The  plunge in the U.S. economy in 2008 and 2009 became an irresistible opportunity to pronounce the failure of the form of capitalism that emerged at the end of the 20th century. “One had expected competition and abundance for everyone, but instead one got scarcity, the triumph of profit-oriented thinking, speculation and dumping,” said Nicolas Sarkozy, the president of France. The current crisis, he noted with a certain pleasure, signaled the end of the “illusion of public impotence” and the “return of the state.”

There was ample reason for such grave-dancing. Between July 1, 2008, and June 30, 2009, total U.S. economic output, adjusted for inflation, dropped at an annual rate of 3.8 percent—the worst 12-month decline since 1946. The unemployment rate, which started 2008 at 5 percent, had doubled by the fall of 2010. The number of jobs fell for 21 months in a row, and by May 2010 the median unemployed worker had been out of work for 23 weeks—compared with 10 weeks in the depths of the 1973-75 recession.

The quarter-century that began shortly after Ronald Reagan’s election had been widely viewed as a period in which a free-market approach had proved its superiority to state direction of economies. In the -United States, cutting top income tax rates in half, reducing regulatory burdens, and spreading free trade seemed to have produced significant prosperity and remarkable stability. Between 1983 and 2008, gross domestic product grew at an average of 3.2 percent annually. Only once did output fall in a calendar year, and that was by just two-tenths of a percentage point. Inflation, interest rates, and unemployment were tame.1

Then, suddenly, an asset bubble in real estate exploded, the growth and stability vanished, and the United States suffered its worst economic misery in (take your pick) 34, 53, or 71 years. So you would expect that the American public, following President Sarkozy, would see the recession as a severe setback—or even a death blow—to conservative economic policies that were aimed at limiting the power of government and liberating the private sector.

You would have expected that, and you would have been right—but only briefly. Since the beginning of 2010, a surprising reversal has occurred. Rather than supporting and encouraging government intervention to mitigate an economic calamity caused by “profit-oriented thinking,” Americans have come to believe that government has failed to fix the problem and may, in fact, have made it worse. Now it is liberal, not conservative, economic policies that are suddenly in jeopardy.


While the recession has at least bottomed out and appears technically to have ended, the recovery, by historic standards, has been anemic. Within two years of the start of every one of the three previous recessions, GDP had rebounded significantly—to 4 percentage points above where it was when the downturn began. But 31 months after the start of the current recession, GDP was still below its starting point. The employment situation is even worse. In the nasty recession of 1981-82, the economy had regained the jobs it lost within just 26 months. This time around, we still have 5 percent fewer jobs than at the recession’s start in December 2007.

What bothers the public, plain and simple, is that the steps that were taken to mitigate the recession—which involved greater government involvement, including ownership of the largest auto and insurance companies, and vastly more federal spending—have not worked.

Worse, the public believes federal action was especially unhelpful to the mass of Americans. Only 27 percent of respondents to a Pew Research Center/-National Journal survey in July agreed that “government economic policies have helped [the] middle class.” A poll in June by Greenberg Quinlan Rosner Research for Democracy Corps, a Democratic organization, asked American adults to choose between two statements:

1: President Obama’s economic policies helped avert an even worse crisis and are laying the foundation for our eventual recovery.


2 : President Obama’s economic policies have run up a record federal deficit while failing to end the recession or slow job losses.

By 49 percent to 44 percent, respondents chose Statement No. 2, and for those who identified themselves as independents, the margin was 52-38. Among independents, the results for backing a statement “strongly” were 42 percent for No. 2 and just 22 percent for No. 1.

Some politicians and economists, notably Paul Krugman of Princeton and the New York Times op-ed page, have argued that the persistent sluggishness of the economy is the result of not doing enough. Again, the public disagrees. As Jodie Allen of Pew wrote about her organization’s study: “Far from demanding that the government reinforce its efforts so as to help neglected middle and lower-income groups, a majority of the public views cutting the federal budget deficit as more important than stimulating the economy.” In June 2009, Pew found that, by 48 percent to 46 percent, Americans favored “spending more to help [the] recovery” over “reducing the budget deficit.” But in July 2010, deficit-cutting was favored over spending by an 11-point margin, 51-40.


