but standardized products that dominated the market. These included everything from Windows, Excel, Hewlett Packard printers, Cisco routers and the miraculous Intel chips to the Wal-Mart discount stores and thousands of almost identical mutual funds. So America grew in the 1990s the way it had always grown. New technology met huge markets. Standardization was back, even though savings were again in short supply, as they were in the nineteenth century.
But this time there was a problem. Wages were too low, inequality too great and poverty too high to support sufficiently growing demand. America’s domestic markets had been weakened in addition by unequal education, poor infrastructure, spotty healthcare and inadequate childcare. Growing demand could be accomplished only by borrowing in record quantities against the value of homes and a rising stock market. Now the consumer debt is a serious obstacle to future growth. At the same time, jobs are being lost, stocks keep falling, housing prices could also be on the verge of tumbling and capital spending is weak and likely to remain so.
Recognizing that well-managed social programs can strengthen the domestic market and contribute to rather than detract from economic growth is critical to this nation’s future. It may also supply Democrats with grounds for the bolder economic policies that their natural constituency is probably eager to hear.