Markets Will Prevail

Richard B. McKenzie & Dwight Lee from the February 1993 issue

Understandably, Bill Clinton's election to the presidency leaves much for the country to worry about. If he holds true to his economic platform and if he gets his way with what appears to be a compliant Congress, many of the market freedoms Americans hold dear will be in jeopardy. Fortunately, those are two very big ifs. The first and most important auxiliary check on the powers of the new president to hold to his platform and to inaugurate his "new beginning" will be the very market forces he seeks to manipulate and suppress.

Those who see the policy changes of the 1980s mainly as a product of Ronald Reagan's election have much to fear. For them, the guard on the public treasury has indeed been changed.

On the other hand, those who see the changes of the '80s mainly as a response to global competitive forces among governments, rather than to Reagan or Thatcher per se, can take heart. Those same forces of global competition among governments for the world's capital base that were so evident in the '70s and '80s remain at work in the real world that Clinton must now face. Clinton will soon recognize that the main change since Reagan is that competition among governments is even more constraining, since capital has become ever more slippery and the number of government competitors has grown with the liberation of Eastern Europe and the break-up of the Soviet Union.

Granted, Bill Clinton has embraced every labor-market mandate that Congress has considered, and he threatens to raise taxes on the rich, which, if passed, would penalize competitiveness and success still further. And he pledges to redistribute wealth–especially health-care wealth–from the rich and middle class to the poor who cannot afford health insurance, plus all others who could purchase it but have chosen not to do so. In effect, he has fostered the delusion that workers can get something for nothing if only government tells employers they must foot the bill.

Moreover, Clinton proposes increased public spending and an array of "industrial policies" (although the expression is never used) that would mire Washington even more deeply in allocating (and misallocating) the country's resources. He doesn't seem to realize the extent to which Washington politics can twist even well-intentioned "infrastructure" expenditures into boondoggles for the home states of the politically powerful. Given that Robert Byrd will continue to lead the Democrats in the Senate, more infrastructure "investment" will likely mean, as some have suggested, paving over a larger portion of West Virginia.

That, in brief, is the economic agenda that less than a majority of the American public swallowed. The pessimists have reason to fret anew.

There are, however, reasonable grounds for being, if not

optimistic, then not terribly pessimistic. The Clinton presidency probably cannot do as much damage as the pessimists are now forecasting. The results of the Clinton presidency might even be no worse than a continuation of the Bush presidency. In the end, the Clinton presidency might reinvigorate pro-market politicians and analysts. They can now regroup around more articulate, intelligent, and effective leaders such as Jack Kemp and Phil Gramm.

A continued Bush presidency would likely have fortified the mythology that the White House was still occupied by a dedicated heir-apparent to Reagan's political philosophy of expanded market incentives and constrained government, leaving market proponents open to the charge that the country's economic failures result from a failed philosophy. In Clinton, the country will get a president who appears (at the outset, at least) to be open and honest concerning his plans to expand the scope of government, which means that Americans will know to guard their wallets now that they have read his lips. Under Bush, they carelessly left their wallets unguarded, much to their chagrin. They might have been duped again by his 1992 no-new-taxes pledge.

Admittedly, these are not strong reasons for optimism, but there are several other justifications that political pundits appear to have missed. First, Clinton may not be as liberal as many think. After all, he is from a place called Hope in a generally conservative Southern state. Clinton, with his democratic aura of ties to the downtrodden, might–just might–be able to open cutbacks in "entitlements" for thoughtful public discussion and reform in the same way that Richard Nixon, cloaked with his anticommunist past, was able to open up China's admission to the United Nations for public discussion.

Clinton has indeed talked a good and long line about the importance of personal responsibility and about making people look to government for a "second chance" rather than making government aid a "way of life," and few in the press and policy circles have raised concerns about his hardheartedness, a level of consideration rarely accorded Ronald Reagan and George Bush. Clinton has also endorsed the Bush version of the North American Free Trade Agreement and will likely have an easier time of getting it through Congress than Bush would have.

