Senior Advisor but Hold the Macro

Hard Heads, Soft Hearts: Tough-Minded Economics for a Just Society, by Alan S. Blinder, Reading, Mass.: Addison-Wesley, 256 pages, $17.95

Alan Blinder's lively polemic makes the case for economic policies based on a "profound respect for the virtues of free markets with profound concern for those the market leaves behind." He argues, I believe correctly, that many economic policies could be substantially improved before addressing the more difficult issues where there is some trade-off between free markets and measures to help the poor and disabled.

The strongest sections of Hard Heads, Soft Hearts, and maybe the most surprising to a lay audience, bear on issues on which there is broad agreement among economists—the inadvisability of such policies as wage-price controls, minimum wages, price and entry regulations, and rent control, for example. In addition to discussing these, Blinder summarizes the conventional arguments for free trade and effectively responds to the arguments for protection in the name of national security, infant industries, unemployment, the Japan issue, and the new arguments for "strategic" trade policy.

A fine chapter on environmental policy makes the case for substituting marketable permits for the current web of command-and-control regulations. A marketable permit is a right to emit a specific amount of a specific pollutant in a given area and period. The sum of these permits would be limited to that necessary to achieve the ambient environmental quality desired in each area. The opportunity to buy and sell these permits would allow each plant to choose its level of pollution and the most efficient means to achieve this level. Changing to such a system would permit both lower costs and a cleaner environment.

In a clever development of Murphy's Law, Blinder recognizes, however, that "economists have the least influence on policy where they know the most and are most agreed; they have the most influence on policy where they know the least and disagree most vehemently." And his explanations of this perverse condition are on the right track.

Politicians often reject the near-unanimous advice of economists on these issues, because they are more responsive to concentrated benefits than to diffused costs. Politicians are more enamored of the extreme positions within economics, because they seem to offer a "free lunch": for example, the promise of simplistic Keynesianism that an increase in government spending could have a "multiplier" effect on national output; Art Laffer's conjecture that a general reduction in tax rates might increase total tax revenues; the rational-expectations argument that inflation can be reduced without a reduction in employment and output; and so forth.

Blinder recognizes that this version of Murphy's Law can be broken, citing as examples the loosening of price and entry regulations governing communications, commercial transportation, and banking beginning in the late 1970s, and the Tax Reform Act of 1986. He also has some useful suggestions for making it safe for politicians to support good economic policy. His general proposal is to package policy proposals—in some cases to compensate concentrated losers, in other cases to force special interests to compete against each other.

A note about the 1986 tax act: While most economists, including Blinder, consider it an improvement over the prior tax code, I do not share this enthusiasm. Much of the reduction in individual tax rates was financed by increasing the effective tax rates on new corporate investment. Blinder's evaluation of this act is not very hard-headed, and he does not understand the consequences of this change on the distribution of wealth in the United States. The business provisions of the 1981 tax legislation in effect redistributed wealth from the owners of the existing capital stock to American labor, yet these provisions were generally opposed by liberals. The 1986 business provisions had the opposite distributional effect but were broadly supported by liberals. Thus, in this instance, Blinder and his liberal economist colleagues are neither hard-headed nor soft-hearted.

The weakest chapters of Blinder's book bear on macroeconomic policies, the issues on which there is also the least consensus among economists. Blinder states that his book ignores most issues for which there is a trade-off among desirable conditions. But he then plunges into a confused argument that American economic policy exaggerates the perils of inflation and underestimates the virtues of low unemployment. The costs of a stable positive inflation rate are probably quite low, but most economists believe that there is no long-run trade-off between inflation and unemployment. In contrast, Blinder appears to believe that we could achieve a higher long-run level of output and employment by measures that would increase the inflation rate.

Blinder regards himself as a Keynesian, and he is predictably caustic about monetarism, "rational expectations," and supply-side economics. However, his own concept of Keynesian economics is quite strange. He describes the characteristic Keynesian prescription for unemployment as "speed up growth in the money supply to push interest rates down and spur aggregate demand." This seems more like the views of some monetarists who argue that a change in money growth has significant temporary real effects, whether or not they are anticipated.

Discretionary monetary policy may be more effective, and more feasible, than discretionary tax and spending (fiscal) policies, but it seems odd to describe this prescription as Keynesian, a position that is usually associated with the use of discretionary fiscal policy to stabilize total demand. Moreover, Blinder's characterizations of the competing macroeconomic perspectives are artificial. Monetarists are described as advocating constant money growth without regard to changes in velocity. Rational expectations is described as an elegant theory without empirical content. Blinder dismisses supply-side economics without acknowledging its important contribution to understanding the effects of the budget and the tax code's details.

Armed with 20-20 hindsight, Blinder is contemptuous of the Reagan fiscal policy, arguing that "the colossal budget and trade deficits…were the predictable consequences of that change in policy." Maybe so, but no one predicted these effects in 1981. Blinder attributes the Reagan fiscal policy to supply-sider Art Laffer's "flight of fancy," but no administration budget projection or economist ever claimed that the general tax acts approved in 1981 would increase revenue. As with any administration, the Reagan administration was subject to some illusions, experienced both good and bad luck, and made some mistakes.

Blinder claims that his views are opinionated but not partisan. As a senior advisor to the Reagan administration, however, I cannot accept his characterization of Reaganomics—"the worst of both worlds: a soft head and a hard heart"—as anything but partisan.

Blinder is smart, witty, a good writer, an effective polemicist, a principled Democrat, and a fine economist. This book should convince anyone that the next Democratic administration should appoint Blinder as a senior adviser—for microeconomics.

William A. Niskanen, the author of Reaganomics: An Insider's Account of the Policies and the People (Oxford University Press), served on the Council of Economic Advisers from 1981 to 1985.