The 1980s
"Reaganism was the rejection of traditional Republican policies of "austerity" - sometimes called castor-oil economics or deep-root-canal economics. But it was more than that. It was an assertion these policies could be rejected without also rejecting many conservative objectives or totems. " 

The Setting for a Shift to the Right

The 1970s will be remembered as a troubled decade, one which opened with TV images of terrorists in Munich's Olympic Village and ended with images of Iranians storming the US embassy in Tehran and a botched military attempt at freeing the 52 hostages. In between was a decade in which American companies seemed to be overmatched by European and Japanese competitors who were the primary beneficiaries of the globalization's return. Another beneficiary was OPEC that successfully orchestrated two oil price shocks in the decade that raised substantially the price of oil. Hammered by job loss and rising energy prices, the wages of American workers began to fall by mid decade as the industrial heartland of the country became the Rust Belt, littered with empty factories and abandoned center city buildings as the deindustrialization and suburbanization of the US economy gained momentum.₁

It was no surprise that the American people voted for change in 1980. In a landslide, Ronald Reagan beat President Carter and promised to reestablish the military and economic superiority of the country. Reagan opened his presidency with the evil empire speech in which he promised to launch "a crusade for freedom" built on a revitalization of the defense industry that had been in decline since the Vietnam War.₂ The country was desperate for some successes, and it got one when US troops invaded the small Caribbean island of Grenada in 1982 and quickly declared victory. The Reagan administration also helped fund the Contra rebels' overthrow of the leftist Sandinistas who had taken control of Nicaragua in 1979 with, what Oliver North describes as, the "profits" from arms sales to Iran - a scandal know as the Iran-Contra Affair.₃ At the end of the decade marines were called upon to lead an invasion of Panama to rid it of Manuel Noriega.

The 1980s "get tough" policies of Ronald Reagan appeared to pay dividends. In Poland an electrician at the shipyards in Gdansk named Lech Walesa became the leader of a 1980 strike that led to the formation of a free trade union - Solidarity. It did not seem like much at the time, but it was the beginning of a process that would ultimately end the Cold War, which is why TIME magazine recognized Walesa as one of the world's 100 most important leaders & revolutionaries of the 20th century. By the mid 1980s the Soviet Union was faltering and Mikhail Gorbachev, who assumed power in 1984, proposed a two-pronged solution - perestroika, a program of economic and political reform designed to institute market type reforms, and glasnost, a policy of openness. What he unleashed was a series of reforms leading to the formation of the new Soviet parliament in the spring of 1989, the same year the communist government of East Germany collapsed in 1989 and the Berlin Wall was dismantled. A wall that had been constructed to keep East Germans from fleeing to the West in 1961, and the most vivid symbol of the Cold War, was torn down, and soon East and West Germany would be eventually reunited with Berlin as the new capital. In Romania, Ceausescu was overthrown in a single week in mid December of 1989 and executed on December 25th of that year. A decade that opened with the US locked in a deadly battle with the "Evil Empire" ended with the Empire imploding. In 1990 the Russian Republic's declared its sovereignty under the leadership of Boris Yeltsin, and by 1992 the Soviet Union no longer existed. Russia and ten other republics formed the Commonwealth of Independent States with Russia taking over the powers once wielded by the Soviet Union. In addition to these political moves, Gorbachev also reigned in the Soviet Union's military sector and worked with the US to back away from the Cold War.₄ The US could begin to think about investing the much anticipated "Peace Dividend."  

In the other communist giant there were also some dramatic changes during the decade. In 1979 China's new leader, Diang Xiaoping, took China in a new direction. While maintaining the absolute political power of the Communist Party, he introduced market reforms in the country and followed the East Asian model of export-led growth. China opened its borders to the inflow of foreign capital and European, Japanese, and American companies were more than happy to establish production facilities to take advantage of China's low wages.

