With Senator Hillary Clinton firmly cemented as the front-runner for the Democratic Party’s nomination, Rubinomics—named after former Treasury Secretary Robert Rubin, who shaped economic policy under President Clinton—has re-emerged as a critical issue. This is because Senator Clinton has firmly embraced it. Rubinomics rests on faulty economics and embodies bad politics. Progressive Democrats and the nation need to understand this. Here’s an explanation.
The central proposition of Rubinomicsis is that budget deficits reduce saving and increase interest rates, thereby reducing investment and lowering future living standards. However, the record shows that interest rates fell to historic lows over the past several years, a time of large deficits. That fits the common sense observation that the Federal Reserve largely determines interest rates contingent on economic conditions. Meanwhile, a flood of savings has poured into financial markets from wealthy individuals and pension funds, and corporations have been net buyers of stock on the back of record profits.
Nor does the “twin deficit†argument—that budget deficits cause trade deficits—make sense, as evidenced by the fact that in the late 1990s the United States ran record trade deficits as the budget moved into record surplus. Japan and Germany also disprove the argument as they have run large trade surpluses and budget deficits for many years. Rather, the U.S. trade deficit is due to undervalued foreign currencies and export-led growth strategies by many countries that look to grow by selling to the United States while restricting purchases of American-made goods.
Despite these logical failings, Rubinomics still has great appeal because Rubin’s tenure as Treasury Secretary coincided with the 1990s boom. That appeal is misplaced. The rooster crows at dawn but does not cause the sunrise. Rubin was Treasury Secretary during the boom, but budget surpluses did not cause it.
The political origins of Rubinomics trace back to the 1970s, when conservative charges about big government and “tax and spend†liberals took deep hold on America’s political consciousness. Throughout the 1980s Democrats struggled to respond, eventually settling in the 1990s on a strategy of “fiscal responsibility.†That strategy was always transitional and defensive, aimed at blunting Republicans’ relentless attack on government and plutocratic tax cuts. The long-term goal was always an alternative narrative to free-market mythology.
The tragedy is that once a myth takes hold it must be lived out to be disproved. That is the price paid for losing the war of ideas. This process has now worked itself out, and America is finally grasping the fallacies of market fundamentalism. That creates a historic opportunity, but Rubinomics risks a tragic second act. Rubinomics worked brilliantly as a political strategy in the 1990s. But its success was political, not economic. However, its supporters have lost sight of this and now credit it with causing the late-’90s boom. Consequently, they argue for sticking with Rubinomics, thereby missing the opportunity created by the dismal failure of Bush’s presidency.
Instead of continuing down a mistaken path that focuses on the budget deficit, proponents of a progressive economic policy should focus on increasing investment, which is key to productivity growth and full employment. Rising wages and full employment, in combination with a fairly valued dollar, create a favorable investment climate. That sets the stage for a virtuous circle of shared prosperity. Investment raises productivity, which raises wages and profits, thereby increasing demand and drawing more investment. This is the real basis of a rising tide that lifts all boats. With regard to the trade deficit, the solution is to revalue exchange rates, raise wages abroad so that foreign workers can consume more of what they produce and have countries adopt coordinated policies that stimulate the global economy. That would benefit all, and it is why labor standards and exchange rate provisions must be in all trade agreements.
Rubinomics is not only bad economics but also bad politics. First, by arguing that the problem is a shortage of saving, Rubinomics promotes a conservative tax agenda privileging saving and profits, which primarily benefits the rich. Second, by placing budget deficits at the center of the saving problem, it sets government up as a problem and makes a case for shrinking it. Furthermore, by promising to lock Democrats into a path of fiscal austerity, it exposes future Democratic Administrations to the charge of “flip-flopping.†This is because fiscal stimulus will inevitably be needed when the current unbalanced boom ends.
The greatest tragedy of all concerns the potentially disastrous consequences for Social Security and Medicare. These programs are more vital than ever, given America’s aging population and retirement wealth inequality. Yet Rubinomics establishes the premise for dismantling them. By claiming the budget must be balanced to increase savings, it sets up a political deal whereby Republicans suspend their unjustifiable tax cuts in return for Democrats putting Social Security and Medicare on the table. This would be the ultimate conservative triumph, the evisceration of the crown jewels of FDR’s New Deal and Johnson’s Great Society.
The cruel irony is that Democrats would be the agent of this destruction at the very moment when history is proffering the opportunity for a great reversal of market fundamentalism. At a time of significant productivity growth, due to the maturation of the Internet and other technologies, Rubinomics establishes the premise that America cannot afford these great programs. Most bitter of all, once institutions like Social Security are dismantled, they are hard to resurrect, whereas tax cuts can be easily restored. This means dealing Social Security benefit cuts in return for repeal of the Bush tax cuts is both unjustified and a political trap. All of this is worth thinking about if you’re thinking about voting for Hillary Clinton.
