As an economics major who graduated college in 1981 into the worst economic conditions this county had faced since the Great Depression of the 1930's, I was personally very interested in, and greatly affected by the mess the American Economy had become. Inflation was running over 13 percent, and unemployment was running at about 15 percent during my stay in the Philadelphia area from 1980 to 1983, during summer breaks and after I graduated college. Philadelphia and surrounding industrial communities were beginning to look like the bombed out European cities did after the Second World War. As a fresh college graduate, I was competing against dozens and even hundreds of people trying to support families for even menial minimum wage jobs.
What was Reaganomics?
Reaganomics was the sum total of economic policy undertaken by the Reagan Administration to address serious structural problems that had caused serious inflation, stagnantion of economic growth, and loss of competitiveness of American Industry. Some aspects of Reaganomics were already in the works when President Reagan took over, but he legitimized them, and made them stick.
There were about 5 major facets of Reaganomics: They were:
Reducing the Money Supply and keeping it tight to reduce inflation
Reducing marginal tax rates, particularly on investments, to encourage investment in business
Reduce government spending on wasteful or ineffective social programs
Reduce regulations on businesses, to encourage efficiency and innovations
Increase military spending, to address perceived deficiencies in the armed forces and to win the cold war. Military spending also ostensably would stimulate the economy by employing workers in defense industries.
What made Reaganomics necessary?
Structural problems with the U.S. economy
At the dawn of the 1980's the United States economy had a number of serious structural issues that needed to be addressed. Most of these structural issues had their roots during the 1960's when deficit spending to finance the Great Society and the Viet Nam War caused inflation to become entrenched in the economy. Inflation caused a number of problems for the economy, which were exacerbated by the tax structure. One effect of inflation was to encourage people to go into debt to buy houses and other consumer goods at the expense of savings. Houses became bigger and more expensive, as people looked at their houses not only as a place to live, but as a place to shelter their inflation bloated incomes from taxes, while they paid off their mortgages in ever cheaper dollars. Since marginal tax rates were high, and mortgage interest was deductible, it made perfect sense to go into debt to buy the most expensive house you possibly could afford. This mentality spread to other consumer goods as well, whose prices were escalating as quickly as houses were. While the pundits and economic prognosticators of the time decried the new spendthrift ways of American consumers, claiming that Americans saved too little and used credit too much, but the behavior was perfectly rational for the time. The pundits and prognosticators of the time also constantly harped about the need to do something about inflation, but nothing much was done by the political leaders of the time because of the fear recession would result if traditional remedies for inflation were applied in any meaningful way.
Distortions in Investment Markets
As the 1970's wore on, and the economy was staggered by price shocks and shortages of oil and other raw materials, the printing presses at the Federal Reserve ran overtime to keep the economy afloat, lest the recessions turn into depressions. As inflation became expected, interest rates, labor agreements, and government entitlements were increasingly structured to reflect expected inflation, and served to insulate the recipients from its effects. High marginal income tax rates combined with inflation meant that passbook savings accounts, and even money market accounts went from an being merely an unexciting place to safely park your money to downright losing propositions. The Stock Market did poorly as well, and was considered too risky for most people. Instead, as was noted above, people with excess cash often invested money back into their homes, or other expensive durable goods. The effects on the business community, particularly to capital intensive industries, were insidious and destructive. Inflation had the effect of inflating taxable profits in the short run and impoverishing those businesses in the long run. Inflation had the effect of increasing prices for all factors of production, and also had the effect of artificially increasing the value of fixed assets. When a company accounts for these increases, the effects of increased prices for raw materials and labor were pretty much a wash, but the increased book value of fixed assets and inventory meant that companies whose fortunes were in fact static and even declining were showing increased taxable profits because inflation was increasing the book value of the assets faster than accounting rules could depreciate them. To finance operations, businesses increasingly turned to debt financing, which was a way to leverage depressed stock prices but left businesses vulnerable to bankruptcy should a company's fortunes suffer a setback. At the same time, the Federal Government was also leaning heavily on business to solve a myriad of social ills, such as cleaning up the environment, implementing affirmative action, and improving workplace safety. This was of little concern to a hungry IRS which collected revenues for a Federal Government spending heavily on social programs of all kinds.
