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Economic Systems

Economic Systems

American Economic History

Alexander Hamilton

Adam Smith’s philosophies were widely embraced by most Americans. Smith's emphasis on free, unrestricted economic action echoed Americans’ political and social commitments to liberty. But from the very start, many Americans also identified a role for government in the economy. Alexander Hamilton, for example, the first Secretary of the Treasury, outlined an ambitious plan for government support of the economy in 1791. He argued that the federal government should advance economic growth by a program of internal improvements—roads, bridges, ferries, and harbors. It should stabilize the nation’s currency through the creation of a national bank. And most dramatically, the government should collect and funnel capital toward certain sectors of the economy through the careful management of the national debt.

In many ways, Hamilton was ahead of his time. Most of his contemporaries were not ready for this sort of government economic activism—especially from a federal government that many feared was already too powerful. But over the course of the nineteenth century, policymakers implemented most of Hamilton’s vision and the American economy began its transition from a pure market to a mixed economy.

For example, even though the national bank Hamilton founded was eliminated in 1836, Congress passed two banking acts during the Civil War that laid the groundwork for a national banking system. The federal government also inched its way into the business of internal improvement through the first half of the nineteenth century, before embracing the idea more fully with the passage of the railroad acts of the 1860s.

In the last decades of the nineteenth century, the federal government also took on a new role in regulating business through the creation of the Interstate Commerce Commission in 1887 and the passage of the Sherman Antitrust Act in 1890. 

The Progressive Era

Far more dramatic intervention into the economy, however, would not occur until the twentieth century. During the Progressive Era, the government took on the role of economic referee. Policymakers like President Theodore Roosevelt concluded that the economic playing field had been distorted by the growth of large corporations. He was not opposed to these new large industries, but he believed that their behavior needed to be supervised by an institution of equal size—the federal government. Following his lead, Congress passed the Pure Food and Drug Act and the Meat Inspection Act to protect consumers. To protect workers, the federal and state government passed a series of workplace safety and minimum wage laws. Congress attempted to restrain the power of corporations with the Clayton Antitrust Act and to expand its oversight of business through the creation of the Federal Trade Commission. And to ensure a more careful use of natural resources, Congress passed a series of conservation measures and created the National Forest Service.

The New Deal

During the Great Depression, the federal government’s role within the economy expanded still further. Faced with the seeming collapse of the entire economic system, President Franklin D. Roosevelt pieced together a collection of measures that moved the government beyond regulation and oversight into the role of job creator and income insurer. Under Roosevelt’s New Deal, the government provided direct relief to the needy under the Federal Emergency Relief Act. And it created jobs for the unemployed under the Public Works Administration, Works Progress Administration, and Civilian Conservation Corps. 

Agricultural prices were manipulated through the Agricultural Adjustment Act. And workers rights to organize into unions were protected under the Wagner Act. Through the Tennessee Valley Authority, the federal government set about re-constructing the economy of an entire region. And through the creation of Social Security, Congress created a federal pension plan for seniors.

The Great Society

Twenty years later, President Lyndon Johnson followed Roosevelt’s example by promoting even broader economic responsibilities for the federal government. Under his Great Society, Johnson pushed through Congress a package of legislation pledged to produce “abundance and liberty for all. . . . an end to poverty and racial injustice.” America’s safety net of social services was expanded through the introduction of food stamps and low-income rent subsidies. The Office of Economic Opportunity was created to assist in training and placing the unemployed. Increased federal aid to education was complemented by the creation of a training program for high school dropouts—the Job Corps.


Government’s role within the economy did not expand without interruption. Eras of government expansion were followed by periods of counter-reform in which government’s role was reduced. During the 1920s, Congress and the Supreme Court struck down many of the Progressive Era measures. During the 1950s, the liberal principles of the New Deal were constrained by the anticommunist conservatism of the Cold War era. And during the 1980s, President Ronald Reagan worked to reverse the century’s trend towards increased government involvement in the economy.

