Latest Stock Market News

Was Larry Summers Right All Along?

Illustration: Philip Burke

There’s a story that progressives like to tell about Larry Summers. The doyen of establishment economics is dining out with a populist politician. The two have made it through the meal with minimal awkwardness — their ideological tensions eased by booze and food — when Summers leans back in his chair and offers his leftwing foil a hard-won insight: There are two kinds of political actors in this world. Insiders and outsiders.

Outsiders are free to speak their truth, Summers explains. But the price of such freedom is irrelevance in the halls of power. Insiders, by contrast, have a seat at the table where history is made. But to keep those seats, they must take care not to criticize other insiders. So, Summers asks his dining companion, which are you?

The anecdote has an apocryphal air. It makes Summers sound like the one-dimensional villain of a third-rate Sorkin script. Yet in their respective memoirs, Senator Elizabeth Warren and former Greek Finance Minister Yanis Varoufakis each claimed that Summers subjected them to such an after-dinner lecture, and advised them to take the inside track.

If the story is true, then Summers has ceased taking his own advice. These days, the former Treasury Secretary is the outsideror at least, he’s acting like one.

Back in March 2021, blue America was in high spirits. Thanks to their improbable sweep of Georgia’s special Senate elections, Democrats found themselves in full control of the federal government. They would waste little time in using it, with President Biden swiftly unveiling a $1.9 trillion COVID relief bill known as the American Rescue Plan. The package won plaudits from all corners of his big-tent coalition. Everyone from the conservative columnist David Brooks to the socialist economist J.W. Mason hailed the bill as a landmark achievement. In polls, a similarly broad spectrum of voters evinced their approval.

But Larry Summers was not among them. In a series of op-eds and interviews, the Harvard economist warned that Biden’s bill was excessively large and could “set off inflationary pressures of a kind we have not seen in a generation.” The president’s first major legislative achievement was, therefore, “the least responsible fiscal macroeconomic policy we’ve had for the last 40 years.”

Summers’s warnings did not resonate in the West Wing. Once the consummate Democratic insider, he now suffered the fate of so many leftwing wonks of yesteryear: to see one’s dissent derided as economically illiterate and politically treacherous. Progressive commentators declared him a “vindictive SOB” whose caterwauling about inflation was really a bid to “spook the markets and crash the economy to punish the administration for shutting him out.” The New Republic entertained the hope that, after three decades at the center of Democratic politics, Summers was finally “becoming irrelevant.”

Ten months later, times have changed. Today, inflation is eroding workers’ wage gains and the president’s poll numbers, while headlines tout Summers’s prescience and the president solicits his counsel.

To some on the center-left, this sequence of events constitutes a parable on the perils of leftwing groupthink. By mistaking their caricature of Summers for the actual man, progressives dismissed his inconvenient truth-telling, undermining their own agenda in the process. From this vantage, Summers is a clear-eyed technocrat who shares progressives’ broad objectives, but questions the efficacy of some of their means. “Larry is constantly seeking to challenge his own ideas and challenge the ideas of everyone around him,” said Jason Furman, a former Obama administration economist and one of Summers’s longtime collaborators. “There’s a narrative on the left that he’s on the party’s right, but that doesn’t map onto his research career or where he’s been on the issues.”

Summers’s leftwing critics see things differently. In their view, skepticism about the economist’s intellectual consistency is well-founded, while celebrations of his foresight are anything but. From their perspective, Summers is the embodiment of a discredited orthodoxy, and a threat to long-belated paradigm shifts in Democratic economic thought. “Inflation is a legitimate problem. But Larry has blown it out of proportion,” said economist Claudia Sahm, head of the Macroeconomic Research Initiative of the Jain Family Institute. “At the end of the day, this whole argument is about the size of government.”

Which perspective you find more illuminating probably depends on your reading of Summers’s career and the past half-century of American macroeconomic policy. Thanks to his long tenure as an insider, the story of one is, to no small extent, the story of the other.