As wealth drained steadily from businesses, particularly capital intensive businesses, economic growth
stagnated. Capital intensive businesses could operate for a while like this, not unlike a person who cannot afford to replace the leaky roof on his house. He might patch the roof for a while so he has money to pay the mortgage until hopefully his finances improve, but eventually the roof will collapse entirely. Like the roof that had been patched too many times, the nation's industrial assets grew older and creakier, while foreign competition
from countries such as Japan
started to flood the market with quality inexpensive goods
built in modern factories with low cost labor. By the end of the 1970's, the game was over for many of America's industrial companies that once were the pride of the nation and the envy of the world. Saddled with expensive labor, worn out factories, increasingly burdensome government regulations
, and drained by corporate taxes of the capital they needed to modernize, icons of American Capitalism started going belly up like fish in a poisoned pond. This was particularly true for capital intensive
basic industries, such as steel
, and automobiles
, with their huge plants and other fixed assets. Entire cities, such as Youngstown, Ohio
and Bridgeport, Connecticut
were effectively destroyed as their industrial underpinnings failed, placing more and more demands on Federal and State safety nets for their unemployed workers.
Loss of Confidence in the economy
Events in 1979 underscored the feeling that America was on the decline. A failed hostage rescue attempt in Iran underscored serious problems with the United States Military, which had been starved of funds and was politically out of favor since the end of the Vietnam War. The near meltdown at Three Mile Island pretty much let the air out of the tires of anyone who believed that Nuclear Power would be our savior. Skylab, America's first space station burned up over the Indian Ocean after NASA failed to come up with the money to keep it operating or to even send up a rocket to boost its orbit. Toyota, Honda, and Nissan were eating Detroit's lunch, while OPEC was raising oil prices pretty much at will. While all of this was happening, the Soviet Union marched into Afghanistan essentially unopposed by the West. The blame for all of this misery was laid of course at the feet of President Jimmy Carter, an honest and well-meaning Washington outsider, naive in the ways of Washington Politics and foreign policy. Maybe he was just unlucky, but Carter’s lack of a commanding presence was a major obstacle to his ability to rally the American public to make the painful sacrifices in the short term to make needed reforms to the economy. As the election year of 1980 dawned, his defeat in the 1980 presidential election was pretty much a foregone conclusion. His infamous malaise speech on July 15, 1979 in the midst of the worst of the gas lines pretty much sealed his fate. It struck a raw nerve with Americans, and the public never forgave him.
Attempts to bring inflation under control during the 1970's
Throughout the 1970's, many things were tried to get a handle on inflation, in addition to trying to regulate the economy through tax policy and the money supply. No rational politician
likes to cause unemployment and recession, particularly close to an election, so a number of less painful options were tried. Richard Nixon
tried to institute price controls
on a wide variety of goods, but inevitably price controls led to shortages of many of these very commodities, such as natural gas
and metals such as copper
, and the price controls were soon abandoned. President Gerald Ford
tried to use Moral Suasion
to influence prices, to curb consumers’ appetites for goods, and businesses desires to make money. Millions of WIN Button
s were distributed, but greed
doomed this initiative from the start. Attempts to tighten the money supply
were tried on several occasions, but were quickly abandoned as soon as the economy would tip toward recession. Paul Volcker
, who was appointed as chairman of the Federal Reserve Bank
shortly after Carter's Malaise Speech took the first decisive action to attempt to control inflation by tightening the money supply. This threw the economy into an almost immediate deep recession whose worst effects were beginning to be felt near election time in 1980. As expected, President Jimmy Carter retired to Plains Georgia
, and Ronald Reagan
took over the White House
Challenges to the economy other than Inflation
The American economy faced many pressures beyond government or monetary control during the 1970's, which would have made robust growth a challenge even with 20/20 hindsight. Price and supply problems for oil were one of the major ones, but shortages of lumber, paper, copper, and natural gas caused problems and bottlenecks as well. American workers were often exhorted to work harder and smarter, (like the Japanese) and often felt like they were cast as lazy, overpaid, and stupid. While there might have been a grain of truth to the stereotype of the lazy, indifferent, and overpaid unionized assembly line worker, most Americans traditionally have worked pretty darn hard for their money. Much of the blame for the stagnant productivity of the time can also be laid at the feet of management as well. A disturbing trend that developed was that management of many companies grew out of touch with the day to day realities of running a business, partly due to the rise of conglomerates, and partly due to old entrenched attitudes about labor and management.
