How the Economy Was Lost: The War of the Worlds (Counterpunch)

by Roberts, Paul Craig

  President Reagan is criticized for adding $1 trillion to the federal debt during his eight years in office, an amount President Obama added in his first six months. During the Reagan years, the Keynesian economists who had been displaced as policymakers tried to scare Wall Street with “twin deficits” doom and gloom in the hopes that fear would drive up interest rates and wreck the Reagan economy. Harvard University’s Benjamin Friedman was one such fear-monger.

  It is not unusual today to encounter people who are convinced that Wall Street was the instigator of the Reagan tax rate reductions. However, it was Wall Street economists and publications such as Barron’s that beat the drums daily about “Reagan’s fiscal irresponsibility.” Wall Street bought the Keynesian line and expected that Reagan’s policy would drive up inflation and interest rates and wreck the stock and bond markets.

  Amidst the hullabaloo respected international institutions published data showing that the Reagan deficits ranked low in comparisons with budget deficits of other developed countries. The OECD (Economic Outlook, May 1988) showed that the U.S. budget deficits for 1983–1987 were substantially less as a percentage of GNP/GDP than Canada’s, Holland’s, Italy’s, and Spain’s, and on a par with the U.K.’s, Germany’s, and France’s. None of these countries were regarded as suffering from fiscal irresponsibility.

  The Bank for International Settlements showed that the U.S. was not a candidate for “deficit crisis.” Between 1973 and 1986 the U.S. experienced one of the lowest growth rates in the ratio of debt to GNP. In the U.S. the ratio rose by 40.8 percent, but in Germany and Japan, countries that were regarded as hallmarks of fiscal responsibility, the ratio rose 121 percent and 194 percent.

  The Keynesians ignored all facts. They understood that conservative Republicans were terrified of budget deficits, and they used this fear in their attempt to discredit Reagan’s supply-side economics.

  Keynesians blamed the deficits on supply-side economists for allegedly predicting that the tax rate reductions would pay for themselves. Keynesians themselves had long been comfortable with their own analysis that showed that tax cuts had a multiplied effect that expanded GNP and brought in more tax revenues. However, the Reagan administration, over whose forecast I had veto power as Assistant Secretary of the Treasury for Economic Policy, made no such forecast. As the official records clearly show, the Reagan administration forecast that every dollar of tax cut would lose a dollar of revenue.

  The Reagan deficits, small by today’s standard, were the product of two Keynesian concepts: “core inflation” and the “Phillips curve.” The “Phillips curve” postulated trade-offs between employment (growth) and inflation. A growing economy would have to pay for its growth by accepting a higher rate of inflation. The price of restraining inflation was a higher rate of unemployment and less economic growth.

  These concepts had no credibility with the supply-side and monetarist economists in the Reagan Treasury. However, OMB director David Stockman and the politicians on the White House staff feared that a forecast with budget deficits would lose the Republican vote in Congress and defeat Reagan’s attempt to cure “stagflation.” Stockman brought the “Phillips curve” into the forecast and used it to raise the projected rates of inflation closer to Keynesian expectations. The higher inflation forecast pushed up nominal GNP and produced the revenues to balance the five-year budget forecast. As I showed in my testimony before the Senate Banking Committee, February 18, 1987, it was the collapse of inflation compared to the forecast that caused the Reagan deficits.

  The unexpected collapse of inflation resulted in $2.5 trillion less nominal GNP during 1981–86. The loss of projected tax revenue from lower than projected nominal GNP was the main source of the budget deficits.

  Paul Volcker, Federal Reserve chairman at that time, is responsible for the deficits. The Reagan administration asked Volcker to gradually reduce the growth rate of the money supply by 50 percent over a period of four to six years. Instead, while warning of future inflation from the tax cuts, Volcker collapsed the growth of the money supply and delivered 75 percent of the requested reduction in 1981. By 1982, inflation was already at the low rate the Reagan administration had predicted for 1986.

  All of these facts were available, but Keynesian economists chose to ignore them. Benjamin Friedman even wrote a book in which he claimed that the Reagan administration had purposely engineered large budget deficits in order to force cuts in federal spending. In Keynesian mythology, the Reagan deficits, puny by any measure compared to those of today that Keynesians such as Paul Krugman and Robert Reich regard as “too small,” remain the source of all of America’s economic ills.

  Paul Krugman, who owes his name recognition among the general public in part to his 30-year quarrels with President Reagan and supply-side economics, has even put the blame on the Reagan administration for the Clinton-Bush financial deregulation, which wrecked the financial system, the economy, and Americans’ pensions and home values. On occasion I encounter the question from readers: “When are you going to apologize for deregulating the financial system?”

  The disinformation spread by people who purport to be scholars is extraordinary. The Reagan administration did not deregulate the financial system. Indeed, we did not even talk about it. The deregulation of the financial system was accomplished by Goldman Sachs and the banks during the Clinton and Bush administrations, after Reagan was gone from the White House and in his grave.

