Republican Mythology: The Reagan Recovery

Recently I compared Obama’s stimulus to the austerity approach favored by Republicans, which Europe has pursued with meager success. But maybe that wasn’t fair. Republicans never call their policies “European.” Instead, they invoke Ronald Reagan and his 1983 economic recovery. For instance, here’s the Vice Chair of the House Republican Conference:

President Reagan took a very different approach. He took an approach that was focused on pro-growth, on free-market solutions… an approach that in the third year of his term resulted in the economy booming by then.

And from the ever-reliable Fox News Network:

Reagan used the tax code to incent people to invest in our economy. And by doing so, he re-created the manufacturing sector. That created high paying jobs, and yes it made some people very rich, but here’s a newsflash for you, it’s the rich people that employ the rest of us.

Ah, yes, supply-side economics. Funny thing, though:  In 1984 I entered Stanford’s Ph.D. program in economics (I opted not to finish, but that’s a different story). Stanford’s econ department was no bastion of liberal orthodoxy — the on-campus Hoover Institution provided too much funding for that — but even so, no one saw Reagan’s recovery as a victory for supply-side economics. Instead, it seemed pretty Keynesian, as in J.M. Keynes, the bad, bad homosexual whose economic theory is behind Obama’s stimulus.

So are Republicans rewriting history, or has time given us new insight? Luckily, we collect economic data every quarter, so this is easy to check. If the Republicans are correct, and “job creators” drove the Reagan recovery, then we’d expect to look back and see a jump in investment leading to an increase in real GDP. Is that what happened?

No. Real GDP shows its first sustained jump in Q1 of 1983. Investment goes up in Q2. Investment seems to responding to improved economic conditions, not causing them. This appears to be true not just for the recovery, but for the 1981 recession as well.

So much for investment. What about personal consumption? Democrats recently worked to extend unemployment benefits and cut the payroll tax, all in the hope of getting more money in the hands of consumers. The idea is that people will buy more stuff, depleting inventories, and encouraging businesses to expand production. So how did consumption figure into the Reagan recovery?

Consumption jumps a bit and begins a slow climb in Q1 of 1982. Real GDP increases slightly one quarter later and then stays roughly flat. However…

In Q4 of 1982, consumption leaps more dramatically, and guess what? One quarter later, the economy begins its long, steady recovery — even though investment is still falling.

Of course, the basic idea behind Keynesian economics (and the stimulus) is that the government can jump start us out of a recession with a little more spending. So let’s add federal spending to the picture.

Eh. I see a connection, but it’s a bit weak. We see a small increase in federal spending in the quarter before the small 1982 Q1 jump in consumption.  But the connection seems to get stronger starting with 1982 Q3, where bigger increases in federal spending are followed one quarter later by the bigger jump in personal consumption, followed by the recovery itself.

I showed these numbers to a conservative friend of mine. He gave me a strange answer. Thinking of Reagan’s military buildup, he replied (and this is a quote): “…perhaps we could say an increase in military spending juices a recovery, but not so with domestic initiatives.”

That struck me as partisan desperation, as if Republican orthodoxy were drowning in a lake of data, clinging to whatever it could find — in this case, the idea that Republican-favored spending is good, but spending that Democrats like is bad, bad, very bad.

Still I figured, What the heck, and I took out total federal spending and tossed in federal nondefense spending. And whoa!

We’ve got a clear chain of events here:

  • 1982Q1:  Consumption increases modestly, and the economy stops shrinking so dramatically.
  • 1982Q3:  Federal nondefense spending begins to climb significantly.
  • 1982Q4:  Personal consumption doesn’t merely increase — it accelerates.
  • 1983Q1:  The economy comes out of recession.
  • 1983Q2:  Investment spending finally begins to increase.

It’s easy to spin a story out of this:

A small increase in government spending eases the recession a bit, but later a bigger increase in federal nondefense spending leads to a bigger jump in consumption, which pulls us out of the recession and finally gets the “job creators” off their butts to increase investment.

And that, my friends, would mean Reagan experienced a standard, textbook, “liberal,” Keynesian recovery. The type that today’s Reagan-worshipping, Tea-Partying Republicans so staunchly oppose.

But be careful. Don’t fall into the post hoc ergo propter hoc fallacy: The fact that one thing happened before another thing does not mean it caused that thing.

