Commentary | 29 July 2019

Progressive US politics meets radical economics

Originally published in The Australian.

Originally published in The Australian.

The Thatcher/Reagan revolution created a popular political mindset favouring small government, low taxes and balanced budgets. Policy practice did not always adhere closely, but it took a maverick American politician to pioneer the case for bigger government.

The success of Bernie Sanders’ 2016 presidential campaign surprised many. Now a bevy of “progressive” Democratic hopefuls is hogging the headlines, eager to have the government do more.

Coincidentally, some high-profile American economists, influenced by the feeble recovery since the 2008 crisis, are providing academic backing for more expansionary budgets.

It’s early days in the presidential race, and the leading Democrat contender is still Joe Biden, occupying the conventional middle ground. But the policy debate has widened.

President Trump might be trying to brand the progressives such as Alexandria Ocasio-Cortez and Elizabeth Warren as old-fashioned socialists who want to emulate Venezuela’s economic policies, but the policy issues raised by these candidates have some popular traction.

With the evidence of climate change impinging more widely, branding a package of policies the Green New Deal resonates, with its reference to a greater government role harking back to the days of Roosevelt’s depression-busting policies.

Moreover, the array of progressive policies isn’t limited to climate issues. Proposals in education and health are more relevant to Trump’s left-behind supporters than the President’s own misguided tariffs.

The proposals are just as radical on the expenditure side. Big-spending Democrats have to be ready to fund their plans with tax increases if they are to avoid damning criticism for budget deficits and public debt.

Sanders understood this and was always ready to raise taxes to demonstrate his fiscal rectitude. So too the new candidates are not only ready with generalisations about the need for more taxes: they have a plan. Ocasio-Cortez has specific proposals for much higher income taxes, while Warren proposes a wealth tax.

The 2008 crisis highlighted the inequity of massive Wall Street bonuses and tax breaks favouring the rich. This sentiment has been reinforced by Thomas Piketty’s 2014 tome on chronic income inequality. Addressing this through higher taxes on the rich will garner support.

Academic studies are questioning the conservatives’ core belief that high taxes stultify economic dynamism, and refute the commonly held idea that wealth taxes can’t be made to work.

Of course there have always been economists who denied the small-government mantra, pointing to the Scandinavian economies as alternatives, operating successfully with a far greater government role in the economy.

They raised their voices when budget austerity was imposed, despite the weak recovery. But they were outside the American mainstream: Paul Krugman’s well-argued economics was heavily interlaced with politics, too readily rejected by potential audiences.

But the slow recovery after 2008 prompted a fundamental rethink among mainstream macro-economists. The intellectual journey of Olivier Blanchard illustrates the transition.

The distinguished MIT professor was chief economist at the IMF when the fund was in the vanguard of the return to austerity after the brief fiscal stimulus in 2009.

In the five years to 2015 America wound back its budget deficit by 6 per cent of GDP. Some academics argued that this austerity would actually stimulate growth through its effect on confidence. For its part, the Fund believed that the budget multiplier was small, so austerity would not adversely affect the recovery.

By 2013 Blanchard had recognised the error, accepting that the budget multiplier was significantly higher than expected and that austerity would be seriously contractionary. By 2019 Blanchard, now at the Peterson Institute, was using his address as president of the American Economic Association to argue in favour of modest budget deficits.

In practice America starts with a large deficit (thanks in part to Trump’s 2017 company tax cuts), but even a growing public debt ratio has not affected financial markets adversely, with interest rates on bonds falling, not rising.

The bond market vigilantes who forced Bill Clinton to raise taxes in the mid-1990s have gone silent. The academics who predicted disaster for any country whose public debt exceeded 100 per cent of GDP have been discredited. Many have come to agree with Dick Chaney: “Reagan proved deficits don’t matter.”

Neither the politics nor the economics are resolved. But the centre of gravity of the political-economy debate has shifted.

Larry Summers, former US Treasury secretary, is advocating budget deficits to address “secular stagnation”. Slow growth isn’t just a problem of a flaccid recovery: it is structural. This favourable climate for bigger-deficit proponents has given new energy to the Modern Monetary Theorists, who have long advocated more government spending whenever there is spare capacity and inflation is low.

On the political side, it is highly unlikely that the current version of the Green New Deal will be put to the voters by the Democratic presidential candidate in 2020.

In their present form, these policies are too radical to appeal to a majority of voters.

Some Democrats — probably including Biden — still hope that conventional policies will woo enough voters in the centre of the political spectrum to deliver presidential victory. But the debate has been opened up, focused on policy rather than personality. The Thatcher/Reagan small government legacy is in question.