The High Cost of Rubinomics
By Jeff Faux
If a Democratic president gets to replace Federal Reserve Chairman Alan Greenspan when the latter's term is up in 2006, Bob Rubin is the odds-on favorite. He has the financial credentials: Goldman-Sachs, U.S. Treasury, Citigroup. He raises money for Democrats. And he is credited with the one accomplishment of the Clinton era that all Democrats are proud of: eight years of peacetime economic growth that, by 2000, had produced something pretty close to full employment.
As Rubin tells the story in his new memoirs, he persuaded Clinton early on to make financial-market "confidence" the administration's chief economic priority. Key to the strategy was Greenspan, who was supposedly concerned that spiraling federal deficits would ignite inflation, forcing him to raise interest rates and thus choke off growth. Cut the deficit, argued Rubin, and Greenspan will let the economy live.
Clinton was an easy sell. He not only reduced the deficit but also went on to balance the budget, run a surplus, and, by the end of his term, put the federal government on a path toward eliminating the entire national debt. Along the way, he embraced large parts of Wall Street's agenda: free trade, privatization, and the deregulation of finance, energy, and telecommunications. In turn, Greenspan kept rates low.
So Rubin's plan worked, but the cost was high. Hopes that the peace dividend from the end of the Cold War would finance major new programs in health care, education, and other areas of public need were dashed. Social investments as a share of the country's national income actually declined over the Clinton years. Fights over free trade split the party and contributed to the loss of the House of Representatives, from which Democrats have still not recovered. And deregulation led to an orgy of irresponsible speculation and fraud that eventually left workers without pensions, small-scale shareholders with worthless paper, and California -- among other places -- without the money to pay for basic services.
While the party lasted; Rubin and Greenspan were the toasts of Wall Street. They watched benignly (with an occasional "tut-tut" from the chairman) as mindless speculation overheated the stock market way beyond the boiling point of 1929. According to Greenspan, inflation was no longer a problem because the end of the era of coddling by big government had made workers more anxious about their jobs and less apt to demand higher wages. At the same time, he and Rubin kept anxiety from discomforting the markets by rolling out the safety net for financiers who bet wrong on Mexican bonds and the Long-Term Capital Management hedge fund. Indeed, Rubin spent much of his term as treasury secretary shuttling from crisis to crisis, organizing, often brilliantly, rescue packages for capital-market failures around the world.
He missed some. Russia defaulted despite his best efforts. And neither he nor Greenspan faced the rising U.S. trade deficit that, by the end of his watch, made our high consumption economy perilously dependent on foreign lenders.
Still, more than 20 million jobs were created. At the end of the decade, people who 10 years earlier had been written off as "unemployable" were working, and, for a few quarters before the crash, employers were actually bidding up the wages of people making $7 an hour.
So, honest liberals might have different answers to the question, was the "trade off" worth it? But there is a prior question: Was it necessary?
Some deficit reduction was reasonable. After all, a fiscal deficit that was rising faster than income is ultimately unsustainable. But the Clinton-Rubin buy-in to a 19th-century Republican economic agenda was clearly over the top. As Clinton economists Joseph Stiglitz, Alan Blinder, and Janet Yellen, among others, have pointed out, the sustained growth of the past decade was largely generated by a perfect storm of favorable factors, including the spread of Internet technology, low energy prices, and a temporary slowdown in health-care costs.
The clearest answer came from Alan Greenspan himself. A few days after the election of George W. Bush, Greenspan endorsed Bush's massive tax cut, which not only wiped out the surplus the Democrats had so painfully built up but quickly put the government back in the red. It turns out that the ideologically conservative Greenspan had used the deficit scare as a way to stop Clinton from social spending. When the Republicans came back, Greenspan was happy to support what has now become the GOP tradition of cutting taxes for the rich, no matter what the fiscal consequences.
