06/06/2004
President Ronald Reagan’s stature will grow as his achievements come to be more widely recognized.
Few Americans realize that President Reagan’s economic policy won the cold war by rejuvenating capitalism. Members of the Soviet Academy of Sciences, with whom I spoke in Moscow during the Soviet Union’s final months, agreed that it was President Reagan’s confidence in capitalism, not his defense buildup, that caused Soviet leaders to lose their confidence.
Unlike many "Soviet experts" in the West, the Soviets themselves were aware of the failures of their economic system. Although their failing economy seemed impervious to reforms, the Soviets took comfort in American stagflation and the various diseases that afflicted the British and European economies.
The Soviets heard from Western economists about worsening "Phillips curve" tradeoffs between employment and inflation and the inability of Western economies to grow without inflation. The Soviets saw the West’s economic difficulties as an offset to their own and had no reason to panic and give up the struggle.
Ronald Reagan took away the Soviets' comfort factor when he said that the "Phillips curve" and falling US productivity were the results of the wrong policy mix, not inherent features of a market economy. The U.S. economy, in other words, could be easily fixed, but the Soviet economy could not.
Reagan then proved his point by slashing tax rates from 70 percent to 28 percent and presiding over a record economic expansion while inflation fell. Margaret Thatcher achieved a similar renewal of the British economy, and the French followed by privatizing their socialized economy.
The Soviets saw that the jig was up. Released from suffocating economic policies, Western economies moved ahead rapidly, while the Soviet economy ground to a halt and declined.
Reagan revitalized the U.S. economy. He abandoned the Keynesian policy mix of monetary expansion to stimulate demand and high tax rates to restrain inflation — which was obviously not being restrained by Keynesian demand management. Reagan got the supply-side message that high tax rates were restraining real output while money growth pumped up demand, thus causing inflation.
Reagan did as the supply-side economists recommended. He reversed the policy mix. Monetary policy was used to control inflation, and tax rate reductions stimulated real output.
Reagan’s policy was a success. But at the time it was misunderstood. Accustomed to thinking of tax cuts as a demand-side measure to stimulate consumer spending, the entire economics profession, along with the Federal Reserve, the Republican Senate, and most of Reagan’s own government, predicted accelerating inflation.
Supply-side voices were drowned out. Even Alan Greenspan predicted that inflation would explode. He told Fed Chairman Paul Volcker at a July, 1981, meeting of the Fed with its economic consultants (at which I was present as the administration’s representative) that monetary policy was a "weak sister" and could "do nothing other than a weak rear-guard action" against Reagan’s "inflationary" tax cut.
The opposition to Reagan’s program caused many of his political appointees to abandon his agenda. They feared that support for Reaganomics would make them unpopular with the establishment and damage their future careers. Consequently, they added their voices to those decrying Reagan’s economic policy.
The supply-side enclave at Treasury fought Reagan’s government for Reagan, but in the end Reagan chose to govern by appealing directly to the people over the heads of both his own government and of Congress. Instead of firing disloyal aides, he simply ignored them.
This practice allowed Reagan to be successful without spokesmen for his policy. But it was a leadership style that allowed opponents to control the explanation of his policy. To this day the erroneous belief persists that Reagan won the cold war with a military buildup but damaged the economy with deficits.
The greatest myth of all about Reaganomics is that the administration made a "Laffer-curve" forecast that the tax rate reductions would pay for themselves. Reagan’s budget deficits are regarded as proof that supply-side economics failed.
As official government documents show, the administration made a static revenue forecast that the tax cuts would lose $718 billion in tax revenues over the forecast period. The budget deficits resulted because inflation fell even faster than the administration predicted, wiping out $2.4 trillion in nominal GNP during 1982-86, a dramatic reduction in the tax base. This unanticipated disinflation also built into the budget higher levels of real spending than the administration had intended.
The predicted inflation never materialized from the "Reagan deficits" because the deficits themselves were the direct consequence of the collapse of inflation. Treasury supply-siders predicted the disinflationary expansion. But their prediction was ignored, because it conflicted with the Keynesian interpretation of fiscal policy and the economic establishment’s belief in the "Phillips curve."
Reagan changed the world, because he did not believe capitalism was a spent force. He liberated our economy and chased away the "malaise" that had paralyzed the Carter administration and given hope to Soviet leaders.
Dr. Roberts drafted the original Kemp-Roth tax rate reduction bill and served as Assistant Secretary of the Treasury for Economic Policy during 1981-82. In August 1981 President Reagan wrote to him: "As I signed the tax legislation, I could not help but think of the great role that you played in achieving this victory for the American people." In 1987 Dr Roberts was recognized by the government of France as "the artisan of a renewal in economic science and policy, after half a century of state interventionism" and inducted into the Legion of Honor. Dr. Roberts is the author of The Supply-Side Revolution and Meltdown: Inside The Soviet Economy.
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Paul Craig Roberts was Associate Editor of the WSJ editorial page, 1978-80, and columnist for "Political Economy." During 1981-82 he was Assistant Secretary of the Treasury for Economic Policy. He is the author of Supply-Side Revolution: An Insider’s Account of Policymaking in Washington.
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