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October 30, 2004

Reaganomics

How Ronald Reagan’s presidency forever changed the way we think about the role of government. By Jeffrey A. Eisenach and James C. Miller III.


The history of twentieth-century economic policymaking is marked by two watershed presidencies: those of Franklin Delano Roosevelt and Ronald Wilson Reagan. By “watershed,” we mean that those presidencies changed forever the way we think about the role of the federal government.

President Roosevelt taught us that free markets often contain imperfections that need to be addressed. His were primarily the “macro” concerns of high unemployment, deflation, and income distribution. But he also felt that regulation and government-orchestrated “cooperation” within industry was needed to a theretofore unprecedented extent.

President Reagan taught us that while free markets aren’t perfect, neither is government. In fact, government often presents serious and debilitating imperfections. As he often said, “Government isn’t the solution to our problems; government is the problem.” Like Roosevelt, Reagan saw these imperfections as having both macro and micro effects.

Both presidents faced historic economic crises. Roosevelt’s crisis was defined by unemployment lines and deflation; Reagan’s, by gasoline lines and “stagflation.” Both men were eternal optimists. President Roosevelt’s line “We have nothing to fear but fear itself” set the tone for his administration. President Reagan’s constant invocation of the “shining city on a hill,” and “you ain’t seen nothing yet” marked his approach. Moreover, throughout their careers, both were willing to compromise—on outcomes, not principles—because of confidence that they would prevail in the end. For example, in negotiating with Congress, President Reagan would often get much less than he asked for, but he would take half a loaf, thank Congress, and then plan to get the rest the next year.

President Roosevelt’s economic policies were primarily about redistribution. President Reagan’s were primarily about making the pie grow larger. In fairness, Roosevelt tried hard to get the economy growing again, but the state of economic learning—at least on the part of the most influential policymakers—was rather primitive, and we know in retrospect his policies had little positive effect on gross economic activity. President Reagan’s policies were geared to growth, and in these he was exceedingly successful.

How did Reagan make the pie grow larger? First, he recognized the importance of the supply side of government policies. Until Reagan, most attention had been on the demand side of government policies—how to regulate aggregate demand to maintain full employment without generating inflation.

First, said Reagan, get the basics right: Respect legal institutions and maintain a stable medium of exchange. Second, cut waste, which is another way of saying increase the real supply of goods and services. This means cutting waste in government. It also means eliminating ways in which government, through excessive regulation, forces people in the private sector to waste resources. Third, remove disincentives to produce—reduce tax rates and eliminate ways in which government needlessly taxes productive activity.

It is clear President Reagan succeeded. He launched the longest peacetime expansion in the American economy. Inflation, interest, and unemployment rates all fell. Other relevant indexes rose: employment, the labor force participation rate, and productivity.

It is interesting that national defense had a fateful impact on both men’s economic legacies. In Roosevelt’s case, most economists agree that his New Deal policies failed to end the Great Depression. What did so, and saved Roosevelt’s economic legacy, was the stimulative effect of massive defense budgets and mobilization during World War II.

Bigger defense budgets had the opposite effect on Reagan’s economic legacy. In those days, the only way to get a recalcitrant Congress to agree on increased defense spending was to go along with more spending on domestic programs. Reagan thus had to choose between doing what he thought was necessary to defeat the Soviet empire, on the one hand, and his lifelong commitment to smaller government and to balanced budgets, on the other. Thank goodness he chose as he did, but he always said afterward he regretted not being able to do more to achieve his objectives.

Both men changed the economic policy debate for decades to come. For better or worse, Roosevelt dismissed laissez-faire economics and replaced it with the Keynesian theory of demand management. Three decades later, President Nixon acknowledged that “we’re all Keynesians now.” It took President Reagan to replace Keynes with the supply-side idea, still dominant, that cutting marginal tax rates and reducing other disincentives are the keys to economic growth.

In the end, it was their ideas that mattered most. Roosevelt will always stand for the idea that bigger government is needed to manage an unruly economy. Reagan’s legacy is that too much government can crush the entrepreneurial energies that make a growing economy possible in the first place.


Jeffrey A. Eisenach is the executive vice chairman of the CapAnalysis Group.


James C. Miller III is a senior fellow at the Hoover Institution at Stanford University and a senior adviser at Husch Blackwell, LLP, an international law firm.

His research papers are available at the Hoover Institution Archives.


This essay appeared in the Washington Times on August 8, 2004. Available from the Hoover Press are Revolution: The Reagan Legacy, by Martin Anderson, and The Collapse of Communism, edited by Lee Edwards. To order, call 800.935.2882.