Reagan's impact on a century marked by expanded government involvement in the economy was perhaps the most dramatic. Arguing that high taxes and excessive government regulation stifled economic initiative, he promised Americans he would get government off their backs. And his promise struck a chord in the American public. Americans rallied to his argument that individual initiative and unfettered markets were the best path toward economic growth.

President Reagan successfully turned many of these ideals into policy. He slashed individual tax rates by 25% over three years. And he reduced business taxes further by improving depreciation allowances and research and development credits. He demanded an agency-by-agency review of government regulations. And these efforts led to increased competition and innovation in, most notably, the telecommunications and oil industries.

But Reagan’s economic record was far from perfect—and where he failed perhaps revealed how difficult it was to fully turn back the clock on America’s drift away from a pure market economy. For example, while Reagan did cut some taxes, the benefits didn't reach everyone. Wealthy Americans reaped the largest gains from the new tax code—the effective taxation rate for the wealthiest one-fifth of families fell by 5.5%, and the richest one percent of Americans saved even more: their tax rate fell by 14.4%. But for many working Americans, lower income taxes were offset by rising payroll taxes. As a result, middle- and lower-class taxpayers saw their total tax liabilities hold steady or even increase. The total effective federal taxation rate for the poorest one-fifth of American families actually increased by more than 16% during the 1980s.

In the area of deregulation, the results were also mixed. Deregulation was successful in many fields, but not all. Most notably, deregulation in the savings and loan industry contributed to the collapse of hundreds of companies. Ironically, this attempt to shrink government led to an industry bailout that cost taxpayers close to $150 billion.

Finally, although entering office with a pledge to shrink government and restore fiscal common sense to Washington, President Reagan left office with skyrocketing budget deficits. Within two years government expenditures exceeded revenues by more than $200 billion; during his eight years in office budget deficits averaged roughly $175 billion annually. Partially, this was because reducing the budget and the size of government could not be achieved without taking on two of the sacred cows of government spending—Social Security and Medicare. Despite Reagan’s popularity, he soon discovered that these programs were too important to too many people to be slashed. But budget reduction was also complicated by the president’s determination to strengthen American defense. During his presidency, defense spending tripled from $100 to $300 billion annually. With these three big-ticket items (Social Security, Medicare, and Defense) off of the negotiating table, there was little room for real savings. By the time the interest on the existing national debt was factored in, only 15% of the budget was even available for trimming… and little of that was actually trimmed.

In other words, while Americans were drawn to Reagan’s call to restore the market conditions of an earlier time, most were too dependent on many of the services that government now provided to allow real change. While the free market ideals of lower taxes, deregulation, and small government struck a chord with many Americans, just as many (perhaps some of the same people) resisted any attack on the specific government services and regulatory functions that benefitted them.

Economists continue to debate the overall impact of Reagan’s policies on the economy. But the Reagan years clearly revealed two things. First, free market principles retain a powerful place in American economic ideology—after a century of drift toward certain principles of a command economy, Americans still prefer the values of the free and unfettered market, an economy in which individuals driven by the rational pursuit of their own interests determine the allocation and distribution of resources. But the Reagan years also revealed that Americans will not fully turn back the clock—that America will never return to a pure market economy (if one ever existed in America)—that taxes can be shifted but it's tough to truly reduce them dramatically, that the public still demands an expensive list of goods and services that have to be paid for by someone, and that when things go wrong, they expect the government to step in with a solution.

Federal budget surplus deficit from 1930-2010


Why It Matters Today

In 2008, Democrat Barack Obama won the presidency after running a campaign based on a promise of vaguely-defined "change." Did Obama's election mark the final end of the era of Reaganomics? Are we now living in a new age of Obamanomics?

Short answer: we probably don't really know yet. It's too soon to really know for sure what long-term impacts Obama's policies will have on the economy. Furthermore, the ferocious political debates of the moment make it hard to tell which controversies of the day are truly of great significance, and which will be soon forgotten.