All the news was not good, however. Things did not go so well in the Middle East. The 1980s opened with Iraq invading Iran and triggering a decade-long war in which millions would perish as the combatants used human waves (Iran) and chemical weapons (Iraq).₅ Also in the Middle East Israel invaded Lebanon in 1982 in an attempt to halt terrorist attacks, and within months the US, under the auspices of the UN, sent troops into Beirut to allow an Israeli withdrawal. Things went badly, though, with 63 people killed in a bombing of the US embassy in Beirut and 241 members of the US peacekeeping force killed by a car bomb at the marine barracks in Beirut. By early the following year the troops had left the country, but the Middle East remained dangerous.₆ In Asia the bad news was that students were massacred in China's Tiananmen Square in 1989 and the decade-long easing of tensions with China ended abruptly.

On the domestic front, Ronald Reagan followed the lead of Kennedy and moved the economy to center stage in his presidential campaign when he told the American people, "We are in the worst economic mess since the Great Depression." The stock market, one barometer of confidence in the American economy, continued to fall throughout the 1970s and by 1980 it was down nearly 50 percent from its peak in the mid 1960s. By the end of the 1970s the dollar, another barometer of confidence, was also down - nearly 20 percent from its peak. Inflation, after rising "gently" through the 1960s, twice reached double-digit rates in the 1970s - both times the aftermath of substantial OPEC led oil price increases. By the early 1980s interest rates on short-term borrowing were well into double digits and mortgages were on their way to nearly twenty percent. You did read that right - I paid 18% on a mortgage at that time. In March of 1980s Time magazine was describing the economy as "scary" as it reported president (Carter) declaring "We have reached a crisis stage" and well-respected investor Felix Rohatyn warning "We are headed for a national bankruptcy." 

Americans had also witnessed a substantial increase in the size of the federal government and the federal tax burden was increasingly falling on individuals who were ready for a tax revolt, which they got in CA in 1978 when the voters passed Proposition 13 that lowered property taxes 53%. At the federal level there was little room for a tax cut given the existing finances. On the outlay side of the ledger there were some substantial changes taking place, most notably the rise of entitlements such as Medicare and Social Security where the government had no discretion over spending that was set by law and those entitled to the government's money would simply get it. Discretionary spending, what the government could actually control, fell from about 70% to 50% of total federal outlays, while defense spending, the largest component of discretionary spending, fell from 50% of outlays to 22%. Over the decade taxes did not increase as sharply as outlays and the budget deficit expanded. The cycles in the budget deficit, evident in the Federal Deficit/GDP diagram, did not hide the fact there was a definite trend toward larger budget deficits. By the late 1970s the deficit was averaging nearly 3 percent of GDP.

As evidence of the sorry state of the economy, Reagan emphasized the Misery Index, which is defined as the sum of inflation and unemployment rates. By 1980 the misery index stood at approximately 20 percent, twice the level of a decade earlier and its highest level since the Depression. There is one graph, however, that is best at capturing the anxiety of the American people and their disillusionment with the economy in the late 1970s. For the Great Depression of the 1930s it was the unemployment rate graph, while for the great stagflation of the 1970s it was the graph of real wages. After a virtually uninterrupted climb beginning after World War II, real (inflation-adjusted) wages for American workers stopped rising in the recession of 1973-75, and continued to fall for the remainder of the decade. By 1980 nearly one-third of all the gains in earnings made since 1948 had disappeared and real wages stood at the same level they had been in 1962.

As real wages fell, so too did confidence in the prevailing theories / policies to turn things around. The situation was beginning to resemble the early 1930s - an economic problem too large to ignore, yet beyond the abilities of the prevailing theories to explain. Liberal Keynesian economists were unable to produce a set of policies to help lift the economy out of the economic doldrums. In 1973 inflationary pressures were building as the US dollar declined sharply and el nino helped send agricultural prices sharply higher. The real shock, though, came towards the end of the year when the OPEC countries imposed an oil embargo. The result was higher unemployment and inflation. This is certainly not what the Phillips Curve promised policy makers. In fact, the Phillips Curve, long thought to represent a menu of choices open to policy makers, seemed to disappear. This was new, so it was given a name - stagflation - the combination of higher inflation and higher unemployment.  