If the American technocracy has a royal family, then Larry Summers was born into it. Both of his parents were distinguished economists; two of his uncles were Nobel Prize-winning ones. His paternal uncle, Paul Samuelson, was arguably the most influential U.S economist of the 20th century, laying the foundations on which a generation of liberal economics was built.

In the aftermath of World War II, Samuelson’s profession found itself torn between the Keynesian implications of recent experience and the laissez-faire premises of established orthodoxy. Wartime mobilization had demonstrated that massive public spending could end a persistent depression, catalyze growth, and promote full employment. Yet neoclassical economics had long held that markets were self-correcting entities, and that state intervention in support of demand was pointless, at best.

It was Samuelson who reconciled neoclassical theory with New Deal practice. In his 1948 textbook, Economics: An Introductory Analysis, Summers’s uncle explained that stimulative fiscal and monetary policies were often necessary to promote full employment — but once that condition was met, markets tended toward an equilibrium between supply and demand, just as pre-war doctrine had promised. Government intervention was therefore legitimate. But its proper role was limited: The state’s job was to regulate levels of consumer demand and compensate for market failures, not plan economic development.

Summers’s own formal education in economics spanned the length of the 1970s, which proved to be a decade of crisis for his uncle’s paradigm.

Samuelson’s theory of demand management had posited an inverse relationship between unemployment and inflation: When jobs were abundant, workers could hold out for high wages, thereby forcing employers to raise prices to compensate for rising labor costs; when jobs were scarce, employers could drive a hard bargain on pay rates, and thus keep prices low. Government’s task was to maintain an optimal balance between the competing goods of full employment and price stability. Times of mass joblessness called for stimulative spending; periods of high inflation demanded fiscal austerity. Uncle Sam could keep the economy from running too hot or too cold by adjusting the federal budget like a thermostat.

But in the 1970s, the thermostat broke.

OPEC imposed an oil embargo on the U.S. in ‘73. Energy prices skyrocketed. And since energy is a key input in the production of virtually every good, high oil prices slowed growth and accelerated inflation simultaneously. Samuelson-ism had no ready prescription for a world in which prices and unemployment rose in tandem.

But the conservative movement did. To Milton Friedman and his allies, stagflation was not the consequence of a breakdown in oil supply chains or any other contingent shock. It was the inexorable byproduct of New Deal liberalism. In their account, the New Deal state had wrought stagnation by strangling free enterprise with high taxes and draconian regulations. And it had cultivated inflation by trying to stimulate its way to full employment. Contrary to Samuelson’s theory, increasing consumer demand through fiscal policy could never durably reduce joblessness, since every economy had a “natural rate of unemployment” that was determined by supply-side factors alone. Profligate public spending could temporarily push unemployment below this natural level, but accelerating inflation – followed by higher unemployment – would be the inevitable consequences.

Summers was no conservative. But the young scholar was not firmly wedded to his uncle’s intellectual tradition either. He was a self-styled pragmatist, more interested in empirical research than abstract theorizing, eager to revise his priors in light of new evidence. Larry was always very curious about the world,” said the economist David Cutler, Summers’s Harvard colleague and early collaborator. “He was always challenging his own assumptions. Always trying to bring data to bear on the problems of the world.”

The late ‘70s were a convenient time to be a seeker of inconvenient data. While stagflation was convulsing economics in the political realm, the computer was transforming it in the academy. When Summers entered Harvard’s graduate program in 1975, vast data-sets had become easily accessible to the university’s researchers. Summers exploited these to test various economic theories against real-world evidence. His research spanned myriad subfields; his conclusions defied tidy ideological categorization. In his first major paper, Summers demonstrated that economists had systematically underestimated the prevalence of long-term unemployment, and thus the social costs of slack labor markets. In another early study, he showed that stock market valuations could be stubbornly irrational. This finding led Summers to endorse a tax on financial transactions, for the sake of “curbing instability introduced by speculation” and “reducing the diversion of resources into the financial sector of the economy.”

