Out of the frying pan into the fire: Government as the problem in the 1970s and 1980s: Martin Feldstein (1979): Introduction to the American economy in transition

The most interesting thing in retrospect is how insistent Marty is here that “BAD BIG GOVERNMENT” arrived suddenly and discontinuously in 1967—that the U.S. economy was fine up until then, but that afterwards things fell off a cliff with “government policies… deserv[ing] substantial blame for the adverse experience[s] of the past decade”. Plus an awful lot of cherry-picking—like assessing corporate America based on the ten large firms whose stock prices plunged the most. And, of course, it was Marty’s guy Ronnie whose policies wound up imposing much larger drags on societal wellbeing, from income maldistribution through draining the pool of productive savings to slow-walking equal opportunity: Martin Feldstein (1979): Introduction to The American Economy in Transition: “The post-[World] War [II] period began in an atmosphere of doubt and fear…

Many economists believed that the nation would slip back into the deep recession from which it had escaped only as the war began…. [But the first two decades of the postwar period were a time of unsurpassed economic prosperity, stability, and optimism. The contrast between the strength and achievement of the economy during those years and its poor record since then signals a major change in the performance of the economy over the postwar period…. Real GNP growth slowed from an annual rate of 3.9 percent between 1947 and 1967 to only 2.9 percent between 1967 and 1979…. The average unemployment rate rose from 4.7 percent of the labor force to 5.8 percent. The average rate of consumer price index (CPI) inflation jumped from 2 percent to 6.7 percent (since 1967) with an acceleration to an average of nearly 9 percent since 1973 and over 13 percent in 1979….

Some of the poor record of the 1970s has undoubtedly been due to inappropriate macroeconomic policies adopted during the Vietnam War, to the change in the production policy of the OPEC cartel, and to other disturbances whose impacts will eventually fade away. But the deteriorating performance of the economy may also have more fundamental causes… so deeply rooted in our social and political system that they cannot be eliminated even when the causes of the problem become better understood…. Many of the papers and comments in this volume point to the expanded role of government as a major reason, perhaps the major reason, for the deterioration of our economic performance. The government’s mismanagement of monetary and fiscal policy has contributed to the instability of aggregate output and to the rapid rise in inflation. Government regulations are a principal cause of lower productivity growth and of the decline in research and development. The growth of government income-transfer programs has exacerbated the instability of family life and perhaps the decline in the birthrate. The low rate of saving and the slow growth of the capital stock reflect tax rules, macroeconomic policies, and the growth of social insurance programs.

The expanded role of government has undoubtedly been the most important change in the structure of the American economy in the post-war period…. There can be no doubt that government policies do deserve substantial blame for the adverse experience of the past decade…. The adverse consequences of government policies have been largely the unintended and unexpected by-products of well-meaning policies that were adopted without looking beyond their immediate purpose or understanding the magnitudes of their adverse long-run consequences. Expansionary monetary and fiscal policies were adopted throughout the past fifteen years in the hope of lowering the unemployment rate but without anticipating the higher inflation rate that would eventually follow. High tax rates on investment income were enacted and the social security retirement benefits were increased without considering the subsequent impact on investment and saving. Regulations were imposed to protect health and safety without evaluating the reduction in productivity that would result or the effect of an uncertain regulatory future on long-term R&D activities…. The government never considered that raising the amount and duration of unemployment benefits to the current high levels to avoid hardship among the unemployed would encourage layoffs and discourage reemployment; that Medicare and Medicaid, introduced to help the elderly and the poor, might lead to an explosion in health care costs; that welfare programs, introduced and expanded to help poor families, might weaken family structures; or that federal aid through the tax laws and through special credit programs to encourage homeownership would have such adverse effects on the cities, precipitating the relocation of business and consequent poverty and other problems for those who remained behind. The list of well-meaning policies with unintended adverse consequences could be extended almost without limit….

Unfortunately, even when the inappropriateness of old policies is recognized, change is difficult to achieve. Existing programs are maintained even though the same programs would not be adopted today. These programs survive and grow with the help of sympathetic bureaucrats and well-organized beneficiary groups. Loyalties develop to the form of public programs rather than to their basic purpose…. The government in its decision-making is inherently myopic, more myopic than either households or firms. Political accountability means that a policy will be judged on its apparent effects within as little as two years….

President Lyndon Johnson rejected the warnings of his economic advisors that taxes had to be raised in order to avoid an accelerating rate of inflation. Johnson chose to accept an increased long-run inflation rate in order to avoid the short-run political cost of a tax increase. His choice, while perhaps politically rational, was economically myopic. During the 1970s, the government and the monetary authorities focused on the short-run goal of reducing unemployment through expansionary policies that served only to exacerbate the inflationary situation. If escaping from the current high rate of inflation requires a sustained period of increased unemployment and economic slack, the shortsightedness of the political process may make this very difficult to achieve….

Of course, politicians do not have a monopoly on myopia. But although some of the political shortsightedness is undoubtedly a response to constituent pressures, the myopia of the political process actually encourages voters to be impatient…. To the extent that the poor economic performance of the past decade can be traced to the growing role of government and the inherent myopia of the political process, improvement of our performance will be difficult to achieve. Difficult but not impossible…. If the public begins to see more clearly the links between current policies and future consequences, there will be less reason to fear the unexpected consequences of myopic decisions.

The 1970s have been a decade of frustrated expectations. The size and influence of the government have grown rapidly, but the public’s distrust of government has grown even more rapidly. The economics profession has discovered a new humility as the economy’s performance has worsened. As the 1980s begin, there is widespread anxiety about the future. Will this decade be a period of severe economic problems with a major recession, accelerating inflation, or both? Or can the poor economic performance of the 1970s be reversed? The current data on the developing state of the economy are not clear. And, while some events may be outside our control, the success of the economy in the current decade and in the remainder of this century will depend also on whether we choose wisely as we reevaluate and restructure our major economic policies.

April 19, 2018


Brad DeLong
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