  The kind of regulation that concerned the Reagan administration was abusive regulation that was pointless and even devoid of statutory basis. Small businesses were being harassed and threatened with fines by OSHA for not having exit signs over the only door into and out of their offices. Paperwork burdens that provided no benefits commensurate with costs were exploding. On occasion farfetched “violations” resulted in unjust prison sentences. For example, Ocie and Carey Mills, armed with a state permit, used clean dirt to level a building lot. Their action was legal under Florida law. However, federal bureaucrats claimed jurisdiction under the Clean Water Act, which regulates the discharge of pollutants into the “navigable waters of the U.S.” No waters, navigable or otherwise, were present, but for putting clean dirt on dry land, father and son spent 21 months in prison.

  Mills and his son were imprisoned for a regulatory violation that had no statutory basis. The Clean Water Act makes no reference to wetlands and conveys no powers to the executive branch to create wetlands regulations. This fact was subsequently acknowledged by the Clinton administration, which declared: “Congress should amend the Clean Water Act to make it consistent with the agencies’ rule-making.”

  Similar bureaucratic overreach harassed farmers for cleaning drainage ditches and ranchers for repairing fence posts.

  The Reagan administration is sometimes accused of starting financial deregulation by deregulating savings and loan associations. This is nonsense. S & L associations borrowed short and lent long on home mortgages, which comprised their loan portfolios. When short-term interest rates rose above long term-interest rates, the thrifts were victims of disintermediation. Disintermediation prevented Regulation Q from maintaining the spread between the interest paid to depositors and the interest rate on mortgages. The Tax Reform Act of 1986 decreased the value of investments held by S & Ls and worsened balance sheets. The regulatory changes that ensued, some of which were ill-considered, were responses to crisis that developed. They were not the beginning of an onslaught on financial regulation.

  Prior to Goldman Sachs taking charge of U.S. financial policy, the only financial deregulation of note was the dismantling of restrictions on national bank branching. This occurred in 1994 and had nothing to do with “Reaganomics.” Indeed, I opposed it in my writings, as did real bankers, such as George Champion, the retired chairman of Chase Manhattan Bank, who testified against it in Congress.

  Champion’s argument was simple. National branch banking would divert banks from th
eir raison d’être, which was to identify local business talent and underwrite entrepreneurial efforts in local economies. Champion told the Senate that managers of branches would see their assignments as short-term ones. Consequently, the managers would neglect local needs, instead investing the bank’s funds in financial instruments while they waited to move up to a larger branch in a larger town or city. However, large banks wanted national branches as a means of vacuuming up deposits, and they prevailed over common sense.

  Liberals and the political left-wing see deregulation as an ideological program of conservatives, of which the Reagan administration was the last political manifestation. Even when Wall Street investment banks, in full view of the public, corrupt the regulatory authorities, the White House, and Congress, liberals blame Reagan. By such self-deception, liberals maintain their faith in government.

  Chapter 47: The Health Care Deceit

  The current health care “debate” shows how far gone representative government is in the United States. Members of Congress represent the powerful interest groups that fill their campaign coffers, not the people who vote for them.

  The health care bill is not about health care. It is about protecting and increasing the profits of the insurance companies. The main feature of the health care bill is the “individual mandate,” which requires that everyone in America buy health insurance. Senate Finance Committee chairman Max Baucus (D-Mont), a recipient of millions in contributions over his career from the insurance industry, proposes to impose up to a $3,800 fine on Americans who fail to purchase health insurance.

  The determination of “our” elected representatives to serve the insurance industry is so compelling that Congress is incapable of recognizing the absurdity of these proposals.

  The reason there is a health care crisis in the U.S. is that the cumulative loss of jobs and benefits has swollen the uninsured to approximately 50 million Americans. They cannot afford health insurance any more than employers can afford to provide it.

  It is absurd to mandate that people purchase what they cannot afford and to fine them for failing to do so. A person who cannot pay a health insurance premium cannot pay the fine.

  These proposals are like solving the homeless problem by requiring the homeless to purchase a house.

  In his speech Obama said “we’ll provide tax credits” for “those individuals and small businesses who still can’t afford the lower-priced insurance available in the exchange” and he said low-cost coverage will be offered to those with preexisting medical conditions. A tax credit is useless to those without income unless the credit is refundable, and subsidized coverage doesn’t do much for those millions of Americans with no jobs.

  Baucus masquerades as a defender of the health-impaired with his proposal to require insurers to provide coverage to all comers as if the problem of health care can be reduced to preexisting conditions and cancelled policies. It was left to Rep. Dennis Kucinich to point out that the health care bill ponies up 30 million more customers for the private insurance companies.

  The private sector is no longer the answer, because the income levels of the vast majority of Americans are insufficient to bear the cost of health insurance today. To provide some perspective, the monthly premium for a 60-year-old female for a group policy (employer-provided) with Blue Cross-Blue Shield in Florida is about $1,200. That comes to $14,400 per year. Only employees in high productivity jobs that can provide both a livable salary and health care can expect to have employer-provided coverage. If a 60-year-old female has to buy a non-group policy as an individual, the premium would be even higher. How, for example, is a Wal-Mart shelf stocker or check out clerk going to be able to pay a private insurance premium?