Second, Clinton will be checked by normal politics. Less than half of the public voted for him, and many who did vote for him held their noses as they did so. They voted against George Bush, whose mean-spirited campaign, organized around largely irrelevant issues (Hillary, the draft, Moscow, and the chicken pluckers of Arkansas) was about as inept as the economic program that he was never able to articulate and hence defend effectively. With closer scrutiny, Clinton's mandate is far shakier than one might think from looking merely at the count of electoral votes. His plurality was smaller than Michael Dukakis's tally in 1988. Many of the non-Clinton majority voters can be expected to impede his more left-leaning political moves.

Third, Clinton and his advisers soon will learn that paying

for his programs off the backs of the rich alone will be far more

problematic than his pre-election numbers suggest. In the heat

of an election campaign, candidates can direct their advisers to

come up with numbers that sound good. Once elected, how

ever, officials, including the president, cannot just conjure up

revenue that will meet the estimates.

As this new president will learn, probably rather quickly, the rich will not play dead when confronted with the prospect of higher tax rates. They will–through their political allies and tax accountants–find ingenious ways of dulling the impact of the greater tax bite directed at them. President Clinton soon will realize the fact that the higher tax burden he contemplates must be shared by people way down the income ladder, an insight that is likely to dampen his interest in "soaking" anyone, certainly not those he has promised a free ride.

If he persists with his tax plans to soak the rich, by the end of Clinton's first term the federal tax burden will once again have moved down the income distribution, a reversal of the experience of the 1980s. In the '80s, the share of all federal taxes paid by the fifth of all households with the highest incomes went up at the same time their marginal and average tax rates went down.

Clinton was never as absolute in his anti-tax stand as was George Bush, but he did say, repeatedly, though not in so many words: "Read my lips, no new taxes on the middle class." He has said that he will scale back his expenditure plans before he will raise the taxes on his favored income classes. He will be shackled, in part, by his own words–and he may have to endure their haunting him in much the same way that George Bush had to endure Clinton's endlessly repeating the words that George Bush had so glibly let roll from his lips in the heady days of the 1988 convention.

Of course, inflation is a potential problem, but even inflation is no longer the government revenue engine that it once was. The power of "bracket creep" has been muted by indexing and the collapse of the tax schedule. Furthermore, bond markets can be expected to rapidly convert higher inflationary expectations into higher interest rates the federal government pays. One of the unheralded legacies of the buildup of federal debt during the 1980s is that federal interest payments loom large in the budget (accounting for about a fifth of it). Any increase in interest payments spawned by higher inflation rates can quickly soak up any additional real tax revenue garnered from higher rates of inflation. Besides, Alan Greenspan will head the Federal Reserve for almost all of Clinton's first term.

Fourth, if Clinton persists with his plans for mandated benefits, economists will learn that the perverse effects of labor-market mandates will not be as severe as many have envisioned. Employers will work diligently to soften the impact of such mandates. Workers will learn that it is they, not their employers, who must foot the bills, and that lesson is likely to muffle their enthusiasm for mandates.

Employers who face competitors not covered by the mandates, both domestic and foreign, will be forced to pass on the cost of mandates to their employees in the form of lower wages and other fringe benefits and greater work demands. Some employees will undoubtedly be replaced by robots unburdened by the cost of mandates, or by foreign workers who obtain the jobs driven off shore by costly mandates. These employees will see the mandates as bad deals, festooned with political goodies not worth their personal economic costs. The higher cost of employing workers who will likely take advantage of the mandates will reduce the market demand for such workers and the wages they can secure.

Finally, the Clinton presidency will be severely checked by global market forces that have been acknowledged, albeit reluctantly and belatedly, by even his most liberal advisers. For example, in the early '80s Robert Reich, one of Clinton's top economic advisers, wrote a book that was full of venturesome proposals to tax, regulate, protect, and subsidize American corporations. To Reich, making American firms more competitive by way of federal aid (and a variety of other industrial policies) was then crucial if our industries were to meet the challenges of "the next American frontier."

More recently, Reich has acknowledged (without really saying so) that many of his earlier proposals will not work. He has written, quite effectively, in The Work of Nations about the emergence of the global economy in which capital can move around the world with ease. As a consequence, he now believes the focus of federal policies should not be "industries," because it is too easy for companies to transfer the benefits of government largess abroad. He has corrected his belief and now recognizes that the true wealth of a country is its people, who should be the object of any future government largess.

