C. Fred Bergsten, “The Costs of Reaganomics,”

Foreign Policy #44, Fall 1981

Main Point

A major dilemma facing the Reagan administration in 1981 was how to justify its current economic policies with its lack of assertive, lucid foreign policy. This lack of a broad economic view was beginning to wreak havoc on the economies of Europe, not to mention here at home. Despite laudable goals, the administration’s desire for loose fiscal policy and a steady reduction of monetary growth has done nothing to help the already high inflation rate or to weaken an overvalued dollar overseas. Bergsten criticizes the administration’s lack of overseas view, noting that

Of course, domestic considerations should – and always will – be the primary determinant of U.S. economic policy. But the administration’s failure even to consider the international impact of its actions will soon have a doubly severe effect of the U.S. economy itself.

He then goes on to outline two major dilemmas in the economy. First, the unprecedented overvaluation of the dollar which will produce high trade deficits, and secondly, the inevitable fall of the dollar which will propel inflation further upwards.

The Soaring Dollar

Bergsten notes that the central issue with Reaganomics is its impact on the overall world economy. Despite the administration’s claims that their program (including tax cuts) will produce a steady decline in inflation and growth in the economy, Bergsten says there is no proof that supply-side tax cuts will do any good. He notes the actual effects up to date: the dollar soaring up to 20% above the 1978 lows, hovering 30-50% higher against most other major foreign currencies caused by high U.S. interest rates. This has caused U.S. price competitiveness to deteriorate against these nations by up to 50%. All of this in tern is expected to cause a deficit in the U.S. current account.

Economic Costs and Protectionism

Bergen predicts deficits to emerge in the second half of 1981, and to accelerate into 1982. He expects the policies of Reagan to hit the domestic U.S. economies in the following ways:

First, net exports will decline and will slow growth, possibly by as much as half of its 1981 level. Unemployment would also probably rise by at least .5 %.

Second, the induced depreciation of the dollar will adversely affect the interest rate. In previous occasions of rising prices, a 10% decline in the value of the dollar left to a 1-1.5 % increase in the prices of goods. Now, the inflationary increase could be 2-3%.

Third, the decline of the dollar will simply introduce a tremendous amount of financial instability and tension into the world economy. He mentions OPEC raising the price of oil and the possibility of the EMS (European Monetary System) to pull out of the dollar to diversify and avoid any subsequent fluctuations.

Lastly, the economic policy set forth seems to revive strong protectionist efforts. The postwar record revealed that an overvalued dollar is the biggest impediment to a liberal trade policy in the U.S. The previous times liberal trade had been tampered with were bills in the early 1970’s which virtually eliminated imports, while driving up the valuation of the dollar.

In general, a severely overvalued dollar deteriorates the price competitiveness of all domestic industries, sharply cutting into all trade policy issues.

The Foreign Repercussions

Berger argues that while U.S. interest rates didn’t cause the economic difficulties overseas, they are indeed exacerbating them. The high U.S. interest rates, coupled with the overvalued dollar have produced a cycle of deterioration in the situations of many of the Western economies. The major effect is the great slowdown in countries all over Europe, which in turn will inflame already high political tensions for all of the affected nations, many of whom find themselves unable to export any products.

Bad Economics = Bad Politics

Overall, these policies of the U.S. have begun to move from being an economic problem to a political and diplomatic one, however the real tragedy is that this could have possibly been avoided.

The size of government could have been cut (like the administration wanted), reduced non-defense spending, and deregulated the money supply without causing the diplomatic and economic ills for itself. A closer grip of the rate of growth could have prevented it from spiraling out of control, and now other nations are accusing the U.S. of simply ignoring the most responsible requests to demonstrate sensitivity to the impact of U.S. policy on their economies. Cooperation has not always been easy, Bergsten argues, but it has been a cornerstone of the foreign policies of all administrations since the postwar period. Bergsten concludes, stating:

One in every six U.S. manufacturing jobs depends on markets abroad. One of every three acres of U.S. farmland produces for export. Almost one of every three dollars of U.S. corporate profit derives from the international activities – investment as well as exports – of American firms. The share of trade in U.S. GNP has doubled over the last decade. America depends on imports not just for oil but also for more than one-half of most of the key industrial raw materials. Any administration, in its own self-interest, must consider with utmost care the state of the world economy in defining the nation’s economic policies.