The Clinton Economy: Good Luck, Good Policy, or Both?

Thanks to the controversy surrounding the Bush tax cuts, there's a growing debate over what policy mix is most conducive to economic growth. Some on the left use Bill Clinton's presidency as evidence supporting their claim that the U.S. economy did very well despite rates of taxation that were higher than they are now. In that case, they say, we shouldn't resist the Democratic Party's desire to increase tax rates.

On the right, many suggest that the economy did well despite, not because of, the policies put in place by Clinton. They argue that Clinton was the lucky beneficiary of a "peace dividend," a divided government thanks to the GOP takeover of the House and Senate in 1994, and an unexpected technology boom in the form of the Internet that would have made any president economically successful.

The greater truth is that President Clinton's economic success was a function of both luck and policy. Indeed, if analyzed free of the partisanship which tends to blur the picture, it becomes apparent that the necessary inputs to economic growth - light taxes and regulation, free trade, and sound money - were all largely in place during the Clinton years such that both he and his Republican counterparts deserve a lot of credit.

Taxes and government spending. It is certainly true that President Clinton supported passage of a tax bill in 1993 that increased the top rate to 39.6%. But what's perhaps not discussed enough is that, relative to the rest of the 20th century, marginal tax rates remained low. Indeed, apart from the late '80s when the top rate was 28%, the Clinton rate of taxation on what economist Reuven Brenner terms the "vital few" was the second lowest that it had been since the 1920s, when the top rate was reduced to 25%.

In the 1950s the top rate stayed at 90% throughout President Eisenhower's two terms in office, and in the 1960s, despite major reductions passed during Lyndon Johnson's presidency, the rate was still 70%. Even during the halcyon days of President Reagan's time in office, for most of his two terms the top rate was in the 50% range.

In short, while President Clinton didn't explicitly endorse the Reagan view that levels of taxation were way too high, he did not push for a resumption of the much higher rates that prevailed in the 1950s, '60s and '70s.  The fact that he did not was at the very least an implicit comment from Clinton that Reagan was right. It's also true that in 1997 Clinton signed a reduction in the capital gains rate from 28% to 20%.

Many Republicans would argue with a high degree of credibility that it was the GOP's control of both houses in the '90s that forced Clinton's hand on capital gains. Even if so, credit should still be given to Clinton for understanding which way the political winds were blowing.

They would also argue much the same in terms of government spending, that GOP opposition was to some degree the driver of spending cuts.  That's somewhat true, plus with spending it could be said that Clinton was the beneficiary of some very good luck.

For one, the Cold War essentially ended in 1990, and the subsequent military downsizing doubtless helped Clinton, as it would have any other president. And while the 1994 election rout that turned over control of the House and Senate surely embarrassed him at the time, it served him well too when it came to reduced government spending.

As Cato Institute Chairman Emeritus Bill Niskanen has noted, "Divided government is, curiously, less divisive. It's also cheaper." Indeed, as evidenced by the two modern periods of divided government, Washington spends less when one political party is not in control of the House, Senate and White House.

President Eisenhower faced a Congress in opposition during the last six years of his presidency, and President Clinton experienced much the same during his. The result, according to Niskanen, was that annual spending increases under Clinton were in the 1% range, while under Ike, spending actually fell.

Conversely, Presidents Truman and Johnson presided over Democrat majorities, and annual spending under both increased 10%. To show that this isn't a partisan issue, we need only consider the tenure of George W. Bush. With both the House and Senate in Republican hands until 2006, spending, according to Niskanen, once again went skyward.

Niskanen found that during periods of divided government overall federal spending has increased 1.7% per year, a rate that triples to annual increases of 5.3% during times of unified government. In this respect, it's perhaps arguable that Clinton and his supporters put too much stock into his supposed fiscal conservatism.