An earlier version of this article appeared in The Nation, 284 (20), May 2007 and at www.thenation.com
Copyright Thomas I. Palley
I wrote a letter to the Nation when they published the shorter version of this piece, so my apologies for any redundancy. Here it is, with some additions:
Thomas Palley [“The Flaws in Rubinomicsâ€] trenchantly outlines the flaws in Rubinomics but he misses an opportunity to put forward a compelling alternative narrative about fiscal policy. The Reagan-Bush-Bush policy of running up public debt has exacerbated the polarization in wealth over the last three decades by letting the rich lend to the government rather than pay their taxes. The progressive solution is to return the tax structure at least to the status quo ante, as Clinton more or less did with his OBRA93 tax increase. While the budget surpluses of the 1990s were probably more a consequence than a cause of the boom, as Palley notes, they did demonstrate that surpluses need not inhibit high employment, provided the Fed keeps its foot on the monetary accelerator. A fiscal program that reaps budget surpluses from progressive taxation, then uses them to pay down debt and invest in the social security and medicare trust funds would permanently redistribute wealth to the working families who rely on these programs. Palley is right to worry that the political rhetoric of Rubinomics risks backfiring on Democrats. We need an alternative rhetoric that emphasizes the potential distributional benefits of public wealth formation.
This approach (call it Left Clintonism), it seems to me, stands a better chance of getting adopted by the Democrats, and gives progressive economists something lasting to offer them. Our role will be to insist on viewing budget surpluses as a means to the end of wealth redistribution, and to maintain vigilance over the Fed so that they hold up their end of the bargain by operating an appropriately loose monetary policy. (One problem with actual Rubinonomics in the 1990s was that the Fed did not pay any attention to the textbook argument that tight fiscal policy needs an accomodating monetary policy, as Blinder and Yellen observe in their book, The Fabulous Decade.)
For those with a taste for economics: Palley argues that budget deficits do not raise interest rates, since these are determined by the Fed. This is true, but it ignores the long run constraints on the Fed. In a word, an economy stimulated by deficits will hit its inflation-barrier sooner than one without the stimulus and the Fed will then raise rates. (Financial markets operate as if they understand the world this way, so rates may go up because of expectations.) We can quibble about whether they have to, or where the barrier is, but this is the way monetary policy is conducted in practice. As Palley knows, while the evidence for this effect is mixed, it does exist.
Hi Tom,
Yes, rubinomics was not particularly good for the world – led to the dot-com boom after all that “transparency” money people were poking out started to vanish. “Traders’ rules,” live off volume, either way; but hardly unusual historically. It seems useless to rail in any case. I suspect pay as you go, not wall street was responsible for what was then portrayed as the “looming surplus.” now again foretold. Then, even PK was scared, and came up with some nonsense that fed-debt wound the world’s clock, had to be protected.
This time, things could be different. Provided pay is upwardly sticky and middle class resistance to privatization stays roused, we could see a dearth of U.S. 5% sticker in a couple or three years, to foist off on the Old Folks.
Now, with the other side in retreat, practically “spent,” why not try again, the fight-back over surplus? T.P. is right, investment needs are critical, the infrastructure alone, the environment, not just us but the r.o.w. So, I have to ask, if we pay off our debts, can we think up a way, short of giving it to RR, of plunking the public’s money into fixing things, and, expecting good return, prime rate, from it?
The fog of the RR industry’s particularized portfolios, at risk and uncertain, cannot keep the sums requires engaged, for long enough, in any case.
Just thought I’d mention this, to avoid our running with shoes tied
Ron
Tom,
Nice one. Remember too that Rubinomics included a further pillar; the permanent revolution of financial market deregulation and liberalisation. That become a flanking wing of US economic foreign policy, led by the Treasury. Ironic that the Clinton administration was a far greater advocate of economic globalisation than the Bush administration has ever been. And should Hilary be elected as president, expect more of the same – why the batle of ideas has to be won by progressives.
Revalue exchange rates? The United States did this in 1971 when international monetary discipline (Bretton Woods) over the dollar proved unacceptable. The world then moved to floating rates. Returning to fixed rates seems unlikely, so what’s the next step? The Peterson Institute was invited by Congress last May to consider the dilemma. http://www.iie.com/publications/papers/paper.cfm?ResearchID=735
Moreover, stimulate the global economy?
It’s a pity the key UN agency (IMF) can’t help.
Printing the world’s key currency may allow “deficits without tears” but it’s a two edged sword–you lose control of your exchange rate. We can’t change our rate versus a nation with a dollar peg and capital controls! First the Japanese, and now the Chinese are exploiting the Achilles heel of dollar hegemony.
Umm, scratch that please. I was thinking of the triangulation post when I wrote that, sorry. It’s true, but not Rubinomics.
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