Some would argue that Rubin and Clinton had no other leverage to keep Greenspan from killing the recovery. But they clearly had more wiggle room. Wall Street's worry was that the deficit was out of control. The Clinton administration could have mollified financiers' fears by cutting the deficit to something like 2 percent of gross domestic product. That would have freed up additional revenue for desperately needed public investment, and Greenspan would have been on weak ground to throttle non-inflationary economic growth. Moreover, Clinton had control over the one thing that Greenspan desperately wanted: reappointment. Had the president been willing to discipline the chairman with some of the job anxiety that kept America's workers in line during the 1990s, a few dollars of that now tragically lost surplus might have been invested in things such as schools, hospitals, and clean air.
Compared with what we have now, of course, we'd be happy to have Rubin back. And if the country lucks out next November, he -- and we -- may get another chance. So I'd be a lot more comfortable if his book had at least acknowledged that he helped Greenspan take us to the cleaners. The next Democratic administration should not be condemned to repeat the mistakes of the last one.
Bradford DeLong Responds:
I find it hard to disagree with my esteemed semi-adversary Jeff Faux. He says so many reasonable and intelligent things. However, let me pick a nit. Mr. Faux writes: "Some deficit reduction was reasonable. After all, a fiscal deficit that was rising faster than income is ultimately unsustainable. But the Clinton-Rubin buy-in to a 19th-century Republican economic agenda was clearly over the top."
To those of us who did buy in to the go-for-a-surplus agenda, it was not a 19th-century Republican economic agenda that we thought we were buying in to. It was a 21st-century Democratic economic agenda. We were looking forward to 2020 or so, when the baby-boom generation retires and when Social Security, Medicare, and Medicaid expenditures start to rise rapidly as shares of the gross domestic product. Running surpluses now, giving the country the debt capacity to finance these forthcoming rises in social-insurance expenditures, seemed to us a wise policy. The alternative -- to merely stabilize the debt-to-GDP ratio and make no special provision for the generational future -- seemed to us likely to create a situation in which a) the elderly programs eat the rest of the social-insurance state alive and b) they then self-destruct.
Truth be told, however, relatively few people ever bought the "surplus" policy as a positive good rather than as a necessary evil. Robert Rubin bought it. Lawrence Summers bought it. Those of us who carried spears for them bought it. The Concord Coalition bought it. But the rest? Nah. Nearly all Democrats would rather have had
moderate deficits -- a stable or slightly declining debt-to-GDP ratio -- and expanded social-insurance spending. Nearly all Republicans would rather have had large tax cuts for the $200,000-plus-a-year crowd, deficit be damned. But in the late 1990s, Republicans preferred surpluses to expanded social-insurance spending. And Democrats preferred surpluses to big tax cuts for the $200,000-plus-a-year crows.
Would we have had a '90s boom with a slightly higher deficit? Yes. The big benefits probably came from shifting the United States from a deficit path that was clearly unsustainable to one in which investors and money managers could look to the future and see a U.S. government that had its finances stable. Beyond that, each percentage point of GDP shaved off the deficit had benefits -- a 0.1 percent per year acceleration in the rate of economic growth, or perhaps a 0.2 percent per year acceleration? -- but not ones that would have justified additional pruning of the federal government.
Would Alan Greenspan have cooperated and tried to keep interest rates low if the Clinton administration's attack on the deficit had been less enthusiastic? I believe that he would have, even without dire hints about the unlikelihood of his reappointment. After all, four times in his tenure he has gone against the central-banker consensus and kept interest rates much lower than his peers thought proper: in the aftermath of the 1987 stock-market crash; during 1993, in an attempt to provide support for deficit reduction; in the late 1990s, as he bet that the new economy was real and that potential output was growing much faster than his staff believed; and again today, when the United States has the fastest growth rate and the lowest interest rates of the North Atlantic economies.
The curious thing to me is how Greenspan has managed to retain his reputation as an inflation hawk given his demonstrated propensity to take monetary policy risks in order to achieve faster growth. Fear of Greenspan was a good reason not to acquiesce in a budgetary policy with an exploding debt. Fear of Greenspan was not a reason to push for a surplus rather than for a stable (or slightly declining) debt-to-GDP ratio.