The problem, in retrospect, is stagflation could not be treated with traditional aggregate demand oriented monetary and fiscal policies. Keynesian fine-tuning policies that seemed to work so marvelously in the 1960s, failed to work in the 1970s. The timing was perfect for a candidate with a simple cure for the Carter malaise, and the Republicans responded with a crowded field of candidates including Ronald Reagan and George Bush. The stage was now set for a shift to the ideological right, with a return to the supply-side policies of the 1920s that favored business over labor.

Imports continued to flow into the country in record amounts, weakening the bargaining power of high wage, union workers who found employers increasingly willing to shut down factories and move operations overseas where labor costs were substantially lower. In the Four-Tigers of Southeast Asia, countries where governments were committed to policies of export-led growth, the cost advantage approached 90% in Korea and Taiwan and  85% in  Singapore and Hong Kong. Even Japan, which by 1980 had become a rising world power, has costs nearly 50% lower than in the US.

The combination of the government's anti protectionist policies and the "flattening" of the world, manufacturing employment in the US actually declined in the 1980s. In the 1970s manufacturing growth was still positive, although down almost 2/3rds from the growth in the 1960s, but weaknesses were showing up in non durables, generally the more mobile industries, where employment in the US actually fell in the decade. By the 1980s employment losses in manufacturing had become widespread with over 1.5 million jobs lost - about 1 of every 12 manufacturing jobs - and the losses were concentrated in the heavier, more unionized, durable industries.

Rising immigration - nearly 2/3rds higher that the previous decade - also pushed wages of American workers lower as they found themselves in competition with immigrants who were increasingly coming from Mexico. Immigration in the 1980s represented a full 1/3rd of the country's population growth - a number not seen since the 1910s when immigration was becoming a national issue. And if that were not enough, Reagan sent a very clear message to American workers that they had no friend in the White House when he ended the air traffic controllers strike by firing all of the PATCO union controllers.

In politics and business, Ted Turner launched CNN (1980), the first woman was nominated to the US Supreme Court (Sandra Day O'Conner), Pac-Man was the most popular computer game and in fact was named Time magazines' "man of the year," and the first space shuttle was launched (1981); the compact disc, or CD, was launched (1983), AT&T was broken up in an anti trust case in 1984, the same year that the Supreme Court gave the OK to home video taping of TV shows; New Coke was first marketed about the time a hole in the ozone was discovered in 1985 - the latter event being the driving force that resulted in passage of the Montreal Protocol in 1989. In the following year the Challenger shuttle exploded on launch and the world witnessed its worst nuclear power accident at the Chernobyl nuclear power plant. This was also the decade when a new plague was recognized by the Center for Disease Control as AIDS (1981), the first liver transplant took place, and Prozac hit the market.

In technology, IBM launched its PC, the TCP/IP protocol was accepted - a BIG first step towards an Internet - a network of networks, the Apple Macintosh computer with mouse was launched in the same year that the software PageMaker and Dell Computer first appeared. But Macintosh's future was sealed when Windows appeared in 1985 because now there was a competitor to Apple's user friendly machines. This was also the decade when the Domain Name System (DNS) were introduced and Microsoft came out with its 'killer' app - Excel. In entertainment and arts, John Lennon was shot and killed in 1980s, the first 3D computer games appeared, and high definition TV was invented. In the movie theaters Star Wars: Episode V - The Empire Strikes Back  and Airplane! (1980), Raiders of the Lost Ark (1981), and Ferris Bueller's Day Off (1986), Indiana Jones and the Last Crusade (1989) and the Vietnam war movies The Killing Fields (1984), Platoon (1986) and Full Metal Jacket (1987), were released. In literature Stephen W. Hawking's A Brief History of Time and Salman Rushdie's The Satanic Verses were published, while in music Michael Jackson's album Thriller were released (1982). 

