Crossroads - economy and politics

Are we at a major market juncture? All the signs indicate that we are -- and in no small part because we are also at a major political juncture.

WHAT a difference an era can make. When free-market entrepreneurial economics were revived during the Age of Reagan, and classical thinkers such as Friedrich Hayek, Milton Friedman, and Joseph Schumpeter replaced John Maynard Keynes, John Kenneth Galbraith, and Paul Samuelson, the American economy flourished on a grand scale.

From 1982 to 1995, the Dow Jones industrial average increased 300 per cent (adjusted for inflation), or 11 per cent per year. All told, a phenomenal performance. Along the way, roughly 100 million Americans who own stocks and bonds (through brokerage accounts, mutual funds, IRAs, and other retirement plans) saw their net worth go up by an extraordinary $10 trillion, a 176 per cent gain, which annualizes to 8.1 per cent. From this rising wealth base, the U.S. economy created 29 million new jobs and produced a whopping 43 per cent gain in real disposable income. No other G-7 industrial nation has come close to this performance. It's a fact. You can look it up.

During the prior Age of Inflation, which I mark as 1965 to 1982, Democratic and Republican Presidents alike practiced Keynesian fine-tuning, de-linked the dollar from gold, inflated the money supply, raised taxes, imposed wage and price controls, and maintained tight government regulation over key economic sectors such as banking, transportation, and energy. Meanwhile, the U.S. stock market declined by 67 per cent (adjusted for inflation), dropping by an average of 6.5 per cent per year.

Of course, in recent years Reagan's tax-cut policies have been compromised, first by George Bush and then by Bill Clinton. But the damage so far has been manageable, and the tide has not yet turned back out to sea. The top income-tax rate, which stood at 70 per cent during the Age of Inflation, is now holding at 40 per cent. The 28 per cent capital-gains tax rate is much lower than the 45 per cent during the 1970s. Corporate-income-tax rates are in the low 30s, compared to their hefty earlier perch of the mid 40s. The inflation rate in recent years has hovered near 2 per cent; it was 10 to 15 per cent during the last years of the Age of Inflation. Interest rates today run from roughly 5 to 7 per cent; they were 15 to 20 per cent 15 years ago.

Just as important, although Reagan himself has departed from the public square, his spirit lingers on, especially among the new generation of business leaders that was spawned during the Eighties. These men and women came to live by the Schumpeterian growth model of innovation and risk-taking. They started new businesses on a massive scale, they modernized business practices through downsizing and consolidation, and they instituted sophisticated financial-management techniques every step of the way. Their footprints are found throughout the economy, in computer tech, telephone tech, information processing, autos, utilities, transportation, steel, textiles, and electronics.

And they went global. For it was Reagan who first opened free trade in Latin and Central America, then negotiated throughout the Pacific Rim, including China, and it was Reagan's political economy that caused Soviet Communism to implode, thus re-opening Central and Eastern Europe, then South Asia, and even kindling hope in the Middle East. In short, American -- not German, not British, not Japanese, but American -- business has provided the leadership and cutting-edge management infrastructure for the worldwide spread of democratic capitalism.

All that said, there is however a growing sense, at least in stock-market circles, that the best of our story may have passed. In recent months the market has stalled, interest rates have again started to rise, and inflation risk is in the air. A year ago, buoyed by the Republican capture of both houses of Congress, many believed that 1995 would bring a new installment of Reagan's agenda: another round of pro-growth tax cuts, serious entitlement reform, more deregulation, and substantially smaller government.

Yet none of this came to pass. Speaker Gingrich showed himself to be a shrill, uncompromising, and unpopular figure, unable to grow into the job. As a unit, the House Republicans were obsessed with dreary numerical budget formulas and the politics of austerity and sacrifice. Gone was Reagan's message of optimism and growth. By early 1996 the Contract with America was dead in the water, and its underlying policy agenda of tax cuts, smaller government, and cultural reformation had been tattered and muddled.

WHAT'S more, politicians ranging from Pat Buchanan to Dick Gephardt have emphasized the darker side of the economic story. Real median family income, they have been pointing out, has slumped in recent years after recovering nicely during the 1980s. And Social Security and Medicare payroll-tax increases have eroded take-home pay.

Of course, when measured properly, the worker wage story over the past twenty years is quite a bit more respectable. Wage data exclude a sizable chunk of the modern worker's real compensation: health care, retirement, vacations, holidays, sick leave, and so on. When those generally untaxed benefits are added in per-worker annual income has been rising at a rate of 1.4 per cent. And, as the wealth numbers suggest, somebody has made good money. Even going back to the early 1970s, real per-capita consumption has averaged 1.7 per cent yearly increases.