The Imperious Economy, by David P. Calleo, Cambridge, Mass: Harvard University Press, 1982, 265 pp., $17.50.
In The Imperious Economy, David Calleo surveys the effects of 20 years of economic policymaking in the United States and concludes that "history is finally presenting America with its bill." He could go further and say that history is presenting the whole world with its bill for the inflationary income redistribution policies of the last decades. The United States is not fundamentally different from any other industrialized country in policies followed and mistakes made.
Calleo doesn't see it that way. For him, the United States over the last two decades "abandoned domestic economic restraint and used American power abroad to permit a seemingly painless inflation at home." "Thanks to our clever economists," America "was supposed to be able to avoid choices forever." But with world stagnation and a crumbling monetary system, "increasingly, America's domestic aspirations have been in tension with its responsibilities to a liberal international order."
Since Calleo believes that all the world's problems stem from the United States' inability to discipline its own domestic economy and thereby to get grip on inflation, it is best to start there. The author aptly spots the outward symptoms of the disease affecting American economic policy; he is less skilled in his diagnosis of cause and prescription of cure. His main mistake is to ignore the cumulative effects of a system that rewards nonproductive action at the expense of productive action.
Economic policy during the past two decades in the United States—as in the rest of the free world—has been dominated by attempts to manage aggregate demand. Taxes and expenditures were manipulated to move the economy toward target levels of spending. It was taken for granted that the nation's ability to produce—the supply side of the economy—needed only a sufficient level of demand to keep going.
By focusing on demand, economic policymakers overlooked the rising disincentives to produce additional income. The combination of inflation and progressive income taxation pushed people into higher and higher income tax brackets, holding down their real after-tax earnings. In 1965 a median-income family of four faced a federal marginal tax rate of 17 percent. By 1981 the rate was 28 percent—a 65 percent increase in the rate of tax on additions to the family's income. If Social Security taxes and state income taxes are added in, the median-income family is in the 40 percent bracket or higher.
Business is in equally bad shape. The combination of inflation and the tax depreciation law caused the costs of replacing the plant, equipment, and inventories used up in production to be understated by $200 to $300 billion over the 1976–80 period. This came out of business saving and, together with the decline in personal saving, the funds available to the capital market were reduced by $350–$450 billion over the five-year period.
The "stop-go" demand management policies of the '60s and '70s created additional uncertainty. No one knew for sure when the policy of expanding demand would give way to a policy of contracting demand and vice versa. An element of uncertainty was added to planning, raising the "hurdle rate of return" that must be met before new investment commitments are made. All these factors, along with government regulation and inflationary monetary growth, combined to reduce the rate of capital formation, to curb business investment in research and development, and to divert resources to nonproductive purposes or into the underground economy.
Over these same years the indictments of our economic institutions have been severe. The market economy is too often portrayed, not as an institution that allows individuals to better themselves, but as a relentless machine for grinding the poor under the heel of greed. In The Imperious Economy Calleo espouses this view, writing that, "market 'freedom' is all too often a euphemism" for a transfer of power from "democratic number" to "oligopolistic wealth."
Allegations of market failures and social costs helped to transform our economic institutions. New property "rights" have been created by government that give some people claims (entitlements) to the income (transfer payments) of others. Drawing resources away from the production of new income and using them in political efforts to acquire existing income from others contributes to economic decline.
David Calleo's lack of faith in the free-market system leads him to conclude that the state should be the engine of progress in the '80s and beyond. Although he is not wholly blind to its weaknesses, he believes that government can be tempered by "endowing it with a greater degree of measured discipline, a discipline that might be expected to help generate and mobilize a greater sense of cooperation and responsibility in the community at large." His "strategy for reindustrialization" would unite government, business, and labor to "formulate a long-range national economic strategy." After all, he points out, "all the phobia against planning has not saved Americans from high taxes, excessive regulation, inflation, and foreign excess."
The other half of Calleo's national strategy is to combat inflation with economic restraint. "Unfortunately for democracies," the author writes, "restraint must be achieved before growth can resume." Calleo attacks supply-side economics as just another political gimmick that "will produce more inflation than growth." The author does not take the time to prove, nor has it ever been proven, that rewarding productive behavior and restoring incentives to the economy are inflationary.
Our experience of the past two years with the policies of traditional Republicans who pushed aside the original Reagan supply-side agenda proves the danger of restraint as an answer to inflation. Thanks to these policies, the unemployment rate is the highest since the Great Depression, and we are threatened with bigger government.
What could be even more serious is the long-term side effects of restraining the growth of the real economy. Competition for existing wealth would grow more, not less, intense, and income would be redistributed to those individuals who are most able to succeed in the political arena. The longer economic growth policies are subjugated to policies of restraint, the further a lasting recovery and a free economy will fade into the horizon.
As for US foreign economic policy, Calleo believes that the American attitude toward the international financial system has over the past 20 years "reflected a basic urge to dominate the monetary system so that no external constraint can limit the expansive impulses, at home and abroad, of the American political economy. The upshot has been to make the world subject to American monetary policy and to make that monetary policy, in turn, not subject to any external constraint."
This view of America as a hegemonistic demon ignores the fact that all the other industrialized democracies and a good part of the Third World were following the same expansionary, demand-management policies in the '60s and '70s. The United States' currency was inflated to accommodate the liquidity demands of the rest of the world.
The dangers to free trade from austere domestic policies can be seen today. With a strong dollar due to a restrictive money policy (which might be coming to an end), our exports are less attractive to potential foreign buyers. Imports are cheaper to the American consumer than the goods produced by American labor. Taking a recent example cited in the New York Times, a two-million yen Japanese car sold in the United States a year ago for $10,000, yet today the same car costs only $8,000. On the other hand, American exports cost 20–30 percent more to foreign buyers than they did only a year and a half ago.
With domestic jobs and profits threatened, demands will increase within the United States for more protectionism at a time when the world can least afford it. Rising protectionism as a response to domestic restraint and international liquidity problems further threatens the world's monetary institutions. Debtor countries are finding it difficult to pay principal and interest, putting unusual pressure on both borrowing countries and their creditors. Without markets to provide earnings to service these debts, foreign countries would be all the more likely to default on their loans.
The road to economic well-being is to reward productive economic activity and to provide a moderate and predictable growth of money to finance real economic growth without reigniting the fires of inflation. In taking this road, supply-side economics would rely on the individual. Calleo would rely on bigger government.
Paul Craig Roberts holds the William E. Simon Chair in Political Economy at the Center for Strategic and International Studies at Georgetown University. In the first year of the Reagan administration he served as assistant Treasury secretary for economic policy. He has authored two books and numerous articles.
This article originally appeared in print under the headline "An Imperious Solution".