The Shift to the Right: Supply-side Economics

The 1980s election victory for Ronald Reagan ushered in a notable shift toward the conservative right in US politics and economic policy. It reflected a lack of confidence in government's ability to manage the economy that was described in a 1985 article in the New York Times.

The Reagan administration believes, contrary to the activist Keynesian view that emerged in the 60's, that economies cannot be managed by the use of tax and budget policy. They reject any notion of 'fine-tuning' policy to try to eliminate the ups and downs of the business cycle. ...The reality is that microeconomics ...has come to the fore in the Reagan years...But macroeconomics...is on the skids.

The shift to the ideological right did not, however, originate in the US.₇ The Republican's victory in the US had been preceded by the decisive Conservative Party victory in the United Kingdom's 1979 election that brought Margaret Thatcher to Downing Street and "Thatcherism" to the country. As Ms. Thatcher described things in Bolton on May 1, 1979:

[u]nless we change our ways and our direction, our greatness as a nation will soon be a footnote in the history books, a distant memory of an offshore island lost in the mists of time - like Camelot remembered for its noble past.₈  

In the US, the conservative message delivered by Reagan was a simple one, and one modeled closely on Roosevelt's message in 1932. Reagan challenged the American people in 1980 to reflect on the past four years and ask the question: 

Can you look at the record of this administration and say, 'Well done'?  Can anyone compare the state of the economy when the Carter administration took office with where you are today and say, 'Keep up the good work'?  Can you look at our reduced standing in the world and say, 'Let's have four more years of this'?

Reagan knew that for too many people the answer in 1980 was NO - and he believed he had the policies that would turn things around.

On the macro side, there were three key elements of the Reagan agenda: reduce inflation, balance the budget, and reduce the size of the government. The American workers had seen inflation erode their buying power as the progressive tax system drove them into higher tax brackets that financed an expansion in the size and scope of government. There was a tax revolt underway in CA and a candidate would be well served by a platform including a tax cut. In fact this is the beginning of the Republican emphasis on tax cuts that continued through to the Bush tax cuts.

But there was a problem with each piece of the agenda. First, significant reductions in inflation would require substantial increases in unemployment - the old Phillips Curve tradeoff. Second, balancing the budget would mean tax cuts, long a favorite Republican proposal, would be impossible to achieve. Third, the budget situation could not be improved with substantial cuts in government spending without a loss in benefits received from the government. When Margaret Thatcher approached a similar situation in England, her solution was based explicitly on the premise that the economic ills could only be cured after a painful period of transition. Ronald Reagan, on the other hand, offered the American people an alternative to the Carter's drift and Thatcher's austerity - what George Bush, Reagan's opponent in the Republican primary, called "voodoo economics" and Herbert Stein called "the economics of joy." Ronald Reagan had lost the Republican candidacy on an austerity campaign in 1976 and he would not make that mistake again. The most striking feature of Reaganomics was it offered a painless solution to stagflation.

Reaganism was the rejection of traditional Republican policies of "austerity" - sometimes called castor-oil economics or deep-root-canal economics. But it was more than that. It was an assertion these policies could be rejected without also rejecting many conservative objectives or totems.₇

One thing was certain, the move would need to be dramatic and quick as Reagan and his supporters felt it was essential to change expectations. As Reagan's supporters and policy advisors saw it:

Thatcherism' can only be avoided if the initial economic policy package simultaneously spurs the output side of the economy and elicits a swift downward revision of inflationary expectations in the financial markets...President Reagan should declare a national economic emergency soon after inauguration. He should tell the Congress and the nation that the economic, financial, budget, energy, and regulatory conditions he inherited are far worse than anyone imagined. He should request that Congress organize quickly and clear the decks for exclusive action during the next 100 days on an Emergency Economic Stabilization and Recovery Program he would soon announce.