Another unheralded factor at play in the economy of the time was that the American economy had to cope with a huge influx of young, well educated, but inexperienced workers in the 1970's. As the baby boomers became adults, and after the experience of the Viet Nam War and Watergate, many of these boomers were distrustful about government and big business in general. My old college roomate, (an extremely bright Industrial Engineering student) wrote me about his Co-Op experience at GM in 1980, and described a suffocating corporate culture of yes men and conformity. After his GM experience, he changed his major to Economics and went to Berkley for graduate school. He was one of many who decided that they didn't want to follow in their parent's corporate footsteps and devote their life working for the man. Women entered the labor force in large numbers as well, and minorities, once relegated to menial jobs at many companies suddenly were asserting themselves as well. A lot of this change was healthy, and underneath the long hair and defiant attitudes were some minds that would revolutionize the American Economy. A few names we already know, a geeky rich kid from Seattle, who started writing computer programs to control traffic signals and a couple of guys named Steve and Steve who played with soldering irons in their garages. They and many others would transform the computer from a huge expensive, resource hungry beast that often had its own building, overseen by a priesthood of white coated technicians to a powerful, yet inexpensive appliance that just about anyone could afford and use with a minimum of formal training. Others, seeing the train wreck that many businesses were becoming became disciples of W. Edwards Deming, whose ideas about quality revolutionized the workplace. Their full impact on business would not be felt for years or even decades, but even their earliest efforts were a beacon of hope to a nation seemingly sliding deeper into decay.
Reagan Takes Over
A long-awaited ray of hope to a confused and "bummed out" nation was an actor turned politician, who spoke softly, but clearly and with a sense of purpose named Ronald Reagan. Although there was pretty much universal consensus about what needed to be done to control inflation and set the economy right, until Reagan came along nobody seemed to have the leadership and the political will to lead the nation to make the sacrifices that needed to be made. It was a tall order. By this time, things had gotten so out of hand that the necessary fiscal medicine would put untold millions out of work, while simultaneously cutting the back the safety net they would need to survive the crisis. The President also needed to help Americans feel good about themselves again. He retained the tight money policies of Fed Chairman Paul Volcker, and in fact gave him a freer hand to act. Fate intervened early in Reagan's presidency, a would-be assassin's bullet nearly found its mark. Quick medical attention saved the president's life, and stories of his courage and spunk in the aftermath of the shooting helped rally the nation to his side.
How bad did it get?
Pretty damn bad! Unemployment in many industrial cities approached levels not seen since the 1930s, and the spread between the Prime Rate and the annual rate of inflation reached over 10 percent, a figure not seen since the Civil War. Expansion of the Armed Forces and Modernization of weapons systems provided some opportunities for the unemployed, but mostly it was a gambit to run the Soviet Union into the ground, and end the cold war once and for all. Unemployment in parts of the rust belt reached over 15 percent, many of these towns never truly recovered. Areas of the country with a remaining viable industrial economy were targets of migration as workers left dying industrial towns in places like Flint, Michigan to places such as California or Texas, but often found high rents and depressed wages when they got there.
