Special interest groups spend resources to induce politicians to adopt policies that benefit them without consideration to the well being of other groups. The urge to redistribute is always present in the special interest groups, and we contend that the pressure is more intense during periods when the economic pie is not expanding. To the extent that the benefits of the policy action are concentrated within the group and the cost associated with the measure are dispersed over the population as a whole, the special interest groups’ likelihood of success increases substantially. In contrast, during periods of an expanding economic pie, special interest groups enjoy a bigger slice of the pie and the urge to redistribute is overwhelmed by the pie expansion.
The issue for politicians is whether they will succumb to the politics of the special interest groups or whether they will pursue policies that benefit the country and the global economy. With this in mind, we can interpret some trends of the last few decades as well as more recent political and economic outcomes.
Candidate Reagan argued that a lower tax rate and subdued inflation would lead to a resurgence of the American economy. While running for office, Reagan asked a simple question, whether the voters were better off than they were 4 years earlier. The answer was clear and he won a resounding victory and began to implement his economic program. Early on he encountered major headwinds including the Volker inflation fight, and the phase-in of the tax rate cuts which resulted in an economic recession.
While President Reagan faced many calls to reverse some of his policies, the Gipper stayed the course and once the tax rate cuts were fully implemented the economy roared. Comparing the pre-Reagan years to the Reagan years, the increase in the after-tax rate of return due to the Reagan tax rate cuts had several effects. One was to increase the incentive to work by US citizens as well as an appreciation in the value of US-based assets. One simple way to illustrate the incentive to work is that prior to Reagan’s election the top personal income tax rate was 70%, hence $1 worth of pre-tax income netted 30 cents on the dollar of after-tax income. After the Reagan tax rate cuts were implemented, the top rate declined to 50% thus $1 worth of pre-tax income netted 50 cents on the dollar: a 66% increase. The US real GDP growth and the employment rate accelerated while the inflation rate decelerated. The US pie began to expand, affording a bigger slice for most of the working people and sectors.
Another effect of “Reaganomics” was to increase the incentives to invest in the US. The Reagan tax rate cuts ushered in a capital inflow. Under a floating rate exchange rate system, the balance of payment is always zero thus a capital inflow produces a deteriorating trade balance and a surge in the US dollar well above the Purchasing Power Parity levels. We contend that this was great for the US economy. Would one rather have capital lining up at the border trying to come in or trying to leave the country? We know the answer.
However, the economic pie did not expand for all sectors. Sectors and special interest groups that had benefitted from the dirigiste policies of the prior administrations were now losing the protection that these policies had afforded. The prior “terms of trade” led to a relative price change that strongly favored the production of US domestic, or what is commonly called non-traded goods and services, away from the internationally traded goods and services. The new “terms of trade” created a stronger dollar which made it cheaper to buy imports instead of producing the previously “protected” traded domestic commodities. The resultant reallocation of resources coincided with the demise of the Midwest industrial base which soon became known as the “rustbelt”. The reduction in tax rates and removal of some trade barriers led to a decrease in profitability of the previously protected sectors while simultaneously increasing the profitability of the rest of the economy.
In short, Reaganomics led to the reallocation of resources via the reduction of tax rates and the removal of regulations which altered the incentive structure. It enhanced the after-tax rates of return of most industries, with perhaps the exception of the previously protected sector who now had to retool in order to compete on a now more level playing field or fade away. The resurgence of the US economy forced many other nations to follow suit and the world embarked on a global reduction in tax rates and trade restrictions. Unlike the autarkic economies who have to consume what they produce, globalization and “free-er” trade allowed countries to decouple their production and consumption decisions. “Free-er” trade allowed the different economies to focus and specialize in activities in which they had a comparative advantage and then sell these goods in the global market to buy what they wanted to consume. Globalization led to a surge in the volume of trade and an increase in the standard of living of many countries and as long as the pie was expanding, the trend continued.
Looking at the US, and illustrated by the top personal income tax rate, we argue that the Reagan legacy has lasted to this day. Although several administrations have raised the top personal income tax rates, the current rates are still lower than the pre-Reagan days. Similarly, the monetary policies adopted to curb the 1970’s inflation still influence much of what the Fed does today. The expanding pie was able to effectively drown out the special interest groups attempt to tilt the administration policies their direction.