More realistically, divided government means less government spending, and Clinton was the unwitting beneficiary of the inevitable growth that results when governments spend less. Those who still believe in fiscal "stimulus" would do well to compare our economic health during periods of divided government versus the heavy spending years of the Bush/Obama united government variety.

Regulatory policy. The Clinton record on regulation is more of a mixed bag. According to the Cato Institute's 10,000 Commandments, the number of pages within the federal register increased under Clinton, much as it has all modern presidents.

Considering healthcare, the Clinton administration beat the Obama administration to the punch in terms of trying to foist a command and control system on the country. Clinton failed in this regard, but one unremarked silver lining at the time was that this bit of overreach helped lead to the aforementioned 1994 election rout that ensured the divided government so helpful to the Clinton economy.

The Clinton Justice Department ultimately fingered Microsoft as a monopoly, and its successful prosecution of the software giant doubtless proved a distracting imposition to one of the most important U.S. companies. It also proved unnecessary. As is often the case with large companies, the tradeoff is a loss of the nimble ways that make a small company grow large to begin with, and Microsoft was ultimately late to both the Internet and to search technology, thus conceding a great deal of market share to Yahoo and Google among others.

At the same time, President Clinton perhaps recognized how the fungible nature of capital made keeping commercial and investment banks separate somewhat useless, and ultimately he signed a bill repealing the Glass-Steagall Act. Some in the commentariat frown on this today owing to problems in the banking sector, but the simple truth is that investment banks Bear Stearns, Lehman Brothers and Merrill Lynch were weakened most by the financial crisis, and it was hybrid commercial/investment banks that saved both Bear and Merrill. As for Lehman, its assets were ultimately purchased by another hybrid financial entity, Barclays.

Trade policy. Though President George H.W. Bush was the initial advocate of the NAFTA agreement meant to expand trade between the US, Mexico and Canada, it was ultimately President Clinton who did the heavy lifting that got the bill passed. Despite major opposition in his own party, he and Vice President Gore were able to find enough Democrats willing to support a bill more to the liking of Republicans on the way to NAFTA's passage.

In the '80s and '90s, Japan was the China of its time when it came to mercantilist allegations of a country exporting its way to prosperity to the detriment of other nations. Economists Ronald McKinnon and Kenichi Ohno pointed out in their 1997 book, Dollar and Yen, that "in the decade before mid-1995, the United States had become increasingly aggressive in asserting trade grievances and then relying on 'Super 301' negotiating authority to threaten Japan directly with sanctions." But beginning in mid-1995, there occurred "a major relaxation of American commercial and financial pressure on Japan."

The Clinton administration's admirable restraint toward Japan surely gave investors confidence, and contrasts impressively with modern China-bashing which is bipartisan in nature, and a dollar negative at that.

Dollar policy. Sure enough, currency brinkmanship is but another form of protectionism, and as evidenced by the dollar's modern decline amid the aforementioned political assault on China, the Clinton administration once again proved impressive in its restraint back when Japan's currency policies were the issue du jour. According to McKinnon and Ohno, during the yen's decline from 97 to 113 yen/dollar, "not once" did "a responsible official in the American government complain that the dollar was too high."

Considering once again how frequently both the Bush and Obama Treasury's have made plain their unhappiness with the value of China's currency, officials during the Clinton years were remarkable for their seeming lack of mercantilist leanings. In this sense, it's no surprise that the dollar showed so much strength versus foreign currencies and gold during Clinton's second term, which coincided for the most part with strong-dollar advocate Robert Rubin's tenure as head of the U.S. Treasury.

With respect to the dollar the Clinton administration deserves a great deal of credit. In modern times the utterance of the phrase "a strong dollar is in our best interest" has become a throwaway line for Treasury secretaries of either party. But given the Clinton Treasury's happy willingness to allow Japan to decrease the value of the yen versus the dollar without protest, it soon became apparent to markets that to the Clinton Treasury, talk of a strong dollar was more than political rhetoric.