However, he succumbs to the faulty reasoning that largess for the many who are not so wealthy should be financed by taxes on the few who are wealthy. What he and others in the Clinton camp do not seem to realize yet is that the human capital at the disposal of the wealthy is more fugitive on a global scale and less subject to government expropriation than the physical capital of corporations. Physical capital can only be shipped across the globe at the slow pace of boat travel. Human capital in the form of brainpower can travel to any point on the globe at close to the speed of light through the world's interconnected network of computers and satellites.

International money markets and integrated world stock and bond markets will teach on a daily basis our country's leaders lessons that they now seem to resist. National elections conducted every four years will remain important. But votes of confidence and approval will be taken daily in the world markets, which because of the country's ties to them can be ignored only at great peril. Clinton has already sought to assure markets that he intends to make markets work better. If he doesn't hold to that promise, the next four years will prove interesting, a test of the relative power of domestic politics and global markets in shaping national policies.

An undeniable fact of the modern global economy is that capital has been transformed. Over recent decades, capital has become smaller and lighter, less physical, more transportable. Capital, in the form of brainpower and information (which is no more tangible than electronic impulses on computer disks), can be sent around the globe at the speed of light and for the cost of a telephone call. Capital has become as slippery as quicksilver, as difficult for governments to tax as it is for them to define and harness it, and this quicksilver capital is primed to move to more cost-effective venues at the slightest government provocation. To shape and constrain government policies, quicksilver capital need not move; it need only threaten to move.

Governments around the world have had to start competing for the world's capital base. And in spite of their ideological inclination to do otherwise, governments have done so over the last two decades by easing the burden of their taxes and regulation–by capping the growth in government expenditures relative to their economies, by lowering their marginal tax rates, by freeing their industries, and by privatizing their services.

Walter Wriston, former CEO at Citicorp, could not have chosen a more apt title for a book concerned with the policy consequences of modern technology than The Twilight of Sovereignty. Governments, including that of the United States, have lost a measure of their sovereignty. Norman Macrae, former editor of The Economist, explained prophetically several years ago, "In the future, we will vote more frequently with our feet. If politicians try to boss us, brainworkers will go away and telecommunicate from Tahiti. Countries that choose to have too high a level of government expenditure or too fussy regulations, will be residually inhabited mainly by dummies." That future is upon us, and Bill Clinton.

Bill Clinton's election is, in part, a reflection of the global forces at work. The Democrats were forced, kicking and screaming, to choose someone far more moderate than were the candidates of just a few years back. At this juncture, we can still hope that Clinton will respond more effectively to the market forces afoot in the world than George Bush would have.

Without a doubt, Clinton will have an impact on this country. Some of that impact will be positive. He is obviously not the total dummy and liberal ideologue whom some would like to imagine he is, and all can take some solace in that. The country needs a quick learner in the White House. The country probably needs to spend more on basic research, and most likely there are some worthy infrastructure projects that have been left unattended. More importantly, Clinton probably will pass a reduction in the capital-gains tax on long-term investments, something George Bush was unable to do.

Just as certainly, some of Clinton's impact is likely to be negative. The country doesn't need a parental-leave mandate but it will probably get one anyway. We can expect, however that more constraint and guidance will be applied to the policy process in the United States and elsewhere than ever before, not by the visible hands of politics but by the invisible hands of market forces that span the globe. Probably the worst Clinton can do is create expectations among his followers (and opponents) that cannot be realized. In his first post-election news conference, Clinton fully acknowledged, albeit indirectly, the power of world markets: He announced his intention to lower taxes on highly mobile capital in the form of equipment by way of a new investment tax credit, and he talked earnestly of the need to reduce in a measured way the federal budget deficit to calm the jitters evident in world markets.

Those on both sides of the political spectrum who believe that politics control policies should wager that government, on balance, will loom larger in the economy in 1996 than it did under George Bush in 1992. Those who believe that markets constrain politics should probably wager that government, on balance, will be no greater a presence in the economy in 1996 than it was under George Bush.

We prefer the latter wager. If we are proven wrong, there is every reason to believe that Bill Clinton will be the next one-term president.