Obama's presidency began in a moment of once-in-a-generation economic crisis, which may have contributed to the intense passion of both his opponents and his supporters. Obama is, no doubt, a politically polarizing figure; lots of people really love him and lots of people really hate him.  For that reason, we already have seen several (radically different!) "first drafts of history" on the Obama Era, each coming from a different place on the political spectrum. Each is plausible, in its way; only time will tell which is closest to the mark.

The first version is the one Obama likes to tell about himself. In that analysis, Obama is a moderate pragmatist, a "post-political" figure more interested in getting things done than in promoting any particular ideological worldview. In crafting his policies, he is happy to "incorporate the best ideas of both parties." This Obama doesn't have any particular desire to make government bigger or smaller as an end unto itself; he wants to use the government smartly where it's useful, and get it out of the way where it's not. He's more interested in bipartisan compromise than ramrodding through exactly the policies he wants.

This Obama passed a fiscal stimulus plan, but made it significantly smaller than Keynesian theory would have recommended given the size of the economic slowdown. He also split the stimulus between the conservative approach (tax cuts) and a more traditionally liberal program (increased spending on government projects). This Obama passed a health-care reform bill that worked to expand coverage within the existing private health insurance industry rather than replacing it with a government alternative. (And that health-care bill, while costing a trillion dollars, is actually projected to reduce the budget deficit because it's more efficient and better funded than the existing setup.) This Obama worked to try to craft a bipartisan climate bill rather than just pushing through a carbon tax. This Obama is moderate, pragmatic, effective.

But Obama's critics see him as a very different kind of president. Two very different kinds of presidents, actually (for two very different set of critics).

The first critique of Obama comes from the left, where many liberals who supported his campaign have been bitterly disappointed by his administration. These folks believe that Obama took power at a unique moment of political possibility, when the economic collapse and general discrediting of George W. Bush's brand of conservatism created an opening for a lasting reform in a kind of echo of Franklin D. Roosevelt's response to the Great Depression 80 years earlier. Obama could have pushed through card-check legislation, making it easier for unions to grow after shrinking for decades. He could have created large new public works programs in the stimulus plan. He could have used health-care reform to create a system of universal public health insurance rather than subsidizing the existing patchwork system of private insurance. In other words, these critics from the left see Obama as a compromiser whose desire to appear bipartisan has prevented him from bringing real change; for them, Obamanomics looks like more of the same, another continuation of the long Reagan Era.

That is, to say the least, not the same Obama that the president's more conservative critics are seeing. Represented most spectacularly by the Tea Party movement, but also embraced less flamboyantly by many nervous leaders within the business community, this critique suggests that Obama has, in fact, brought serious change... just change for the worse. 

This version of Obama is a slick politician using a veneer of quasi-bipartisan sheen to cover up an anti-market agenda of big-government liberalism.  He doesn't understand business and he's getting in the way of recovery.  The stimulus, in this version, was an enormous boondoggle, much of which went to subsidize states' paying over-market wages to Obama's supporters in public employees unions. The health-care bill was a trillion-dollar assault by the government against private industry. Obama's intervention to prevent the collapse of GM and Chrysler was an illegal and unconstitutional act that stripped investors of their rights for the benefit of the United Auto Workers. Obama's proposal to let the Bush tax cuts expire, which would raise the top bracket from 35% to 39%, smacks of "soak-the-rich" class warfare. And new climate-change legislation is likely to end up creating tons of pointless new government bureaucracy and regulatory red tape. In short, this Obama has a bias toward big government and against the free market system, and his policies are likely to lead to economic disaster.

So which of these is the real Obama? What do you think? Check back in ten or twenty years, when we'll probably be able to offer a more definitive answer.

Sometimes, a Song Says it Better: Gold Digger, by Kanye West

In American history, there were those who had gold and those who sought it.

One who desired money is the woman in Kanye West’s “Gold Digger”: “Oh, she’s a gold digger way over time.” She went with him because she could tell he could “rock.”

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