Markets clearly keyed on this as evidenced by a largely stable gold price during Clinton's years in office. Economics writer Nathan Lewis has observed that from 1989 to 1997, "the dollar fluctuated between $320 and $400 per ounce of gold." This wasn't perfect dollar stability, but relative to time before and after, it was pretty close.

That the dollar was largely stable and strong during the Clinton years is important to remember in light of the Internet boom that occurred during his presidency, and that some view as pure luck. Logic says otherwise.

That's the case because as the 1970s and decade just passed show, during periods of dollar instability and weakness, investment largely dries up; that, or it moves into more defensive assets of the commodity, art and property variety. In that sense while one can presume that the growth of the Internet was a foregone conclusion in the '90s, the fact that this area of technology attracted so much investment would have to be attributed to a policy of dollar strength that made riskier investing more attractive.

It could be credibly argued that policy in favor of a strong dollar to a high degree made the Internet boom possible. To suggest otherwise, that Clinton was merely lucky, is to suggest that when the market for technology IPOs dried up in the latest decade that this was a function of entrepreneurs running out of ideas.

The above seems doubtful - Google, for example had a very splashy IPO not long ago - and it would be more reasonable to say that more modern policies in favor of a weak dollar post-Clinton made investing in technology a much riskier proposition, particularly when we consider that the same policy in favor of a weak greenback made defensive investment in commodities a far more certain bet. Clinton is said to have been lucky when it came to the Internet, but cooler heads might say that absent the Clinton dollar, advances in the Internet space wouldn't be nearly as impressive.

Clinton vs. Reagan. Concerning economies and presidents over the last 30 years, it's generally agreed that the two most successful were those of Ronald Reagan and Bill Clinton. Both oversaw eras of economic happiness that were not matched by those who arrived in the White House before them, let alone those after.

Though Reagan and Clinton were in many ways ideological opposites, a more fair reading suggests that at least as far as economic policy, there were some similarities. Clinton, like Reagan, was in favor of a strong dollar, both were largely free traders, and while they went in different directions on rates of taxation, Clinton's support of higher rates was hardly extreme.

In terms of government spending, economist Richard Rahn has calculated that domestic federal discretionary spending as a percentage of GDP declined 1.4% on Reagan's watch, and 0.2 percent on Clinton's. Real GDP increased 32% during Reagan's two terms, versus 31% during Clinton's.

Stock-market returns are arguably the best barometer of economic performance, and as is well known, the S&P 500 increased under both presidents; 121% on Reagan's watch versus 208% on Clinton's. Though he once again wasn't an ideological soulmate of Reagan, Clinton's economic policies ultimately mirrored those of Reagan, and both were successful.

Conclusion. When it comes to politics, and specifically the analysis of presidential economies, there's frequently the desire to attribute any successes to things beyond the existing person's control, all the while attributing any errors to the individual inside the White House. So while it's acknowledged that President Clinton had a successful economic presidency, it's not surprising that his detractors find fault with the suggestion that he alone promoted policies that led to an economic boom.

In a sense the detractors are right. It was a policy failure, specifically an attempt to nationalize much of the U.S. healthcare system, which sufficiently scared voters into dividing power between the Democrats and the Republicans. The Clinton economy benefited from this division given the reduced spending and broader policy moderation that inevitably occurs within divided government.

At the same time, President Clinton most certainly did some things on his own that were essential to his economic success as president. From the signing of NAFTA, to welfare reform, to a cut in the capital gains rate, to a Japan policy that eased global tensions in concert with a stronger greenback, some of his success was largely of his own making.  Counterfactuals can't be done, but it seems the height of silliness to suggest we would have had the Internet boom if Clinton had pursued policies in favor of a weak dollar embraced by the two men who followed him to the White House. 

So while luck surely plays some role in any president's achievement, good decisions are the deciding factor. Not perfect, just as no politician is, Bill Clinton made enough good choices such that he can lay credible claim to one of the great postwar U.S. economic booms.