But this did not stop special interest groups from pushing their agenda and they made modest gains in several areas including the bipartisan push for a reduction in the financial hurdles to home ownership which was a laudable goal pursued by the Clinton and Bush administration. Yet, despite the good intentions, the policy had disastrous results and the Financial Crisis is a testimony to the power and perseverance of the special interest group drive for legislation to benefit their own at the expense of the whole economy. Fueled by perverse incentives, home ownership became a leveraged one-sided bet, e.g. the homeowner got to keep all the gains from home price appreciation, more than likely tax free, while also able to walk away from non-recourse loans without any financial penalty if/when the value of the house declined.
The aftermath of the Financial Crisis and the economic policies of the Obama administration contributed to the creation of an economic environment where real GDP grew at a subpar pace dubbed the” new normal”. The “new normal” environment left income redistribution as a key driver for the expansion of the economic slice of the special interest groups. The “new normal” fueled the politics of special interest groups on both sides of the aisle with the Republicans focused on populist policies while the Democrat’s pursued identity politics. Yet there was a common element – BOTH sides wanted to tilt the economic balance in favor of their preferred special interest groups.
Donald Trump secured the Republican nomination on an economic platform that blended some of Reagan’s conservative principles with a strong dose of mercantilist populism. His platform included a promise to appoint conservative textualist Supreme Court justices as well as an across-the-board reduction in marginal tax rates at the personal and corporate levels. He also pursued his populist agenda with gusto and some of his actions revealed the inner dirigiste in him. The GM-Lordstown factory, the NAFTA renegotiation, the border wall and his mercantilist trade and tariff policies were prime examples of the implementation of his populist agenda that catered to special interest groups.
Trump’s tax rate cuts resulted in an improvement in the real GDP growth rate, capital inflow and record low unemployment rates. Trump’s populist component did not fare as well as evidenced by the ongoing struggles at Lordstown and a border wall that was only partially built but never paid for by Mexico. President Trump’s “America First” trade policy argued that a trade deficit denotes a transfer of wealth to other countries. But this is nothing more than a mercantilist and static view of the world. He ignores that globalization allowed countries to maximize their gains of trade by specializing in the production of the goods where they have an edge, sell them, and buy goods they needed but had no comparative advantage. According to Trump,
“Our politicians have aggressively pursued a policy of globalization, moving our jobs, our wealth and our factories to Mexico and overseas. To understand why trade reform creates jobs, and it creates a lot of them, we need to understand how all nations grow and prosper. Massive trade deficits subtract directly from our gross domestic product.”
He is wrong on several counts. First, double entry bookkeeping means that the trade deficit is matched by a capital flow, i.e., borrowing or a reduction in one’s previous savings. Perhaps that is why he sees the deficit as bad. But is borrowing a bad thing? The answer depends on how one uses the proceeds. If one invests and earns a rate of return that allows for the repayment of the borrowing and still has some funds leftover, then borrowing should be a good thing. President Trump should know this given he is a businessman who borrows a lot. Regarding the dissaving, it need not be a bad thing and the household analogy provides an explanation. It is possible that one worked hard at a stage of life and saved to provide for retirement or a rainy day. The resultant savings is a way to smooth out consumption. In contrast, those who do not save experience an increase in the volatility of their consumption and consume their income every period. President Trump ignores all these issues and concludes:
“I am a Tariff Man. When people or countries come in to raid the great wealth of our Nation, I want them to pay for the privilege of doing so. It will always be the best way to max out our economic power. We are right now taking in billions in Tariffs. MAKE AMERICA RICH AGAIN.”
But did his mercantilist and populist policies work? All we can say with certainty is that the protected sectors did better. Their profits went up as did the domestic price of their product’s prices. However, consumers were clearly worse off and the economy lost some of the gains of trade that the globalist policies had delivered but were still large enough to offset the cost of his mercantilist policies.
Soon, Trump’s pandemic policies destroyed his conservative credentials and left him as a dirigiste that thought he knew better. His reelection campaign catered to the special interest groups to get reelected as did his opponent, then candidate Biden, albeit to different groups. The presumption that whoever won the White House would cater to special interest groups was almost a predetermined outcome but the deciding factor for many voters was President Biden’s promise to restore civility and normalcy to the White House and the country. Nevertheless, we know that it is very difficult for a “conservative” to out-special interest a progressive candidate, especially when the other candidate is more likeable.