  Even the present public option—Medicare—is very expensive to those covered. Basic Medicare is insufficient coverage. Part B has been added, for which about $100 per month is deducted from the covered person’s Social Security check. If the person is still earning or has other retirement income, an “income-related monthly adjustment” is also deducted as part of the Part B premium. And if the person is still working, his earnings are subject to the 2.9 percent Medicare tax.

  Even with Part B, Medicare coverage is still insufficient except for the healthy. For many people, additional coverage from private supplementary policies, such as the ones sold by AARP, is necessary. These premiums can be as much as $277 per month. Deductibles remain and prescriptions are only 50 percent covered. If the drug prescription policy is chosen, the premium is higher.

  This leaves a retired person on Medicare who has no other retirement income of significance paying as much as $4,500 per year in premiums in order to create coverage under Medicare that still leaves half of his prescription medicines out-of-pocket. Considering the cost of some prescription medicines, a Medicare-covered person with Part B and a supplementary policy can still face bankruptcy.

  Therefore, everyone should take note that a “public option” can leave people with large out-of-pocket costs. I know a professional who has chosen to continue working beyond retirement age. His Medicare coverage with supplemental coverage, Medicare tax, and income-related monthly adjustment comes to $16,400 per year. Those people who want to deny Medicare to the rich will cost the system a lot of money.

  What the U.S. needs is a single-payer not-for-profit health system that pays doctors and nurses sufficiently that they will undertake the arduous training and accept the stress and risks of dealing with illness and diseases.

  A private health care system worked in the days before expensive medical technology, malpractice suits, high costs of bureaucracy associated with third-party payers and heavy investment in combating fraud, and pressure on insurance companies from Wall Street to improve “shareholder returns.”

  Despite the rise in premiums, payments to health care providers, such as doctors, appear to be falling along with coverage to policy holders. The system is no longer functional and no longer makes sense. Health care has become an incidental rather than primary purpose of the health care system. Health care plays second fiddle to insurance company profits and salaries to bureaucrats engaged in fraud prevention and discovery. There is no point in denying coverage to one-sixth of the population in the name of saving a nonexistent private free market health care system.

  The only way to reduce the cost of health care is to take the profit and paperwork out of health care.

  Nothing humans design will be perfect. However, Congress is making it clear to the public that the wrong issues are front and center, such as the concern of Rep. Joe Wilson (R-SC) and others that illegal aliens and abortions will be covered if government pays the bill.

  Debate focuses on subsidiary issues, because Congress no longer writes the bills it passes. As Theodore Lowi made clear in his book, The End of Liberalism, the New Deal transferred law-making from the legislative to the executive branch. Executive branch agencies and departments write bills that they want and hand them off to sponsors in the House and Senate. Powerful interest groups took up the same practice. The interest groups that finance political campaigns expect their bills to be sponsored and passed.

  Thus: a health care reform bill based on forcing people to purchase private health insurance and fining them if they do not.

  When bills become mired in ideological conflict, as has happened to the health care bill, something usually passes nevertheless. The president, his PR team, and members of Congress want a health care bill on their resume and to be able to claim that they passed a health care bill, regardless of whether it provides any health care.

  The cost of adding public expenditures for health care to a budget drowning in red ink from wars, bank bailouts, and stimulus packages means that the most likely outcome of a health care bill will benefit insurance companies and use mandated private coverage to save public money by curtailing Medicare and Medicaid.

  The public’s interest is not considered to be the imp
ortant determinant. The politicians have to please the insurance companies and reduce health care expenditures in order to save money for another decade or two of war in the Middle East.

  The telltale part of Obama’s speech was the applause in response to his pledge that “I will not sign a plan that adds one dime to our deficits.” Yet, Obama and his fellow politicians have no hesitation to add trillions of dollars to the deficit in order to fund wars and to bail out financial gangsters.

  The profits of military/security companies are partly recycled into campaign contributions. To cut war spending in order to finance a public health care system would cost politicians campaign contributions from both the insurance industry and the military/security industry.

  Politicians are not going to allow that to happen.

  It was the war in Afghanistan, not health care, that President Obama declared to be a “necessity.”

  September 14, 2009

  Part Two: The War of the Worlds

  Chapter 48: Where Economics (Mainly) Succeeds

  Economics can successfully explain the efficient allo-cation of resources by the price system and the allocation of investment by profitability. Relatively speaking, these successes are new. It was Alfred Marshall at the turn of the 20th century who explained price formation. Prior to Marshall, economists debated whether price was determined by the cost of production or by demand—what people were willing to pay. Marshall ended the controversy by pointing out that supply and demand are the two blades of the scissors. Together they determine price.

  Profit is the normal return on capital. A normal profit depends on time and circumstances. It is the profit necessary to retain capital in an activity. If capital cannot earn a normal rate of return in an activity, capital is not supplied to that activity. This ensures that capital is not wasted in low value uses. Whenever capital earns a higher than normal return, it is a sign that it is employed in a high value use. The excess profits will lead to an expansion of investment in that use until profits are reduced to normal.