Fortunately, we’re not trying to go that far, so we can fall back on a sounder and simpler principle:  The cause should happen before the effect. So the next time a Republican invokes the Reagan recovery, you can reply:

Reagan didn’t save the economy through supply-side policies. The job creators didn’t get moving until after the economy was getting better. No, Reagan’s recovery started with an increase in personal consumption, not investment — and the best way to boost personal consumption is to focus on the middle class and the poor, not the rich.

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5 comments to Republican Mythology: The Reagan Recovery

  • 1
    James Martin says:

    Okay, one thing missing in the analysis is the understanding of market responsiveness.  Just because you plow $10 billion into an economy doesn’t mean it beenftis from it the next day, it takes many months for that infusion to take effect.  Once you consider lead and lag times, then yes, the surge of private investment in 1981 gave the economy a kick but to sustain it the federal spending was kicked into high gear.  Both of those increased consumer spending where it was hoped they would generate enough demand to get the investment to grow from market demand and that the additional tax revenue would make up for the extra government spending.  It is a temporary fix and it did work just like it did back after WWII until July 1959 when it all came crashing down.  It did the same again in 1987 when people assumed the infsuion of money would continue, but when the well ran dry, that is when it all collapsed again.  No one asked how long it was viable, they assumed it would go on for ever.  They to did not look at market responses such as lags and leads.  Why does everyone in media forget a basic Eceonomics 101 fundamental?

  • 2
    robtish says:

    Well, James, of course lead times and lags are built into this. You’ll note that in every case there’s at least one quarter lag from a possible cause to its possible effect. Even so, you’re obviously not going to give Reagan credit for the investment surge of 1981 Q3 given that his tax cuts were put into place that same quarter — not with the importance you place on lag times. Which still leaves us with the fact that Reagan’s policies did not stimulate investors to pull us out of recession, as Republicans like to claim.

    Also, I should note the concept of endless stimulus is not part of Keynesian economics. More here.

  • 3
    Spunky says:

    Rob, could we say something similar about the unemployment rate (which peaked in 1982 and then declined) during those years?
    Also, is it just me, or is it a little simplistic to say that “it’s the rich people employ the rest of us” in both directions? a) Isn’t it the company that employs people, rather than the owners? Maybe tax cuts that help the rich also help their companies, but still, people and companies are different entities, no? b) Not every rich person creates a job.

  • 4
    Fred in the U.K. says:

    I would like to point out that Europe is pursing austerity not because it favours it but because it can’t afford not to follow it. America is in the fortunate position that the bond markets will lend it vast amounts of money at a reasonable rate. In Europe austerity has been a necessity to maintain the supply of smaller amounts at reasonable rates.

  • 5
    Regan DuCasse says:

    There is another head to this hydra. How the banking industry, and deregulation on export and other corporate manufacturing, allowed major factories and production to LEAVE this country altogether. Instead of seed investment and building another factory overseas, the ENTIRE of it left and nothing replaced that industry in the US.
       I can tell you on some other levels how some of those industries INSOURCED foreign labor to compete with American labor, and Americans lost. Corporate dependency on such labor, coupled with the burden of support of that labor through social services and other tax funded public infrastructure has depressed wages even further.
    Saturating any market with more people than jobs will do that. There was a time when such corporations wouldn’t get in bed with Communist or unstable foreign countries. No more. Banks, in order to maximize their profits, lobbied for daily transfers to exceed modest amounts, allowing foreign organized crime to benefit as well.
         The avariciousness involved here, without shame or restraint, is what is destroying this country and it’s stability. And we’re a young country, and anyone that doesn’t think that those at the top of the chain won’t have the power and will be moral or impervious to corruption enough to do so, are naive and ignorant. Our consumer based economy was never going to be enough. We had to balance it with productivity and the ability to have a SEIGE economy in case other global industries and economies collapsed. Being too interconnected is our undoing, and distractions like systemic prejudice and discrimination that’s already maintained the more vulnerable at the bottom of the pyramid, such as blacks, will suffer ever more greatly.
        I’m already suffering from such economic miscalculations where my own employment is concerned and I know from each avenue this problem is growing. Too bad the ones causing it, couldn’t care less about doing anything, as long as their skids are greased.

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