No doubt the favored special interest groups changed with the election of the Biden administration, but more importantly there was a noted acceleration in activity catering to special interest groups. While Biden kept many of the trade restrictions implemented by Trump, he amped up his industrial policy agenda, despite a narrow majority, by successfully enacting the Economic Recovery Act, the Inflation Reduction Act, the Chips Act and a whole host of regulations aimed at guiding and/or forcing the economy to implement Biden’s dirigiste agenda and Industrial Policy.
For example, the impact of the Chips Act has been immediate with a surge in construction as companies rush to take advantage of benefits the government is offering to return manufacturing back to the US. The production, employment, wages and profits, inclusive of the government subsidies and tax breaks, in the semiconductor industry will unambiguously increase and the import of semiconductors will decline. But will the reduction in semiconductor imports result in an improved trade balance and/or GDP? While we need additional information to determine what happens to the rest of the economy, to the extent that the expansion in the manufacture of semiconductors draws resources from the rest of the economy, we know the answer.
Biden’s Green Energy agenda aims to make the US economy carbon-energy independent and consists of a carrot and stick approach. Through a host of subsidies, regulations and mandates it aims to cajole the private sector to pursue its preferred agenda. Not surprisingly, the private sector has responded to the government’s actions by embarking on a host of subsidized activities, albeit with strings attached to the government largesse. These businesses have to buy American, employ union workers and pay “prevailing wages”. Again, the policies have produced an increase in output and employment and higher wages in the favored sectors. But, given the current unemployment rate, it seems reasonable to assume that a portion of the increase in employment in these activities will come at the expense of other sectors. If consumption remains the same, it then follows that output and exports in these sectors will decline. As before, the impact of the industrial policy on the trade balance and real GDP growth will be ambiguous. It is more likely that it will increase domestic production in the favored sector while reducing it for the balance of the economy.
Biden claims that his industrial policy, “Bidenomics”, is working but we contend that these calculations MUST include the subsidies that the government is paying. As Milton Friedman used to say, there is no free lunch. Someone has to pay for the subsidies. Wind projects are now demanding higher subsidies to improve financial viability. Electric vehicle production in the automotive sector is a large cash drain that threatens to bankrupt companies. While Biden may point to the increased output and employment in the favored sector as evidence of the success of its policies, the numbers do not add up. Both the data and the historical experiences are not favorable to the Industrial Policy approach as we can quickly recall Solyndra, solar panels and now Lordstown in addition to a host of other “winners” picked by the different administrations of both sides of the aisle.
We contend that the policies of Trump and Biden were and are susceptible to the pressure of special interest groups. Trump adopted a populist agenda while Biden has pursued a social justice approach. While coming from different ends of the political spectrum, these two approaches appear to produce policies that are very different. However, the logic and analysis presented here suggest that an import restrictive mercantilist policy aimed at reducing imports will increase the production of the import competing sector. Symmetrically, an Industrial Policy aimed at stimulating the production of a particular sector in the economy will unambiguously result in an increase in domestic production thereby reducing the imports of similar items. In both cases, the increased domestic production reduces the import of the goods in question. This line of reasoning suggests that the protectionist and industrial policies aimed at reducing imports and the volume of trade are two sides of the same coin. In effect, they are equivalent policies.
The similarities of these policies begs the question of whether they make the US economy better off, and do they improve the US trade balance and increase the economy’s real GDP? While one can easily document the increase in output and employment, as well as the higher wages in the protected sector, what happens to the rest of the economy is more difficult to measure. What we do know is that the subsidies used to entice production in the protected or favored sector must come from somewhere, i.e., the taxpayers. Hence the government policy amounts to a net transfer from the rest of the economy to a special interest group favored by the government. Finally, revealed preference suggests that the economy is worse off. If not, why did the private sector not choose the desired output mix without the cajoling from the government. The political justification for the mercantilist or industrial policy is the existence of a presumed externality thereby requiring government intervention. Politicians are quite fond of telling voters how we either face an externality or an existential threat and that government action is appropriate. If true, they are correct. But then again, how accurate are the politicians’ forecasts and who is keeping track of their long-term forecasts?
The protectionist and industrial policies being advocated by the two leading presidential candidates are equivalent, despite the differences in packaging. The policies will alter the economy’s incentive structure, and it will not be for the better and a strong argument can be made that these policies will make the economy worse off. We argue that the private sector could have opted for such a situation prior to the import restriction and industrial policy and it chose not to do so. We posit that It must be because the government induced outcome makes the economy as a whole worse off. Voters should pay attention to the special interest group driven details of each candidates’ economic agenda, but it is clear we all deserve better than the economic agenda proposed by both of the leading candidates.
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