What’s the best way forward for American economic policy? On Independence Day it’s natural to look to the country’s founding principles—political freedom and economic freedom—for an answer. 1776 was not only the year when Thomas Jefferson wrote the Declaration of Independence, it was the year when Adam Smith wrote the Wealth of Nations. We can learn what to do by studying the alternating periods in American history when careful attention was paid to these principles and when they were recklessly neglected.
From the perspective of today’s dismal economic performance—high unemployment and a nearly non-existent recovery from a devastating recession—the final two decades of the 20th century are particularly relevant for they stand out as unusually good economic times. With lessons learned from the 20th century’s tougher decades, including the Great Depression of the ‘30s and the Great Inflation of the ‘70s, America entered a period of unprecedented economic stability and growth in the ‘80s and ‘90s. Not only were 47 million jobs created, economic growth was more stable than ever before in American history.
Economic policy in the ‘80s and ‘90s was less interventionist in comparison with earlier 20th century decades. Attention was paid to the principles of economic and political freedom: limited government, incentives, private markets, and a predictable rule of law. Monetary policy focused on price stability. Tax reform reduced marginal tax rates. Regulatory reform encouraged competition and innovation. Welfare reform devolved decisions to the states. With strong economic growth and control of government spending the budget moved into balance. As the 21st century began many hoped that applying these same principles to education and health care would create greater opportunities and better lives for all Americans.
But economic policy went in a different direction. Some public officials found the limited government approach to be a disadvantage; they wanted to do more—whether to tame further the business cycle or increase homeownership. Others took the good economic performance for granted, forgetting that good economic policies made that performance possible. Still others forgot the earlier lessons that interventionist policies frequently made things worse. Complacent about the success in the ‘80s and ‘90s, they let down their guard against political pressures that thwart good policy and lead to reckless ones.
So policy moved in a more interventionist direction. The result was not the intended improvement, but rather an epidemic of unintended consequences–a financial crisis, a great recession, and the high unemployment and wasted resources we see now. The change in direction did not occur overnight. We saw increased federal intervention in the housing market in the late 1990s. We saw a countercyclical fiscal policy in the form of rebate checks in 2001, and then a failure to control of government spending growth from entitlements to defense. We saw monetary policy moving in a more activist direction in 2003-2005, and interventionism reached a new peak with the bailouts before and after the panic in 2008. In the past three years Washington doubled down on the interventionist approach, and deficits and debt have exploded. With high unemployment and fears of a secular American decline, there is now an urgent need to get back to the principles of political and economic freedom put forth in the Declaration of Independence and in the Wealth of Nations. The good news is that it’s not too late.