A Tale of Two Memos to Two President-Elects is a recent entry posted by John Taylor on his blog, Economics One. In the piece, the economist contrasts two approaches to solving the present crisis: That of Republicans who advised President Reagan in the early eighties as he took over the White House and that of Larry Summers who was advising President Obama as he himself took over the White House following his 2008 election. Both presidents came into power when the economy was in a deep crisis and both seem to have followed the prescriptions of their advisers. Were they right?
We know that we eventually came out of the deep recession - a double dip recession actually - of the early eighties but we are still waiting to find out whether we are going to emerge from the Great Recession of 2008. The Question is thus whether the advice given to Ronald Reagan by his advisers in the early eighties would have been a better remedy for the current crisis than what Dr.Summers prescribed to his own patient, Barack Obama.
On the one hand, the current economic situation certainly looks more like that of the the one we had following the Great Depression of the thirties than the situation which prevailed in the early eighties. We are stuck with high unemployment but very low inflation. Morevoer, firms are investing very little. Hence they are creating very few jobs which in turn explains why we are not seeing inflation pick up in spite of very aggressive monetary policies on the part of the Fed. By contrast, the early eighties were all about fighting inflation and anchoring inflation expectations. In this context, short-term policy remedies, like the ones proposed by Larry Summers to Barack Obama, may seem appropiate.
On the other hand, more than three years after the measures were adopted, nothing much has happened. After spending money freely on the hope of jump starting the economy, the jury is still out as to whether this was a good idea and whether we should continue. The problem today thus appears to many to be more related to a lack of competitiveness on the part of U.S. economy than to a lack of stimulus. Moreover, credit constraints, rather than unfavorable "animal spirit", seem to be responsible for the lack of investment on the part of SMEs which, usually, invest and create jobs domestically in a disproportionate fashion. Finally, like in the seventies, the system appears to be strongly defending entrenched interests. This time, however, it is the interests of the ruling financial elite rather than that of unions which are holding us back. In this context, it would certain appear more appropriate to intervene with longer-term policies aimed at improving productivity, encouraging investments and providing the right incentives by resetting the rules of the games and crushing the power of entrenched interests.
The real problem, however, is the current political situation. While Republicans seem to have the right set of solutions in their arsenal, they appear less inclined to use them to fix the problems today than they were in the eighties. The New Deal had eventually badly biased the system in favour of unions and regulations that led to a crisis in the late seventies and early eighties. Ronald Reagan was able to bring us back on the path to prosperity by applying the receipe proposed by his advisers which mostly consisted in giving the right incentives to paricipate in the economy. Today, we are forced to acknowloedge that the ruling financial elite who has captured the system and who wants to preserve its privileges is protected by Republicans. It's like findout that my brother had been stealing my money. We are thus in a deadlock with Republicans.
Democrats, for their part, are nostalgic of the past and want the state to take over. Bad idea; especially now that the financial elite controls the government. Neither strategy will work.
It's not that the short-term measures proposed by Larry Summers were necessarily bad. They helped save the system from a complete collapse after all. But they needed to be accompanied by credible longer term measures to break the monopoly of bankers on the state and to reset incentives; just like Ronald Reagan had done in the eighties by breaking the monopoly of the unions and regulations on our economic life.
We need today again to reform the system to encourage everyone to participate in the economy. We want students to acquire the skills needed in tomorrow's economy. We want workers to work at high-paying jobs. And we want entrepreneurs to invest and take risks. But who wants to play when the game is fixed? With incompetent Democrats and irresponsible Republicans, we are a long way from being able to solve our problems.
And the longer we wait, the more costly it will be to fix the system. Unfortunately, today the amount of austerity that would be required to fix the system - and there is no doubt in my mind that, like in the eighties, it is needed - is already being rejected by a population who no longer trust its leaders. The amount of needed austerity is also only going to grow with time. We are thus headed towards a social and political crisis of unprecedent proportion. When? I don't know. The sooner, the better because the alternative is worse.
It's too bad that President Obama missed his opportunity to save the day in 2009!
Here is John Taylor's recent blog entry:
Today the Wall Street Journal dedicated more than three-fourths of a page to publishing large excerpts from a 1980 memo to president-elect Ronald Reagan from George Shultz and other economists who had advised Reagan in the presidential campaign. In my view, that memo represents a watershed in the history of economics with great relevance today, and that is why I focused on it in my new book First Principles, where I explain why the economy prospers when policy adheres to the basic principles of economic freedom, but falters when policy deviates from those principles, as it is doing now. That original fifteen page 1980 memo was an important reason why policy veered back to the principles of economic freedom the 1980s and the 1990s. Here is how I describe the memo in First Principles:
Less than two weeks [after the 1980 election], on November 16, 1980, many of the economists who had worked together in the campaign wrote an extraordinary memo to Reagan entitled ‘Economic Strategy for the Reagan Administration.’ It began with a call for action: “Sharp change in present economic policy is an absolute necessity. The problems . . . an almost endless litany of economic ills, large and small, are severe. But they are not intractable. Having been produced by government policy, they can be redressed by a change in policy.”
The memo then outlined a set of reforms for tax policy, regulatory policy, the budget, and monetary policy. There were no temporary tax rebates, short-term public works projects, or other so-called stimulus packages. Rather there were sentences like “The need for a long-term point of view is essential to allow for the time, the coherence and the predictability so necessary for success.”
I believe it is instructive to compare this 1980 memo to President-elect Reagan with a similarly-timed fifty-seven page 2008 memo to President-elect Obama. The 2008 memo from Larry Summers was recently posted by Ryan Lizza on the New Yorker web page generating much political and economic debate. Both were written in times of great economic difficulties, but the contrast between the overall approaches to economic policy is striking. Most important, unlike the 1980 memo to Reagan, the 2008 memo focused mainly on short-term interventions and so-called stimulus packages. The recent debate in the press has been over whether the short-term stimulus package should have been larger. In contrast the 1980 memo did not even mention such short term stimulus packages, but rather focused on more permanent long-term strategies and policy predictability.