Rubin's Remarkable Achievement
By Bradford DeLong
In 1992, the incoming Clinton administration had, broadly speaking, two strategic options for domestic policy. The first was a double-or-nothing "social democracy" strategy. Federal spending at the time was running at 22 percent of the gross domestic product, hardly changed from 1980. Contrary to conservative mythology, the Reagan revolution hadn't shrunk the government, but it had changed its shape. As a share of federal spending, domestic expenditures outside of the entitlement programs were down by one-third, while debt interest and military spending were up. Forecasts showed deficits continuing -- indeed, rising -- as far as the eye could see. If policy had stayed unchanged, the federal debt -- which had already risen from 26 percent of the GDP in 1980 to 48 percent in 1992 -- would have continued climbing to 72 percent in 2000.
Bill Clinton could have said: Let the deficit problem be the responsibility of some future Republican administration. We'll pursue Democratic priorities while keeping the deficit constant, or maybe even allowing it to grow a bit in relation to the economy. Spend more to give every American good medical care (instead of using health-care reform for cost containment). Raise public investment in roads, bridges, and other crumbling infrastructure. Expand social insurance to provide better benefits and retraining for workers who lose their jobs. Provide incentives -- such as a carbon tax -- for industry to rest lightly on the environment.
Some liberals will not forgive Clinton for failing to pursue this approach, but it was politically infeasible. In Congress, the Democrats had an organizational but not an ideological majority. Many centrist Democrats would not support a social-democratic program, as was evident in the spring of 1993, when Clinton's short-term economic stimulus program (which included money for infrastructure) went down to defeat.
The double-or-nothing strategy also carried serious economic risks. The long-term growth trend had slowed markedly in the late 1970s and stayed low throughout the 1980s. (Only by the most egregious data manipulation have conservative ideologues claimed to find "seven fat years" in the 1980s.) Governments that run large and persistent deficits find that their appetite for cash diverts spending that would otherwise flow into productive investment, and that investors get nervous and capital starts to flee the country. Low investment means stagnant productivity and wages, not just in a recession but over the entire business cycle. Would it have been good for the country if Clinton's inauguration had been followed by year after year of slow growth? And what would have been the chances of passing any Democratic legislative priorities if the macroeconomic news was never very good?
Faced with those considerations, Clinton rejected the social-democracy strategy in favor of the second possibility -- call it the "Eisenhower Republican" strategy. Make economic growth the first priority. Attempt to get the Federal Reserve to be dovish on interest rates in exchange for seriously reducing the deficit. Take other steps such as trade liberalization to try to boost growth. Reform rather than expand social insurance so that you can argue that taxpayers are getting good value for what they are buying. Hope that these policies will boost investment. And make the Clinton legacy a high-investment, high-productivity growth expansion. If all goes well, a decade of rapid growth and a resolution of the deficit will open up new possibilities for progressive policy.
This was the strategy that Bob Rubin executed, first as head of the National Economic Council and then as treasury secretary under Clinton. Rubin's new memoir shows why he was able to do such a superb job, close to the very best job that could be done. Even the title page gives a clue. How often in a political book does the person who crafts the prose (in this case, Jacob Weisberg) get his or her name on the cover as a full co-author? Rubin listens to the people who work for him, and he is not shy about giving them credit. As an economist at the U.S. Treasury from 1993 to 1995, I had a chance to see him at work, and his people-management skills are remarkable. I have never seen anyone else able to guide a meeting to the consensus he wanted by occasionally raising his eyebrows and saying little other than, "That's very interesting, very important. Now I think we should hear what X has to say."
Rubin himself emphasizes his habit of "probabilistic thinking," always asking such questions as, "What else might happen?" and, "What if we're wrong?"; looking at the full range of possible outcomes rather than the most likely or the most comfortable; and recognizing that just because things came out well in one case, you didn't necessarily make a good decision, or that just because things turned out badly, you didn't necessarily make a bad one.