Government played two distinct roles during and after the crisis. The first was shoring up shaky financial institutions. On March 24, 2008, the Federal Reserve Bank of New York issued JPMorgan Chase a $29 billion non-recourse loan that allowed it to buy Bear Stearns, an investment bank on the verge of collapse. Six months later, the Fed provided $85 billion (more came later) to save AIG, the insurance giant with assets of more than $1 trillion. Congress then enacted the comprehensive Troubled Asset Relief Program, or TARP, which authorized loans and equity purchases for hundreds of institutions (mainly banks but also auto companies).

By June 30, 2010, the U.S. Treasury had disbursed $386 billion in TARP funds. Another $145 billion went to keep afloat the two government-sponsored (though ostensibly private) institutions that provide lenders with mortgage money, Fannie Mae and Freddie Mac.

How did all that work out? The Bear Stearns, AIG, Fannie Mae, and TARP dispositions were far from perfect. Robert Pozen argues in his book Too Big to Save? that too much of the federal money injected into AIG was used to bail out banks—many of them foreign—that AIG had insured against mortgage losses through credit default swaps. Those banks, he writes, could have taken a -severe haircut without jeopardizing the global financial system. Also questionable was giving General Motors and Chrysler more than $80 billion (though President Bush acted honorably in keeping the automakers alive until the start of the Obama administration.) A good case can be made that automakers should have been allowed to go bankrupt through the normal legal process, with their assets passing from weak hands to strong. As for Fannie and Freddie, had perfectly sensible warnings from experts like Peter Wallison been heeded, they might not have collapsed at all, and the entire subprime-mortgage meltdown might not have occurred. So far, Congress and the president have simply kicked the Fannie-Freddie can down the road, delaying a long-term solution.

Overall, however, it has to be said that the TARP and the other financial rescues were necessary and -efficient. The global financial network did face systemic failure, mainly because of a lack of liquidity, or cash to meet immediate demands. The U.S. government was able to provide that liquidity, using its authority as lender of last resort, and most of the direct beneficiaries could eventually repay their loans, with interest, as they recovered. In fact, within a year and a half after the TARP was launched, the Treasury had been repaid $211 billion—or more than half what it had put out.

The second role government played, however, was far more questionable. Instead of lender of last resort, it determined to be the spender of last resort. And this decision, more than any other, is what has led to the crisis in the liberal economic experiment.


John Maynard Keynes argued in 1933 that in a deep recession, consumers and businesses were too frightened and broke to spend and invest, so it was up to government to do the job with massive public-works projects and short-term tax cuts. Following Keynes’s theory, Congress and the White House enacted the American Reinvestment and Recovery Act of 2009, which allotted $787 billion to a potpourri of stimulus programs to invigorate the economy.

In an article in Commentary (“Stimulus: A History of Folly”) in March 2009, I recounted the discouraging history of Keynesian stimulus and predicted its failure this time out as well. The surprise, both to me and I’m sure to those who planned, advocated, voted for, and implemented the stimulus package, is just how quickly the American public came to recognize the sweeping nature of the failure.

The reasons for the failure, and for the literally depressing pessimism that the failure seems to herald, were first described 160 years ago by Frederic Bastiat in his essay “The Seen and the Unseen.” Bastiat was describing the effects of economic actions, including public spending. That spending leads to results that are “seen,” meaning, in the case of the current stimulus, the jobs of medical residents, teachers, road builders, and the like—jobs created or preserved by stimulus dollars. Then there is the matter of what is “unseen”—meaning all the money government used for those projects that has been diverted, through -taxes or borrowing, from other uses.

Usually, the public is too dazzled by the seen to take account of the unseen. So politicians often get away with saying they have “created” this or that many jobs by spending taxpayers’ money.  Few follow the trail back to where the money came from or project it forward to divine the consequences. That was not the case this time. Quite the opposite, in fact.

In the current crisis, advocates of stimulus and of government intervention in general have been badly hurt by two developments. First, the short-term effects of the stimulus—the “seen”—have been extremely disappointing. The stimulus was signed into law on February 17, 2009. In the preceding month, unemployment stood at 7.7 percent. A study released at the time by Christina Romer, who shortly thereafter became chair of the President’s Council of Economic Advisers, and Jared Bernstein, economic adviser to Vice President Biden, predicted that unemployment would never exceed 8 percent and would fall to 7.5 percent by June 30, 2010, if the stimulus were enacted. Without the stimulus, they claimed, unemployment would rise to 9 percent.

Instead, unemployment rose above 10 percent and was a still horrific 9.5 percent in June 2010. Perhaps a lack of stimulus spending would have made matters even worse. No one knows. You can’t do a controlled experiment. But you can understand the public reaction: We spent all this money, and got almost nothing.

