Why Countries Never Thrive Without Activist Government Investment

History shows that economies have never grown through minimizing government involvement in the economy

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By William Berkson

If there is one national goal that Americans can agree on, it is opportunity for all. However, the political parties have been sharply divided over the role of government in creating economic opportunity.

Since President Ronald Reagan, Republicans have advocated a simple and beautiful theory of how to grow the economy: the more you reduce government involvement in the economy, the more efficient markets become, and the more the economy grows. However, a beautiful theory can, as T. H. Huxley put it, be “killed by an ugly fact.” The beautiful theory of ‘free market’ or ‘laissez faire’ economics has, in the past 35 years, been killed not by just one fact, but by a torrent of contrary facts. Both Democratic administrations since Reagan—that of Bill Clinton and Barack Obama—have raised taxes, and under them, the economy grew more rapidly than under the tax-cutters Reagan and George W. Bush. Further, the “rising tide” hasn’t “lifted all boats.” The wages of the poor (the lowest 10%) have actually gone down 5% in real terms since Reagan took office, while in the middle, wages increased only by 6%. However, the top wealthiest five percent have had their wages go up over 40%. Also indicative of increasing wage inequality is that CEO salaries have gone from 30 times the typical worker in 1979, to nearly 300 times today. Since 1980, the only periods when the trend to greater income inequality has been somewhat reversed is under the Democratic administrations.

It would be reasonable to think that decades of contrary evidence, culminating in the financial crisis of 2008, would end the political viability of minimal government or ‘laissez faire’policies. However, in reality Republican candidates have not only continued to support these policies, but also campaigned on them to win the House in 2010, and the Senate in 2014. Finally, now in 2016, we may at last be experiencing a sea change in public sentiment. We can see it on the Republican side in the seeming indifference of Republican primary voters to the siren song of laissez faire; the candidates who expressed the most devotion to “conservative free market principles” lost.

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This election cycle is in fact a unique opportunity for progressives – a moment when they can actually kill the false and destructive narrative that the “free market” is the elixir of economic growth. Fortunately, some economic historians have, since 2008, written books with invaluable new documentation of what has actually grown economies. These books not only show that laissez faire policies have always failed to grow economies, but they also contain a clear rival vision for growing the economy—a vision that is completely grounded in and validated by economic history.

Survival of the unfittest

There are two reasons why laissez faire policies have survived against the weight of contrary evidence. First, though simply reducing taxes fails to increase opportunity for all, many other factors are also involved in economic growth and income equality. The distinctive contribution of tax reductions or tax increases is not easy to disentangle. Further, the relationship between economic models and economic reality never has been as clear and decisive as between theory and reality in the natural sciences. This fuzziness of economic theory has meant that there have been few knock-out punches against economic theories by evidence. And that has left the door open for arguments among economists that are, at least to the general public, arcane and inconclusive.

The second and more important reason for the survival of tax-cutting “free market” policies is that progressives have had no coherent rival theory or vision for promoting economic growth. Instead, they have focused on opportunity “for all,” supporting programs which simply counteract the inequalities that arise in market economies. These programs include social security, public education, health care, unemployment insurance, and an adequate minimum wage. Because our economy has, in fact, had strong trends toward economic inequality, and these trends have hurt the opportunities of the middle class and poor, these efforts have been much needed. However, the programs promoting equality are not a direct rival to the conservative theory of what grows the economy. And, as they say, “you can’t beat something with nothing.”

Compounding the lack of a clear counter-theory, Democratic Presidents have actually tried to coopt pieces of the laissez faire policies in order promote economic growth. In the name of growth, President Carter deregulated the banks—leading to the savings-and-loan crisis of the 1980s—and President Clinton refused to regulate the market for financial derivatives—leading to the financial collapse of 2008.

President Obama has been different, championing a more activist government, including financial re-regulation, Keynesian stimulus spending to pull us out of the Great Recession, new taxation for increased health care, and spending on infrastructure and Green Energy. However, even Obama has been unwilling to advocate or defend these vital efforts as a program for sustaining economic growth. In the 2012 election, rejecting the role of government in economic growth, he said that “biggest misperception” about him is that he believes that the “government creates jobs. … That’s not what I believe. I believe that the free enterprise system is the greatest engine of prosperity the world’s ever known.”

Both of these reasons for the persuasiveness of conservative free market policies have been destroyed by a series of new books on the history of economic growth. First, in place of “on the one hand on the other hand” economics, we now have some “always” and “never” economics. These histories show that economies have never grown through minimizing government involvement in the economy. Instead, they have always grown by government leadership through public investment—investment that, yes, grows jobs at all income levels.