Many companies in the smokestack economy were forced out of business, but the survivors emerged more efficient, with a new focus on quality and efficiency. The deep recession had tamed inflation within a couple of years, but high real interest rates continued into the 1990's. As a result of deficit spending, the National Debt bloomed (mostly from the defense buildup), and kept interest rates high as the Federal Government crowded the credit markets to finance the deficit. Except for occasional spinoffs of defense technologies, military spending did little to put new goods directly into people's hands, except to the extent it keeps the bad guys at bay. Despite of the huge drag on civilian business activity these high interest rates caused, with inflation tamed and saner tax laws in place, it was easier to make productive investment choices, and by the end of the first Reagan term things were on the rebound. The recovery was uneven at best across different sectors of the economy. Most traditional smokestack industries continued to decline, but newer businesses, based on high technology filled much of the gap, but it was a difficult transition for the economy. The classifieds were full of high paying jobs for people with advanced specialized skills, but there were few good jobs for former steelworkers or autoworkers, who swelled the ranks of the unemployed. Those who could do so went back to school and often did well, but many were left behind, particularly in such crumbling inner cities as Baltimore, Detroit, or Philadelphia. Conditions for the poor in cities like these went from bad to worse, as poverty got worse, and opportunities for the unskilled dried up. Adding to the miseries of the urban poor was a new and deadly turn in the drug culture of the day which was brought about by the introduction of crack cocaine, and the mayhem it brought about. Full employment and affordable interest rates proved elusive for years to come, and it was difficult for later Baby Boomers and Gen X’ers to buy into the housing market due to high interest rates that persisted throughout the 1980s.
Throughout the 1980's the National Debt ballooned, quadrupling in nominal terms, and rising from 34 percent of GNP in 1980 to about 65 percent of annual GNP in 1992, but as inflation vanished and interest rates started to decline, the real burden of servicing the debt actually decreased by the late 1980s and early 1990s to levels lower than at the beginning of the 1980s. In effect, Uncle Sam was able to refinance his larger mortgage at more favorable terms, and a national debt of 65 percent annual GNP at the low interest rates at the end of the decade was as least as manageable as it was at 34 percent GNP, given the high interest rates at the beginning of the decade.
Reaganomics Winners and Losers
Defense and Technology businesses: The military buildup of the 1980s meant an almost immediate shot in the arm to Defense contractors, and workers in technology, as the military purchased high technology weapons systems, and modernized its forces.
Declining energy prices, better cars, and deregulation of the airline business made travel easier and less expensive. This was offset somewhat by increases in traffic congestion, and frustrated by the ever present and often ignored 55 mile per hour speed limit.
Investors and Investment Bankers
The 80’s was a good time to have money to invest. Stock prices tripled during the decade, as lower taxes on business and investment encouraged investment in real estate and new factories, despite high interest rates. The revitalized investment climate resulted in many takeovers and mergers of struggling enterprises, as investors ruthlessly seeked maximum value for their investments. Conglomerates were broken up, while companies in related businesses often merged to take advantage of new economies of scale. Deregulation of the Savings and Loans, along with favorable tax treatment of Real Estate resulted in an overbuilding of new commercial real estate, which resulted in a huge surplus of space, and a resultant failure of many Savings and Loans. The upside of this overbuilding of commercial real estate was that eventually much of this space was eventually absorbed by new businesses at bargain prices.
Deregulation of AT&T was a boon to companies and people who relied on communications services, as long distance rates plummeted and restrictions were eased on the use of the telephone system. One major effect of this was the development of many new information services and technologies, which allowed individuals and companies to share data more easily between far flung operations in real time. By having more timely and better information, business managers were able to improve operations by trimming excess inventory, and detect sales trends more quickly. Lower cost and more sophisticated information management services allowed smaller businesses to compete better with larger, more entrenched businesses. While not related directly to Reaganomics, the Personal Computer brought the computer out of the back room and onto the desktops of many workers, who took advantage of its capabilities. Banks took advantage of the new economies of scale in information management and an unprecedented wave of consolidation took place.
The 80’s was a time of rapid change in technology, labor markets, and skills needed to make a living in the new economy. Traditional low skill jobs that paid well, such as unionized jobs in transportation, manufacturing, or government either dried up to a great extent, saw wages fall, or required new skills. College became almost a necessity to make it in the new economy, and many middle aged workers went back to school to learn new skills.
People in low skill jobs
Low skill industrial jobs either vanished, or the wages paid to workers in these jobs dropped in real terms due to foreign competition. Many of the formerly well-paying jobs were deemed to be either doomed, or the wages had to fall to reflect the new realities of the marketplace. Former steelworkers (or autoworkers, longshoremen, etc.) would either settle for the new wages or learn new skills. Those unwilling or unable to adapt settled for low wage service jobs.