Bastiat would have appreciated one of the obvious explanations for the impotence of the stimulus. In 1957, Milton Friedman argued that attempts to increase consumer demand through government spending are doomed. The reason, Friedman wrote, is that individuals make their decisions about consumption by looking at their likely income and wealth far into the future. (He called it the “permanent income hypothesis.”) If the government starts spending huge sums today, consumers foresee higher taxes and, by inference, presume that their lifetime incomes will drop because of the increased level of their tax burden.

If government spending is short-term or one-time-only, which is what the stimulus was supposed to be, then individuals might be expected to take a more benign view. But the 2009 stimulus did not take place in a vacuum. It was soon accompanied by other economic policies and proposals of the Obama administration and the Democratic Congress: health-care reform extending public coverage to 30 million new people, cap-and-trade energy proposals featuring vastly higher taxes, and the imminent expiration of the Bush tax cuts at the end of 2010.

Because of these policies, the “unseen” became “seen” in a fashion devastating to the politicians supporting them. Americans judged that the party in power intends the radical expansion of the size of government in perpetuity. That expansion will have to be paid for. There is no reason to expect very much good from the future if you are the sort of person who generates income and creates jobs. Your “permanent income” is going to decline, and your gut response will be to husband your resources.

More disastrously for the Democrats, the “unseen” became “seen” almost immediately, in the form of metastasizing budget deficits. In order to spend all that money it didn’t have, the federal government was, of course,  forced to borrow. So Treasury debt held by the public has grown from an easily manageable 36 percent of GDP at the end of fiscal 2007 to a troubling 62 percent at the end of 2010. Only once in U.S. history—during and right after World War II—has the debt-to-GDP ratio ever exceeded 50 percent.

With the new health-care law and other increased spending on the horizon, the debt-to-GDP ratio will keep rising—to 66 percent in 2020 and 79 percent in 2035, under what the Congressional Budget Office calls its “extended-baseline” scenario. In a worst-case scenario (using reasonable assumptions of spending growth), the ratio may jump to about 100 percent in 2020 and nearly 200 percent in 2035, predicted the CBO.

Americans are worried about this rising debt, and they have reason to be. As the CBO puts it, “Unless policymakers restrain the growth of spending, increase revenues significantly as a share of GDP, or adopt some combination of those two approaches, growing budget deficits will cause debt to rise to unsupportable levels.”

What does “unsupportable” mean? Interest rates—and thus borrowing costs—could rise significantly as lenders worry about America’s ability to repay. And if history is a guide, a debt-to-GDP ratio in the 100 percent range will seriously constrain the economy, -according to gThis Time It’s Different: Eight Centuries of Financial Folly, a 2009 book by Carmen Reinhart and Kenneth Rogoff that may turn out to be the most influential analysis of the current crisis.

For the public, the worry extends beyond the debt itself to the very role of the federal government. According to Gallup, by a margin of 57 percent to 37 percent, Americans say there is “too much” rather than “not enough regulation of business by government.” Big business is unloved, but more and more, government is seen as clumsy, venal, and self-serving.


There is no denying that the narrative about how greedy financiers caused the economic crisis still has currency. But another narrative now looms larger. It is that the government’s attempts to fix the problem through spending have been ineffectual at best and, more likely, dangerous to our economic health.

When the financial meltdown occurred, it seemed almost certain that Americans would judge that the conservative economic experiment of 1981-2008 had failed. Instead, they seem to be leaning in the opposite direction—toward a conclusion that it was the liberal economic experiment of 2009-10 that has failed.

This conclusion is not being warmly embraced so much as reluctantly conceded. Things could change. Conservatives will face a challenge later this year over whether to extend tax cuts that, at least from a “seen” viewpoint, will further increase the debt. Still, when you consider that a repudiation of free-market capitalism and what President Sarkozy called a “return of the state” appeared almost certain when the crisis broke, we should be both humbled by and thankful for this strange and constructive turn of events.

1 The decline in GDP came in 1991. On inflation: Between 1992 and 2007, the Consumer Price Index never increased more than 3 percent in any calendar year. By comparison, between 1967 and 1982, annual inflation was always over 3 percent and 12 times over 5 percent. Despite two recessions, annual unemployment exceeded 7 percent only once between 1986 and 2008 (7.5 percent in 1992) and was below 6 percent in 17 of the 23 years—including every full year of the George W. Bush presidency.

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