Economic growth: the real story

The new books on the history of the growth of economies all have different focuses. But they have the same critically important policy implication: While the short-term impact of government spending is difficult to disentangle from other factors, government investment in the economy is what actually has grown economies in the long term. Successful long-term economic growth has never come from government getting out of the way of the private market. Growth has always come from government leadership that leverages private sector growth. Government investment in public goods and services, targeted and sustained over decades has in fact always been necessary for sustained growth of the private economy and increasing opportunity for all.

Recent books documenting the critical role of public investment include: Land of Promise by Michael Lind (2013), Success in Agricultural Transformation by Isabelle Tsakok (2011), State of Innovation by Fred Block and Matthew Keller (2011), and The Entrepreneurial State by Mariana Mazzucato (2013). And new this March, 2016:Concrete Economics, by Stephen Cohen and Bradford DeLong and American Amnesia, by Jacob S. Hacker and Paul Pierson. (Disclosure: Tsakok is the author’s wife.)

The center of the American story is the clash between the views of Alexander Hamilton and Thomas Jefferson. Hamilton believed that, as Lind puts it, “government is not the enemy of the private economy, but its sponsor and partner.” He believed in big government debt to finance economic growth, including the growth of industry and cities. Jefferson, in contrast, hated big government, big debt, cities and industry—and idealized small farmers and businessmen.

The very first clash between the two views is indicative of the whole story. DeWitt Clinton, a follower of Hamilton and the Mayor of New York City, wanted the Federal government to finance the building of an Erie Canal. The 400-mile canal would provide an alternative to the long, difficult overland route for Midwestern grain to reach the populated East Coast and Atlantic trade. Jefferson called the big government, massive debt canal proposal “a little short of madness.” When Clinton became Governor of New York, he circumvented the Federal government by getting New York State to launch a massive bond issue to fund the project. The year after the canal opened, in 1825, the price of Midwestern grain at New York harbor fell by 90%. The Port of New York boomed. New York City became the biggest city in the U.S., and for a time the biggest city in the world. The money flowing in also made it a financial and industrial center, helping to fund the industrial revolution in the U.S. So Jefferson wasn’t just a little wrong. He got it completely wrong, because the Erie Canal was the key to economic growth and the creation of the U.S. as a world economic power.

Subsequently, the U.S. has oscillated between periods of growth through Hamiltonian investment—under presidents such as Lincoln, FDR and Eisenhower—and periods of drift and stagnation, led by those, who, like Jefferson, idealized a fictive, idyllic small-scale past—historical leaders such as Andrew Jackson, William Jennings Bryan, and recent ones Ronald Reagan and George W. Bush, under whom wages stagnated. The creation and growth of the opportunity society in America is, then, not a story of small government leaving the private sector alone, but of strong, activist government empowering the private sector through investment.

Mazzucato’s book continues the story into the post-WWII period, where growth has been led by high-tech innovation. In one striking case study, she documents that all the technologies which made the iPhone “smart” were developed through sustained, massive government investments. These include LCD flat screens, multi-touch screens, lithium-ion batteries, GPS, communication satellites, the internet itself, cellular technology, SIRI voice recognition and more. It took a great private company with visionary leadership, Apple, to put them all together into a great consumer product. However, the vitally important but overlooked fact is that Apple was “surfing,” as Mazzucato puts it, on a wave of government-funded­­ and government-led research and development. “The State …is a key partner of the private sector—and often a more daring one, willing to take the risks that business won’t. …An entrepreneurial state … operates boldly and effectively to make things happen. Indeed, when not confident, it is more likely that the State will get ‘captured’ and bow to private interests [and become] a poor imitator of private sector behaviors, rather than a real alternative.”

Tsakok’s book pulls back to the wide view—the history of economic development worldwide. It documents all the successful cases of national transformation from traditional agricultural economies to modern economies, and many of the failed efforts as well. The ‘before’ societies consisted of largely independent farmers eating the food they grew—farmers who were literally dirt poor. The ‘after,’ transformed societies, are societies with commercial agriculture, growing crops primarily for sale. The transformed societies have high specialization and complex networks of interdependent individuals, schools, businesses, industries, research institutions, and government agencies. In these societies, farmers are much more dependent on finance, other businesses, and government—and are much richer.

So how many of the historical successes in economic transformation were driven by policies of minimal government involvement in the economy? Zero, zilch, nada. In every case, governments have made targeted investments in public goods and services, sustained over decades. These investments have always included education, infrastructure, research, and technology transfer to the private sector. But public investment is not easy; while it has proven to be necessary, it can still fail. In fact, all countries have had failures and setbacks in leadership through investment. What distinguishes the long-term successes from the continuing failures is, as the book Concrete Economics emphasizes, active, pragmatic government leadership. When programs fail, effective governments terminate them and try something else. Different successful countries have in fact succeeded with a large variety of institutional structures and policies. But all have had “government in the driver’s seat,” as Tsakok puts it. All the successful governments have led through targeted, sustained investments to create the modern, complex networks of interdependencies that empower high productivity and high income.