If Reagan was to deliver on his promises, then the assumptions upon which his program was based would need to be accurate since it was a finely balanced plan. For that reason, in the first section of this unit the theories and assumptions upon which supply-side economics was based will be described. The revival of interest in the supply side of the economy also triggered a revival of interest in the long-run growth of the economy, and thus economic growth will be the topic in the unit's second section. We will focus our attention on the importance of growth differentials and explanations of the pattern of world economic growth that tend to center on the concepts of productivity growth and technological change. The section will close with a discussion of the problem known as the cost disease of the service sector.

1. For those interested in images of this era, you should check out the movie Miracle about the US Olympic hockey team that beat the Russians in the 1980 games. It opens with a montage of images from the 1970s that captures the mood of the country.

2. In 1983 protestors filled the streets of Europe protesting the deployment of Pershing missiles aimed at the Soviet Union, while at home many questioned the viability of the Space Defense Initiative (SDI) - the shield to protect the country from missile attacks.

3. The Executive Summary of the Report of the Independent Counsel for Iran/contra matters contained the following description.  

In October and November 1986, two secret U.S. Government operations were publicly exposed, potentially implicating Reagan Administration officials in illegal activities. These operations were the provision of assistance to the military activities of the Nicaraguan contra rebels during an October 1984 to October 1986 prohibition on such aid, and the sale of U.S. arms to Iran in contravention of stated U.S. policy and in possible violation of arms-export controls. In late November 1986, Reagan Administration officials announced that some of the proceeds from the sale of U.S. arms to Iran had been diverted to the contras.

4. For some background on the collapse of the Soviet Union you can check out Time's 10 year anniversary article including pictures that include the one shown here. 

5. The Federation of American Scientists describes the situation leading up to the war as follows:

7. Ms. Thatcher assumed the job at a time where prices and wages were rising at rates exceeding 15 percent, spurred on by money supply (M1) growth that peaked at 22 percent in 1978. The unemployment rate was in the mid 5 percent range, up from the mid 2 percent range before the 1975 recession, economic growth put it at the bottom of the OECD countries, and productivity growth was limited. The result was unit labor costs rising at double-digit rates and import competitiveness falling sharply. The exchange rate continued to fall throughout the decade, falling a full 20 percent between 1975 and 1978, while the balance of trade deficit continued to rise. In fact in December 1976 the IMF needed to 'rescue" the pound. As economists Richard Caves and Lawrence Krause saw things, "Britain's economic malaise stems largely from its productivity problem whose origins lie deep in the social system."₂ The people of the United Kingdom and the United States were ready to listen to, and elect, people who offered them a way forward, and that was Margaret Thatcher in the UK and Ronald Reagan in the US.

For Margaret Thatcher, a "disciple" of Milton Friedman and Freidrich von Hayek, the "solution" to the economic malaise had three major components. First, strict monetarism was the answer to inflation. Second, government interferences with the economy needed to be reduced - in large part to be accomplished by "rolling back" the reach of the public sector. She also set about to reduce government spending, but she was less successful at achieving the second of these goals. Third, productivity growth needed to be increased, an outcome that relied on increases in incentives. The Conservative manifesto states the case as follows:  "To become more prosperous, Britain must become more productive and the British people must be given more incentive."  Part of the incentives came in the form of tax changes. People should be rewarded, not penalized for working,  and thus in the first Conservative budget income taxes were cut, especially at the high end, and consumption taxes (Value added tax (VAT)) were raised.  The result was a deep and troubling recession in 1980-1981  - prompting comparisons between the early 1980s and the 1930s. Rising interest rates drove up exchange rates that made it hard for manufacturing firms to compete, and between 1979 and 1981 manufacturing employment fell by 16 percent. In addition to the economic slide, there was also a notable increase in inequality, with the manufacturing centers in the North and West experiencing double digit unemployment rates. One success, however, was a sharp reduction in inflation, which was down to 4.5 percent in 1983.  Another was the victory in the very brief conflict with Argentina over the Falklands Islands in 1982. 

8. Herbert Stein in Presidential Economics