These qualities made Rubin an ideal first lieutenant in economic policy, but another critical factor in his success was the president himself. Clinton took policy seriously and was usually willing to be convinced that what was good policy would turn out to be good politics (or, at least, that this was a reasonable bet).
Where, if anywhere, did Rubin go wrong? He certainly placed a lot more trust in markets than in laws and in regulatory agencies as devices for monitoring and disciplining corporations -- especially financial corporations. Hence his support for the repeal of the Glass-Steagall Act (which limited mergers in the financial industry) and his distrust of regulations that restricted financial corporations. You can argue (and, on odd-numbered days, I do) that this orientation left him blind to the problems of large-scale corporate fraud that later surfaced in Enron, WorldCom, and Adelphia and (although here I was blinder) to the gathering international financial storms that hit Mexico, East Asia, and Brazil.
But on even-numbered days I think that when international financial crises did erupt, Rubin's reactions were swift, powerful, and well thought-out. Modern finance provides ample evidence of government failure as well as market failure, and no one knows for sure the appropriate point of balance.
But there is a bigger question. The Clinton-Rubin economic policies certainly contributed substantially to the economic boom of the 1990s, though economists will debate whether they deserve 20 percent, 40 percent, or 60 percent of the credit. In the end, however, the resolution of the deficit did not widen the politically realizable possibilities -- at least not in the way we hoped. Rubin's success helped George W. Bush return us to the budgetary ground zero of 1992 through enormous tax cuts for the $200,000-plus-a-year crowd, higher military spending, and pork for Republican legislators and favored companies such as Dick Cheney's Halliburton.
Might the social-democracy laissez-deficit strategy have been better for the country after all? Of course, neither Clinton nor Rubin could have foreseen the outcome of the 2000 election. And if they had bequeathed deficits rather than surpluses, would the current crew in power have been any less inclined to the reckless fiscal policies it is now pursuing? It's George W. Bush who has gone for a double-or-nothing strategy, and the country will someday pay the price.
Jeff Faux responds:
Brad DeLong is a smart guy and a good economist. He makes the best argument one can that Bill Clinton and Bob Rubin did the best economic-policy job they could have under the political circumstances of the 1990s. But it does not convince.
The "double-or-nothing" social-democratic alternative, says Mr. DeLong, was politically infeasible. This, of course, is the classic political conversation stopper. But as the probabilistic thinking of Rubin that Mr. DeLong so admires tells us, nothing is certain. Political feasibility is in the eye of the beholder. In recent years, Ronald Reagan and George Bush Senior managed to ram through right-wing agendas that the conventional Washington wisdom told us were infeasible. Anyway, isn't making things feasible the function, and the test, of leadership? Clinton and Rubin gave so much to the Republican agenda -- on welfare, trade, regulation, and privatization, just to name a few. Couldn't Rubin's vaunted negotiating skills have been used to get something for the Democratic agenda in return?
And what's with this "double-or-nothing?" language? Tarring the modest social-democratic alternative with the same brush as George W. Bush's radical reactionary program wildly distorts the options that were available. My quarrel is not with the attempt to bring the deficit back under control. It is with the administration's obsession with proving itself to Wall Street by moving from deficit reduction to balanced budgets to surplus ... to eliminating the entire federal debt! If anything was double or nothing, it was the gamble that this process would, in some unspecified way, create space for what most of us saw as the Clinton administration's historic mission: to rebalance America's economic priorities after 12 years of conservative rule.
Probabilistic thinking -- yes, it does seem to be an overwrought term to rationalize one's decisions, but taking it at face value provides some insights here -- apparently was not applied to assessing the risks of failure to achieve the Democratic agenda. Indeed, Mr. DeLong lectures us on the evils of government spending crowding out "productive" (i.e., private) investment. Missing is any mention of how fiscal austerity crowds out
productive public investment. Does anyone believe that more investment in health care and education would have been less productive for the American economy in the 1990s than yet more private investment in financial derivatives or shopping malls increasingly loading up consumers with imported toys and unsustainable debt?
