The principle of homeopathic medicine is to “let like be cured by like”: treat an illness by giving patients minute quantities of medicines that produce the same symptoms. But treating indigestion with a 10-course meal is not a good idea. This is why throwing borrowed funds at the current economic crisis, which was caused by excessive borrowing in the first place, has failed to set the U.S. economy on course to a lasting recovery. Such policies are likely to make matters worse — as the government debt crisis in Europe has demonstrated.
Jobs will need to be created and consumer demand revived as a prerequisite for renewed economic growth, but it will have to be done by tapping underutilized sectors of the economy. In other words, economic stimulus should be provided not by the government, which is already dangerously in debt, but by those who are sitting on a pile of cash, notably U.S. corporates. The challenge is to encourage them invest this money.
The 2008 crisis marked an end of an economic era. In 2008, the sources of growth powering the U.S. economy since the early 1980s suddenly disappeared. The economy went into a free-fall. It was arrested by massive government spending, a rescue package for banks and relentless printing of money by the Federal Reserve, but those measures could not restart the economy. After three years of anemic growth, signs of another recession emerged in August 2011.
This situation is not unique. It was seen twice over the past hundred years. Economist Nikolai Kondratieff identified long-term cycles, the so-called Kondratieff waves lasting a number of decades and ending in a depression. The economy ran out of sources of growth in the late 1920s, triggering the Great Depression. A similar situation arose in the 1970s, except the result was stagflation, an unprecedented combination of no growth and double-digit inflation. The Great Recession of 2008 featured a contraction followed by a weak recovery that could yet turn into a double-dip slump.
The early 1930s and late 1970s saw many proposed economic fixes. In both eras, there was a do-nothing school of thought, contending the economy was fundamentally healthy and in time growth would return on its own. Herbert Hoover, who was in the first year of his administration when Wall Street crashed, spent the remaining three years doing nothing. His approach was later validated by economist Milton Friedman, who believed that the only mistake had been made by the Fed, which failed to pump in enough liquidity for the banks to resume lending.
In the second half of the 1970s, Jimmy Carter similarly failed to offer any new ideas to revive the stalled U.S. economy. On the contrary, the Democrats were opposed to Ronald Reagan’s economic agenda, which created a new growth paradigm for the economy and was instrumental in building economic prosperity over the ensuing 30 years.
In the 1930s, the Roosevelt administration alleviated the effects of the Depression by public works. But its more lasting contribution was to put into place a socioeconomic framework that ensured that the U.S. economy would continue to grow long after the end of World War II. FDR tapped the underutilized resources of the federal government, which before the Depression had played a relatively small role in the U.S. economy.
However, the system bore the seed of its own destruction. Aggregate demand was sustained by various government programs and consumer demand was sustained by redistributive programs such as Social Security, unemployment insurance and welfare. At the same time, though, supply was constrained by a tangle of regulations. Eventually, too much money ended up chasing a set quantity of goods and services, spurring price increases that further dampened investment and inhibited economic growth.
The success of the Reagan reforms was also based on the fact that they tapped underutilized economic resources. Reaganomics scrapped regulations, freed up the labor market by reducing the power of the unions and unleashed the American entrepreneurial spirit. Underpinning the revolution on the supply side was the deregulation and the rapid growth of the financial services industry. The revolution in finance funded the information technology revolution in the 1980s and the 1990s and created an entrepreneurial boom of the past two decades, while at the same time financing demand growth among American consumers.
For all its anti-government rhetoric, the Reagan revolution failed to reduce the size of the government. Taxes were cut, but government continued to grow in size and scope, becoming more and more costly. Starting in the early 1980s, government debt began to expand. In a sense, the government contributed to the consumer boom of the past 30 years by returning cash to taxpayers in the form of tax cuts and replacing the lost revenue with borrowing.