As American politics grew more conservative, however, evidence-based economics seemed to do the same. The electoral ascent of Ronald Reagan’s GOP coincided with the academic triumph of Milton Friedman’s macroeconomics. Through it all, Summers’s research remained heterodox. But by the early 1990s, it was clear that his ideology lay to the right of his uncle’s. As his mother, Anita Arrow Summers, told the New York Times in 1991, “Larry’s generation re-emphasized the importance of markets and the failures of government.”

“It’s time to remember that We the People are the government,” President Biden said in his first address to Congress last April. “Not some powerful force that we have no control over — it’s us.” In Biden’s estimation, “We the People” had much to be proud of: Government-run schools and universities had “opened wide the doors of opportunity,” while government-funded research had brought us the moon landing, life-saving vaccines, and the internet. “These are investments we made together as one country, and investments that only the government was in a position to make. Time and again, they propel us into the future.”

Biden’s rhetoric was an implicit rebuke of Bill Clinton’s famous 1996 declaration that “the era of big government” was over. The president’s recently passed stimulus bill, meanwhile, encapsulated an explicit critique of his immediate Democratic predecessor.

In justifying the American Rescue Plan’s historic scale in March 2021, Senate Majority Leader Chuck Schumer told CNN, “We’re not going to make the mistake of 2008 and 2009, and do such a small, measly proposal that it won’t get us out of the mess that we are in right now.”

If the supposed failure of Barack Obama’s “small, measly” stimulus emboldened Democrats to “go big” last year, it also inclined them to write off Larry Summers’s complaints about their party’s newfound fiscal ambition. After all, many saw Summers as the leading author of “the mistake of 2009.”

In the 2008 primary, Obama had cast himself as the anti-Reagan — a figure who would change America’s ideological trajectory in an equal and opposite way. The financial crisis lent credence to Obama’s promises of transformation. The 2008 crash so thoroughly humiliated the gospel of free markets that some of the creed’s leading clerics had felt compelled to recant. In testimony before the House in October 2008, former Fed chair and Ayn Rand acolyte Alan Greenspan conceded that his view of the world “was not working.” As economic themes moved to the center of Obama’s stump speeches, the socialist author Naomi Klein suggested that he was turning his campaign “into a referendum on Friedmanism.”

If the crisis brought America’s macroeconomic orthodoxy into doubt, however, it also brought Summers into Obama’s inner circle. Two years in the Senate weren’t enough for the Democratic nominee to assemble his own brain trust. As global capitalism teetered, Obama became increasingly reliant on the Clintons’ stable of economic advisers. And Summers was its thoroughbred.

The 2008 crash wasn’t the first time that the world’s financial woes worked to Summers’s professional benefit. In the Clinton administration, he had initially been shunted into the modest post of Treasury Under-Secretary for International Affairs. When financial globalization birthed a domino rally of emerging market debt crises, however, this apparent career setback turned into a boon. Summers played a starring role in negotiating a series of bailouts for developing countries that had been economically destabilized by fickle foreign capital. In each case, the basic logic of the bailout agreements was the same: To achieve prosperity, governments needed to win the confidence of private investors — and to do that, they needed to commit to slashing public spending.

In the Clinton era, this theory of growth was not reserved for the global economy’s up-and-comers. At Treasury, Summers worked under the wing of Robert Rubin, a Goldman Sachs alum and evangelist for “expansionary austerity.” In Rubin’s analysis, public spending “crowded out” private investment by pushing up long-term interest rates. The idea being: the more interest that firms needed to pay on borrowed capital, the less likely they would be to finance new plants or enterprises. Therefore, to secure robust economic growth, Uncle Sam needed to win the confidence of the bond markets. To appease those market gods, Rubin and Summers advised Clinton to moderate his economic ambitions and pursue deficit reduction. “In 1993 and 1994, people like Alan Blinder and I were worried about insufficient aggregate demand,” recalled Columbia University economist Joseph Stiglitz, who chaired Clinton’s first Council of Economic Advisers. “Larry was more worried about budget deficits than demand or inequality.”

