Why The 'Clinton' Recovery Is Unrepeatable

Tyler Durden's picture

Amidst the debates on what the US should do to re-establish an era of prosperity, there are a lot of references in the media and at political conventions to the "Clinton Recovery". This refers to the period from 1992 to 2000, the best in post-war history: 19% equity returns, 3.8% annualized real GDP growth, monthly payroll gains of 265,000 (adjusted for today’s population) and an average budget deficit of less than 2% of GDP. As Michael Cembalest of JPMorgan notes, applying a President’s name to a recovery or recession always seems to be a case of artistic license; you might as well call it "The Kardashian Recovery" in some cases, given how little Presidential policies had to do with it. Most of the time, domestic and global business cycles, monetary policy and other factors were the primary drivers. However, to recreate the policy conditions which prevailed would require a centrist - who most likely would have been excommunicated by his party for heresy as the political middle ground occupied by the party non-conformists is gone.

 

However, let us assume that there was a “Clinton Recovery”; what policies drove it?

To begin: 2 policies normally considered liberal/progressive: increase taxes on the wealthy and cut military spending to reduce the deficit. In 1993, Clinton raised the top marginal rate (also raising the top bracket, which mitigated part of its impact).

However, later in the decade, he cut the long term capital gains rate to 20%. As for military spending, the US benefitted from that brief synapse in time in between the collapse of the Soviet Union/fall of the Berlin Wall in 1989, and the emergence of another combatant 10 years later whose conflict with the US is almost as costly, and much more diffuse. The origins of this clash are complex, but can in part be traced to Operation Cyclone, a policy enacted by Carter and expanded by Reagan. It was designed to stop Soviet expansion by channeling sophisticated weapons and billions of dollars to militant Islamic groups, mostly via Pakistan. This program arguably backfired, contributing to a series of events in 2001 that brought the decline in post-war US military spending to an end.

 

Here is where the story deviates from the progressive script: Clinton Administration support for free trade and deregulation. While NAFTA was not the only catalyst for the improvement in trade (the rise of India and China after the Rao and Deng reforms played a role as well), it was a clear sign of the Administration’s support for free trade. Two years later, the Clinton Administration presided over two major deregulation efforts, one involving electricity and the other telecom. An NBER paper from 2003 analyzed data in both the US and Europe, and found that regulatory reforms that liberalize entry barriers spur investment, a trend which benefitted US capital spending during the latter part of the decade (see chart below).

 

Other aspects of the Clinton Recovery are equally centrist: welfare reform, and private sector solutions to healthcare. The 1996 welfare reform act was a fundamental shift, in that it introduced work requirements for recipients. It also delegated more responsibility to states, and reduced the burden on Federal public finances. On healthcare, it was not the intention of the Administration to rely on private sector solutions. The First Lady’s universal healthcare plan was the President’s preferred approach, but it could not get past Congress. However, around the same time, growth in healthcare expenditures began to slow, a by-product of the HMO era. While HMOs emerged in the 1970’s, private sector control of healthcare costs through managed care gained some traction in the 1990’s, and the growth in healthcare expenditures fell. HMOs leveraged increased enrollment to negotiate discounts from providers, and controlled the amount/type of care that was provided to insured members. When the US Department of Health and Human Services looked back at the 1990’s, they cited competition among HMOs as being one of the major factors leading to slower growth in healthcare expenditures. Healthcare expenditures are still growing at 3%-4% in real terms, which is a problem since the structural growth rate of the US may be declining.

 

On housing, the Clinton Recovery benefitted from conservative underwriting standards, although his administration’s policies contributed to the eventual housing crisis a decade later. I am not going to go into detail here, since I’ve written about this before. Home prices and housing’s contribution to growth were stable during the 1990’s. However, seeds were sown when President Bush passed the Federal Housing Enterprises Financial Safety and Soundness Act in 1992 (a delightfully Orwellian name since it ended up destroying them). By allowing the Department of Housing and Urban Development to set mandatory affordable lending targets for the GSEs, the government unleashed an avalanche of 3% down-payment loans by the end of the decade (see below), a trend which the private sector then followed, and the rest is history. The Clinton Administration’s contribution to the mess includes raising affordable lending targets from 30% to 50% of all GSE loans.

 

So, where does that leave us? To recreate the policy conditions which prevailed during the Clinton Recovery (not necessarily the President’s preferred policies), we would theoretically need to find a Presidential candidate who would:

  • Raise taxes on the wealthy to improve public finances, but also be willing to reduce taxes on capital gains
  • Cut military spending whenever possible
  • Agree to reduce the scope of government entitlements and take on entrenched constituencies, in spite of multiple decades of program expansion, and in spite of the political risks (there were multiple resignations at Health and Human Services after the Welfare Reform Act)
  • Encourage free trade and deregulation
  • Support private sector solutions to healthcare
  • Maintain conservative housing underwriting standards, without coercing private sector entities to act as conduits for fiscal policy/affordable lending programs

Good luck finding this person, since he/she would be a centrist, and most likely excommunicated by their party for heresy.

 

As shown in the accompanying chart, using the Senate as an example, the political middle normally occupied by party non-conformists is gone.

Source: JPMorgan