Some social democrats and socialists, especially in Western Europe, view the current financial crisis in America with a certain gladness. They think this may discredit “democratic capitalism,” and confirm the superiority of social democracy.
This stance returns our public conversation to the questions of the 1972 electoral campaign, during which a significant number of left-wing American thinkers and activists began to rebel against statist institutions, habits, and ways of looking at things propounded by the New Left, and the many promoters of the large omnivorous state.
Looking at the state of social welfare in the United States at that time, these liberals (social democrats) were “mugged by reality.” They saw that social democratic programs did not work. Since they had begun to find socialism in all its forms unsatisfactory (and self-destructive), they sought a better guidance system. They found it in the American tradition of limited government, personal initiative, and economic inventiveness. They wanted to trim government by cutting both taxes and expenditures. They wanted to preserve the welfare state, by limiting its functions, and restoring responsibility to individuals and families. Enemies called this movement “neo-conservative.” It was actually neo-progressive. It gave primacy to the initiative, creativity, individual moral maturity, and to Aristotle’s conception of virtue. Without recognizing it, they adopted something like the Thomistic evaluation of the human person as the most noble and beautiful of God’s creatures. In their eyes, the common good meant nurturing citizens in virtue and happiness.
By 1980, many in this young movement had begun to coalesce around presidential candidate Ronald Reagan, who believed that a just government had to be a great deal more limited than the government he would inherit, and that its budget needed to be greatly restrained. Mostly, he believed that the most dynamic propellants of a modern economy are the inventions and risk-taking of imaginative entrepreneurs.
Reagan recognized that more than 80 percent of new jobs in this country are created by businesses that employ twenty-five persons or fewer – and that the crucial incentives that lure entrepreneurs from the sidelines to the creative arena are marginal tax rates—which he cut from 70 to 28 percent. By also dropping the tax rates on capital gains (assets) to 30 percent, Reagan offered entrepreneurs a lure that they could not resist.
He foresaw that they would risk their capital, work as hard and inventively as they could, constantly hire new people, and keep 70 percent of their own capital gains. Under Reagan, the world experienced the passage from a Machine Age to an Electronic Age, a transformation that created whole new industries and large numbers of jobs.
More than half a million new small businesses came into being in each of the eight Reagan years, and 20 million new jobs overall. This new burst of production raised our GDP to nearly one-third larger than it had been when Reagan took office.
Reagan also opened the way to new methods of improving the welfare of the poor and the vulnerable. Not all of them were realized during his administration. An important part of it – asking millions of Americans to volunteer to help the poor – was put in place by his successor, the first President Bush. Another – welfare reform – was reluctantly accepted by President Clinton in 1996. Still other parts were extended by the second President Bush (e.g., generous aid to Africa).
The best way to grasp the new welfare approach pioneered by Reagan is to visualize it as a change in the nation’s guidance system: Aiming not at a larger, but a more limited state. It gave ample room to the dynamisms of civil society: enterprising individuals, voluntary associations, lively civic corporations, churches, and other institutions that provide aid to the poor, the ill, and the down-on-their-luck.
Today, the crisis in the home mortgage system, which has involved many other financial institutions in its toils and tangles, has raised new questions about our guidance system. Do we need another fundamental shift?
Recall that the current system failed in all three of the interconnected systems: political, economic, and moral. For a decade, my colleague at AEI Peter Wallison ( Privatizing Fannie Mae, Freddie Mac, and the Federal Home Loan Banks) has been showing how Fannie Mae and Freddie Mac, the government-sponsored buyers and resellers of mortgages, have been improperly regulated. Usually, the Republicans favor deregulation. But in this case, the Democrats led by Senator Chris Dodd and Congressman Barney Frank blocked attempts to regulate Fannie and Freddie, both large sources of campaign contributions and votes for the Democrats. That was the key political failure, which brought the whole house of cards tumbling down these past few weeks.
The economic system failed when financial whizzes too clever by three-quarters invented elaborate schemes for packaging mortgages, good mixed with bad, which they resold for a profit. Then they invented still fancier schemes of “derivatives” to resell for further profit. They did not examine as closely as they should have the rot running through what they sold, the levels upon levels of packaging that disguised it, and their own responsibilities.
The moral system failed when Americans who borrowed at rates unknown to their parents or grandparents and rejoiced in the rapidly rising value of their homes, did not stop and think: “Something smells. This will all come crashing down.” We watched the gains pile up, and we glowed with pleasure.
No system will work without vigilance in all three sectors. Making up for a train of abuses in our time will bring some of the pains of purgatory to everyone, before the system rights itself, each part of the system vigilant over the others.
The advantage of our poor system is that it carries within it latent powers of self-correction – not without pain, yet in a way that may be relied upon better than any other.