"Would it have been good for the country if Clinton's inauguration had been followed by year after year of slow growth?" Mr. DeLong asks. Certainly not. But as the National Bureau of Economic Research tells us, the recovery was, in fact, on its way throughout 1992. Yes, the recovery was slow, but the analytical point is that the economy was expanding at a time when it seemed unlikely that neither a re-elected George Bush Senior nor a "liberal" Bill Clinton would get the budget under control. So from the perspective of the financial markets, it appears that the probability that the budget deficit would not be tamed was not enough to stop the growth. Indeed, Mr. DeLong acknowledges that the contribution of the Clinton-Rubin policies might be as low as 20 percent.
In contrast, the probability that the austere federal budget would strangle the social-investment agenda upon which Clinton was elected increasingly became 100 percent. Once on the balanced-budget path, progressives started asking, "Where's the beef?" We were then told that social investments would have to wait until the federal government's balance sheet was clean enough to start borrowing for the baby boomers' retirement -- 20 years from now!
But if it was all about saving Social Security, why did we need this elaborate story about being credible to Wall Street in order to make room for progressive policies? This shift in rationale kindles some suspicion among we social democrats that there never was any intention of revising the basic Reagan priorities. Tragically, it also probably motivated disappointed progressives in New Hampshire and Florida to vote for Ralph Nader in 2000.
There is not enough space here to go into the Social Security problem, but the probability of the program not fulfilling its obligations to retired workers in 2020 is about zero. Certainly there are plenty of ways to solve the impending trust-fund deficit without forgoing investments in the education and training of the next generation of workers, which of course will make the problem even worse. Isn't probabilistic thinking supposed to assign probabilities to all of the options?
Moreover, given the experience with the Reagan-Bush Senior regimes, wouldn't there have been an extremely high probability that sometime in the next two decades the next Republican administration would loot the surplus carefully built up by the sacrifices of the Democratic constituencies and use it to reward its own -- as George W. Bush has done? Wouldn't serious probabilistic thinking have had someone estimating those odds?
The last line of defense is that Rubin did a masterful job in dealing with the various financial crises that erupted in the '90s. Even though I never had the inspiring experience of seeing Rubin resolve one of these crises by raising his eyebrow, I will concede the point. Just imagining our present treasury secretary in the same situation makes me tremble for my country.
But we have to connect the dots between Rubin's role in pushing for business deregulation and the subsequently unleashed speculative behavior that inevitably led to crisis. The repeal of Glass-Steagall is but one of the financial land mines Rubin left in the road that will surely one day explode in our face -- with the probability that a less talented treasury secretary will have to deal with it.
Thus, for example, Rubin's book appropriately gives him credit for the ingenious 1995 Mexican peso rescue. But it ducks any acknowledgement of his role as a champion of the North American Free Trade Act (NAFTA), the overselling of which created a speculative bubble in Mexican assets and drove up the peso to unsustainable heights. Even without the aid of probabilistic thought, it wasn't hard for many observers, including this one, to assign a high probability that the combination of an overhyped agreement, an overvalued currency, and a group of crony capitalists running Mexico would blow away the peso after NAFTA was signed.
Rubin's rescues -- foreign and domestic -- bailed out the very class of financial speculators whose unregulated herd behavior created the mess. It's an outcome Rubin says he regrets, but the market made him do it. Rubin was a financial fire chief with a talent for putting out fires and a policy of encouraging speculative pyromania.
The great thing about probabilistic thinking is that it allows one to escape responsibility for what actually happened. It's not so much what you did that counts, it's how you did it. The operation succeeds and the patient dies. In this case, what died was the hopes of millions who had worked for, voted for, and elected a smart, talented Democratic president who filled his administration with smart, talented people -- who then starved their constituency's and their country's needs. Unwittingly, and with the
best of intentions, to be sure, they set the table for the reactionary Republican feast that followed.
Jeff Faux is the founding president, and now distinguished fellow, of the Economic Policy Institute in Washington, D.C. Bradford DeLong is a professor of economics at the University of California, Berkeley.