If the American dream is not dead, then surely it is in intensive care. Consider this. Compensation per hour, adjusted for inflation, grew at a compound rate of about 3 per cent in the twenty-year period between 1948 and 1968. This meant that the family of a typical worker could consume about 3 per cent more each year, year after year. At that rate the standard of living was doubling about once every generation. But a dramatic change took place in the American economy between 1968 and 1973, approximately contiguous with the Vietnam War. In the twelve-year period since 1973, real hourly compensation increased at a rate of about three-tenths of 1 per cent per year. This means that the standard of living of the typical American family is doubling only at a rate of about once every few hundred years!
Laissez-faire is the doctrine popularized by Adam Smith, the Scottish philosopher who wrote the Wealth of Nations in 1776. Literally interpreted, it means ‘to let it be or to let go’. The eighteenth century was characterized by the rise of strong nation states in Western Europe. Within the context of the economic and political environment in which Smith lived, laissez-faire was an argument for keeping government out of the affairs of commerce.
In his preface to The General Theory Keynes agonized over his ‘long struggle to escape … from habitual modes of thought and expression’. The difficulty, he said, ‘lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds’. It was the conventional wisdom of his time that Keynes attacked. Its inability to correct economic dysfunction, coupled with the heroic attempts of its defenders to shelter it from criticism, had led to what Keynes observed to be ‘deep divergences of opinion’ among the professional economists of his time.
The mechanics of Keynes’s disequilibrium analysis were not highly visible. Rather, these were smuggled into his system by distinguishing between realized and notional quantities of saving and investment. Whereas realized or ex post saving and investment are continuously in equality (because an extant economic system can only be viewed in equilibrium), the values of notional or ex ante saving and investment are allowed to be unequal.
Americans wanted to believe that the supply-oriented proposals of the Reagan administration were better alternatives than the failed demand-oriented Keynesian policies of the Johnson, Nixon, Ford and Carter administrations. But the supply-side prescription for economic success has created many unexplained consequences for the American public, and these do not appear to be compatible with the success claims being made by Reaganomics advocates.
Our quest in Part IV is to consider a second glitch in doctrinaire laissez-faire capitalism. Since a glitch is a malfunction, our concern is to observe aspects of the conventional economic theory that may explain economic dysfunction, and to set forth a corrective programme to restore traditional capitalist economies to health. Recall that the first glitch of economic theory is unemployment. It results from the disparity between the ideal conditions of the economic archetype which has its basis in natural law, and conditions prevailing in an extant economy. Time and friction are characteristics of an actual economy. When time is present, disequilibrium is the normal outcome. During the gold-backed monetary system of the Great Depression, disequilibrium was revealed in the hoarding of gold in anticipation of its appreciation. The outcome was a shortfall in output, and therefore unemployment resulted.
Recall in Ricardo’s system the significance of equality between saving and investment. It is a condition of equilibrium embedded in the comparative static method. In equilibrium, all opposing forces in a system are cancelled out. Without a change in some system parameter, we would expect the status quo to prevail in perpetuity. In economics, there are only two cases in which saving and investment equality may remain constant over time. Both are steady states.
The operating environment of the typical firm in the late twentieth century is very different from the prevailing environment described by Alfred Marshall nearly a century ago. Marshall wrote near the end of the industrial revolution, which transformed agricultural society during the nineteenth century into a society of manufacturers. The individual entrepreneur had not yet given way to the modern stock company. Research and product development mainly proceeded at the initiative of individuals, rather than large organizations. Management science as a discipline did not exist, and the hand of government was not ever-present in its attempts to redistribute or to improve market efficiency.
Keynes pointed out in Chapter 12 of The General Theory that investments which are ‘fixed’ for the community are thus made ‘liquid’ for the individual. Transactors too often concentrate their efforts on liquidity, rather than productivity. ‘The actual, private object of the most skilled investment to-day,’ according to Keynes, ‘is “to beat the gun”… to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow.’ Such transfers of assets, according to Keynes, are ‘a game of Snap, of Old Maid, of Musical Chairs — a pastime in which he is victor who says snap neither too soon nor too late, who passes the Old Maid to his neighbor before the game is over, who secures a chair for himself when the music stops’.
Free trade means free from government intervention. Free international trade is exploding. From 8 per cent twenty-five years ago, it has grown to 16 per cent of the combined domestic products of international trading partners. For the United States alone it accounts for 14 per cent of GNP. By virtue of its size, the American economy is the world’s largest exporter. This means that one out of every nine American jobs is in an export industry. And one in every seven GNP dollars is earned from sales to foreigners. On the import side, one of every four cars, 60 per cent of all televisions, 40 per cent of clothing and two-thirds of all shoes are produced outside the United States.
Ronald Reagan came to power with a mandate to purge the economy of the ills of Keynesianism. Since the Federal Reserve had already begun the task a full year ahead of the Republican landslide of 1980, momentum was well under way. Among the architects of the laissez-faire resurgence, or ‘supply-siders’, was Arthur Laffer who argued for a reduction in tax rates. According to the supply-siders, a cut in tax rates would stimulate output and income, and therefore generate a larger federal base from which tax revenues could be drawn. So even though rates might be cut, the end result would be an increase in total tax revenues.
Once again laissez-faire has come to crisis. It no longer works appropriately because the world has changed since the eighteenth century, which then was more compatible with Adam Smith’s vision of natural law. Most aspects of capitalism still work, or can be made to work. These include the private ownership of capital, and the institution of the unregulated (or partially regulated) market for the allocation of current output and resources. But the aspect of doctrinaire capitalism which has become inoperative, specifically, is the ability of market economies to make choices affecting the future. Now the allocation of output and resources for the future must be governed through non-market collective choice.