In sum, American and world history show that if you want minimal government, you can have it—but only if you want almost everyone in your society also to be a dirt-poor, subsistence farmer. If you want a prosperous, growing modern economy, you need high specialization and a huge, complex, interdependent network of individuals, businesses, research centers and education. And only government has the authority or money to regulate that network and to regularly pump in the targeted funds needed to sustain and grow it.

How progressives can win

Progressive candidates can consistently win elections with platforms advocating a policy of leadership through public investment. First, they can credibly promise opportunity for all, because, as we have seen, this is historically the only path to success. And they can credibly hammer conservative proponents of laissez-fairepolicies for advocating something that has never worked, even once, as a miracle cure.

Laissez-faire advocates harbor the false belief that money in the hands of the rich is always better for the economy than the same money taxed and spent on public goods and services. In reality, wise spending on public goods and services doesn’t “crowd out” private investment; rather it “crowds in” private investment, lifting it to a higher and more effective level—as was the case for the smart phone. The bottom line is that some of the money that a rich individual would spend on a bigger house would be better taxed and spent by government on public education, in order to promote opportunity for all. And some of the money that a car manufacturer would spend on a still higher salary for its CEO would be better taxed and spent on repairing roads and bridges—better for both the car company and for society at large.

Leadership through public investment is a vision that goes beyond overall growth. It is also a powerful argument to support social insurance and other “safety net” programs to promote opportunity for all. For governments can stimulate overall economic growth but still fail to grow opportunity for all. In fact, this is what has happened since Reagan. The actual Republican policies have been what Rep. Barney Frank called “weaponized Keynesianism”: huge deficit spending on the military, and starvation of other domestic spending. The result has overwhelmingly benefited the rich. To achieve broad-based growth in jobs and income, and opportunity for all, government needs to invest directly in education, research, health care and infrastructure, and also to fund social insurance and other ‘safety net’ programs.

Investment costs money, but as a country we have it. The U.S. is the richest country in the history of the world. In the 1960s, when top rates were 70%, we were both growing more, and more equally. With the current top rates at about half that, the historical evidence is that we have plenty of room to tax the rich more and publicly invest the funds to benefit all—including the rich, who in fact got richer faster in those high tax years.

The complaints that we are too broke to invest are not credible when rich individuals are stashing hundreds of billions in offshore banks, and corporations are not vigorously investing. Furthermore, when government has a clear purpose and role, it can do the opposite of what has happened under recent Republican administrations, with the capture of government by private interests and an orgy of corporate welfare and tax benefits for the super-rich. With a focus on investment, and with oversight and feedback, government can, as Mazzucato has pointed out, be more efficient and effective, so there is a virtuous cycle of taxation, wise investment and economic growth.

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The policy of investment empowerment solves a current, urgent problem of political messaging for progressive candidates. Currently Hillary Clinton, the likely Democratic nominee, has proposed many good policies, but has offered no compelling vision to unify them. In fact, the vision of public investment for the long term fits perfectly with her life-long focus on the needs of women and children. The well-being of the next generation is a responsibility that government—together with and in support of families—can take on. Corporations cannot fulfill this role, because they are pressed to benefit their investors in the shorter term. Only the government, representing the concern of its citizens for the well-being of next generation, can have the backing and the money to make the investments and to take the risks that promise only to pay off in the long term.

This vision of investing for the next generation goes directly against Donald Trump’s policies. For while he has been inconsistent on much of past conservative ideology, he has largely stuck to the bottom line of Reaganomics: give money to the rich through massive tax cuts, and don’t worry about the consequences. If Clinton directly attacks the idea of giving more money to the rich—more reverse Robin Hood—and urges that the same money be spent on education, infrastructure, health care, social security, and research, she will be on completely solid grounds historically. And she can show up Trump as part of the same con that conservatives have been playing since Reagan: funneling money to the rich on the grounds that it will benefit everyone else hugely—which it hasn’t, and won’t.

If progressives are to win back control of all branches of government, so that they have real leadership power, they need to put the opportunity society at the center of their campaigns. They need to make the case that public investment, wise regulation and the social safety net will together create greater opportunity for all Americans. And they need to relentlessly rebut the idea that a minimal government means a strong economy, and argue for the essential role of government leadership through public investment. Then they can actually win the argument, as Reagan once did on the other side. And then by wise government investments they can empower individuals and businesses, and can restore the American dream of opportunity for all.

Originally published here.

2016 July 25

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