White Collar Middle Managers
A wave of downsizing of businesses continued throughout the 1980s, aided and abetted by improved information technology and a cutthroat business climate that emphasized improving business results at all costs. Business Takeovers became a looming threat over all publicly traded companies as investors such as Warren Buffett and others seeked underperforming companies to take over and sell their pieces if necessary to recapture their purchase price and turn a profit. Even companies which were not taken over felt the pressure to improve results and raise stock prices to ward off these vultures of capitalism. This usually meant shedding unprofitable operations, cutting benefits, increased use of temporary employees, and most of all, layoffs. Middle managers often found their jobs made obsolete by computers that could gather and process the information that their bosses used to rely on them to furnish, or found themselves cast adrift when reorganization after a takeover or merger made their jobs redundant.
First time homebuyers
Depressed wages for jobs on the lower rungs of the economic ladder, along with high interest rates and large numbers of baby boomers reaching the age when they wanted to start families conspired to push home ownership out of reach for many. High interest rates and poor economic conditions in the late 1970s and early 1980s resulted in a housing shortage in many of the more prosperous communities, rents skyrocketed and later housing prices increased as quickly as interest rates fell and baby boomers went into the housing market for the first time. Many young people of my generation had to share apartments with several people, or else live with their parents well into their 20’s in order to make ends meet.
The cost of healthcare skyrocketed, partly as a result of increased regulation and litigation of health providers, and partly because of expensive new healthcare technologies that could save or benefit many who otherwise could not have been helped previously. For example: Treatment for a heart attack used to consist of defibrillation, followed by a few drugs and rest, and all patients could do was take it easy, try to lose weight and exercise, and hope for the best. By the 1980's, advanced surgical procedures, sophisticated diagnostic imaging, and expensive new drugs could repair damaged hearts and minimize damage from an attack. The new technologies were great if you could afford it or had insurance that paid the tab, but increasing numbers of workers had their coverage cut, had to assume a larger part of the cost, or went without it entirely. Reaganomics looked dimly on government mandated insurance paid for by companies as overly burdensome on business.
Companies such as the airlines, trucking companies, and some of the “Baby Bells” saw mixed blessings. Deregulation of formerly heavily regulated industries in transportation and telecommunications opened up new opportunities for upstarts such as MCI
(Telecommunications), and Southwest Airlines
(transportation). Consumers reaped the benefits of new services and competition for the most part, but AT&T
and the older airlines suffered under the new competitiveness of their industries, as their corporate cultures were slow to adapt to the new competitive marketplace. Parts of the bell system that retained their monopolies, the Regional Bell Operating Companies
, prospered as they leveraged their monopoly power.
In the end, not all facets of Reaganomics were implemented as originally envisioned, but the majority of the policies were. Because of the huge dislocations caused by changes to the economy during the 1980's, Reaganomics fell short of its goal to reduce the Welfare State
considerably, but by the end of the decade sustained prosperity did put a dent into its need. At the end of the 1980’s, it can be said that Reaganomics was a qualified success, unemployment and inflation were down, real per-capita income was up, and interest rates had gradually fallen back in line with a lower inflation rate. Reaganomics cannot take credit for all of the good things that happened to the economy, for many of the reforms that bore fruit in the 80's and 90's saw their beginnings in the 1970's. What it did at great cost, was to purge the economy of serious structural problems, and at the same time purge the national psyche of bad habits and pessimistic attitudes. In a way, it gave America a chance to start over. Despite a mild recession in 1991 and 1992, Reaganomics laid the foundation for nearly 2 decades of prosperity in the 1980's, 1990’s, and perhaps beyond. In hindsight, perhaps additional government spending, particularly on infrastructure
, such as roads and bridges, and a bit less on the military
could have blunted some of the economic trauma and put some people to work building lasting assets we could still be using today. Then again, governments are not that adept at spending money efficiently either, and such spending would have exacerbated already severe budget problems. Not everyone benefited equally, but those who adapted to the changes prospered,and those who didn’t or couldn't adapt to the new economic climate suffered.