Where Have All the Answers Gone?

By John Greenwald

Economists seem bankrupt just when their ideas are needed most

President Reagan's extraordinary holiday proposal for aiding America's growing army of the unemployed popped up again last week. Noting that businesses still outnumber jobless workers,* the President suggested that every firm try to hire just one more person. At his first 1983 news conference, however, Reagan conceded that employers are not yet rushing to respond.

Economists might dismiss the President's remedy as frivolous, but their own prescriptions have not helped much either. Faced with a grinding recession that has driven the unemployment rate to 10.8% of the work force, the economics profession has dissolved into a babel of conflicting voices. Result: as the new year gets under way, economists seem further than ever from agreement on how to restore the economy to robust health.

That leaves policymakers with few clear guidelines to follow. Last month, for example, White House Adviser Edwin Harper briefed Reagan for an hour on the dismal state of economic thinking. Harper's conclusion: "The U.S. economy is too complex and depends upon too many human decisions to be explained by any single theory."

Economists now know far more than ever about how the economy works. But stagnation and rising unemployment have turned the current economic debate into a brawl. Take Nobel Prizewinner Lawrence Klein, who received the 1980 award for his work in the development of economic-forecasting techniques. Klein, a Keynesian who believes in deficit spending to pump up a slack economy, dismisses the rival supply-side school, which Reagan championed. Supply-siders claim that cuts in tax rates should spur savings and investment and release a torrent of new production. "Our dispute with supply-siders is that their theories are nonsense," retorts Klein. Then he adds, in only partial jest: "They pulled a vast swindle on the American public--so much so that I've often thought that if there were Nuremberg trials for economists, supply-siders would be in the dock."

An equally savage blast comes from Michael Evans, chief economist for the Wall Street investment firm of McMahan, Brafman, Morgan & Co. Evans, a fallen-away supply-sider, blames high unemployment on the monetarist theories of 1976 Nobel Laureate Milton Friedman, who holds that slow and steady money growth is the key to economic health. Evans charges that some overzealous Friedman followers believed that the money supply could be squeezed without harming the economy. Says he: "Those people are now proved to be nuts, and they're gone forever. That aspect of monetarism belongs on the trash heap of economics."

Such invective now confronts the Reagan Administration, which came to power brandishing exceptionally strong economic convictions. The Reagan program consisted of four parts, which newsmen quickly dubbed Reaganomics. These consisted of supply-side tax cuts, reductions in federal spending, moves toward deregulation, and a monetarist tight-money policy to curb inflation. Reaganomics did cut inflation sharply, lowering the annual rate of increase in the Consumer Price Index from 12.4% in 1980 to a current level of less than 5%.

Although the Reaganauts had promised to conquer inflation without causing much pain, the price of victory turned out to be extraordinarily high. The tax cuts led to huge budget deficits, which could reach $200 billion in the current fiscal year. Those unprecedented shortfalls then teamed up with monetary restraint by the Federal Reserve Board to send interest rates and unemployment through the ceiling.

The upshot for the Administration has been a new pragmatism and a marked softening of ideology. In that spirit, the White House backed the new 50-per-gal. gasoline tax that became law last week, and it also fought for and won a $98 billion tax increase in August. And while some squabbling continues among key policymakers, like Treasury Secretary Donald Regan and Martin Feldstein, chairman of the Council of Economic Advisers, much of the fierce partisanship that marked earlier power struggles within the Administration has vanished. Says Feldstein, a conservative Harvard economist who has headed the CEA since September and subscribes to no one viewpoint: "Some zealots think that their school has the answer and that if only it were followed religiously, then all our problems would go away. But real life is not that simple. There are some truths in many theories, and my case is for a balanced, eclectic package."

The intellectual fathers of the monetarist and supply-side movements, however, are not quite ready to surrender. Friedman, for one, denies that the Federal Reserve has really followed his advice. Says he: "Monetarism has been given no trial, fair or otherwise. The rhetoric has been monetarist, but not the practice." Friedman charges that the Fed behaved erratically by squeezing the money supply during the first half of 1982 and then letting it swell. "If that be monetarism," says he, "I am not a monetarist."

Although they no longer have much policy clout, some supply-side economists remain as jaunty and ebullient as when they did. Arthur Laffer, for example, still believes in his famous curve. It was designed to show that cutting tax rates would stimulate so much output that the total tax take would rise and the budget deficit would fall. So far, of course, the opposite has happened: the recession has depressed tax revenues, while the deficit has swollen. Says Laffer now: "Supplyside economics has hit the nail on the head. The expansion in the first quarter of 1983 is going to be enormous." He reasons that people and companies arranged to defer part of their income in 1981 and 1982 in order to take advantage of the lower tax rates in 1983.

The most despairing group of economists today may be the Keynesians, who enjoyed prominence as the leading school of thought during the 1960s and '70s. They met their Waterloo in the late '70s, when their pump-priming policies pushed up inflation. Says Allan Meltzer, a Carnegie-Mellon University professor and an influential monetarist: "If the Keynesian program had worked, Jimmy Carter would still be President." Although many Keynesians now want to trim the deficit, the recession has emboldened others to call for continued high deficit spending. Says Lester Thurow, a leading Keynesian who teaches at the Massachusetts Institute of Technology: "For the next four or five years the problem is how you get the economy moving to reduce unemployment. For a period, we can afford to practice old-fashioned Keynesian economics again."

One new school that has been winning converts is that of rational expectations. This approach holds that the Government should not try to spur the economy through deficit spending and loose-money policies, since such efforts just jack up inflation. The proper economic role of Government, this theory argues, is simply to provide a stable background for consumers and business. Says Mark Willes, an executive vice president of General Mills who became a spokesman for the school while serving as president of the Federal Reserve Bank of Minneapolis: "Rational expectations will become the dominant economic theory in the next ten years." Willes and his colleagues also maintain that economic forecasts are not to be trusted, since people react to policy changes in unpredictable ways.

Forecasters naturally disagree with that. Although they admit to making errors, they insist there is no glitch in their complex economic models. Data Resources Inc., for example, was one of dozens of outfits that failed to anticipate the sharpness of the recession. But Allen Sinai, senior vice president of the big Massachusetts firm, attributes that shortcoming to factors that range from unexpected Federal Reserve shifts to a misreading of the role of foreign trade. In any event, says Sinai, DRI usually assigns its forecasts no more than a 50%-to-55% probability of being right. Adds he: "Clients who have left us because of mistaken calls can be counted on the fingers of one hand."

The warring economic theories have produced casualties. Not the least of them is public confidence, without which no policy can survive. Observes Felix Rohatyn, a senior partner in the investment banking house of Lazard Freres & Co.: "Keynesianism seems to have created a runaway inflation, while supplyside, monetarism and Reaganomics seem on the way to creating a depression. People are not only becoming more skeptical of economic theory, but it is highly appropriate that they do so." Economists will have to trade their old quarrels for some new ideas if they hope to keep that justifiable skepticism from growing.

--By John Greenwald. Reported by David Beckwith/Washington and Adam Zagorin/ New York

*This is true: at last count there were 14.7 million businesses and 12 million unemployed. However, more than 11 million of the businesses were proprietorships, most of which employ only a few people.

With reporting by David Beckwith, Adam Zagorin This file is automatically generated by a robot program, so viewer discretion is required.