By decade’s end, Summers’s bet on austerity had appeared to pay off. In the late 1990s, as the federal budget went into surplus, the U.S. economy enjoyed its strongest expansion since the stagflation crisis. His analysis apparently vindicated, Summers inherited Rubin’s post atop the Treasury Department in 1999. In that role, Summers took his advocacy for budget restraint to new heights. Speaking before a technology conference in San Francisco in May 2000, Summers argued that the “information revolution” had increased the importance of government living within its means. “In a world that is rich with investment opportunities,” Summers explained, “the importance of running a surplus and pursuing prudent policies becomes much, much greater.” For this reason, the Treasury Secretary called for “the elimination of the net debt held by the public,” and suggested that a top policy challenge of the 21st century would be figuring out “how we manage trillions of dollars of budget surpluses now in prospect.”

Summers’s enthusiasm for balanced budgets moderated after the dot-com bubble burst. But his faith in the beneficence of lightly regulated financial markets persevered. In the early aughts, Summers disavowed his past support for a tax on financial transactions. Over the same period, he collected millions in consulting and speaking fees from Wall Street firms. When Summers became Treasury Secretary in 1999, he had declared a net worth of roughly $400,000; when he returned to serve in the Obama administration less than a decade later, his estimated net worth lay somewhere between $7 million and $31 million.

Nevertheless, in late 2008, some on the left were willing to give Obama’s hand-picked National Economic Council director the benefit of the doubt. Noting Summers’s increasingly liberal commentary in the run-up to the election, publisher of The Nation Katrina vanden Heuvel told the New York Times, “The Larry Summers of 2008 is not the Larry Summers of 1993 or 1999.” Other progressives greeted the Clintonite’s appointment as the death knell for their dreams of economic transformation. After all, in a memoriam for Milton Friedman just two years earlier, Summers had declared that “any honest Democrat will admit that we are now all Friedmanites.”

Events would flatter the pessimists. As the financial system’s implosion decimated the middle class’s 401ks and choked off credit to businesses, private spending and investment collapsed. By December 2008, the crisis had ripped a $1.7 trillion hole in the economy. Textbook Keynesianism — which is to say, the centrist kind that Summers was raised on — had a clear prescription for this circumstance: Public spending must fill the hole in private demand.

But the Obama White House consciously chose not to do so.

In progressive lore, Summers single-handedly sabotaged the 2009 stimulus. The lone D.C. outsider on Obama’s team, the economic historian Christina Romer, had calculated that nothing short of $1.2 trillion in deficit spending could fill the gap in private demand. Yet Summers, the master briefer, had final authority over the team’s memorandum to the president in December 2008. He left Romer’s proposal on the cutting-room floor, opting to make a $890 billion stimulus the president’s most ambitious policy option. Thus, Summers personally ensured the inadequacy of the administration’s fiscal response.

This narrative is not entirely fair. Judging by subsequent accounts from both Summers and Romer, Obama’s NEC director favored $1.2 trillion of stimulus spending on the merits but believed that a trillion-dollar package would be dead on arrival in the Senate. Given that Summers ultimately recommended an $890 billion stimulus — only to see the White House propose just $775 billion and Congress authorize $787 billion — his presumption that politics placed a hard cap on the package’s size looks plausible, in retrospect.

And yet, congressional Democrats’ aversion to large deficits didn’t come from nowhere. To no small extent, their debt-phobia derived from the fiscal orthodoxies of the 1990s, which Summers had done as much as anyone to enshrine.

The costs of underspending on stimulus proved higher than Obama’s team had bargained for. Between 1947 and 2007, the U.S. economy had fallen into recession 10 times. In each case, the ensuing recovery had brought a period of unusually fast “catch up growth” that had fully restored the nation’s pre-crisis productive capacity.

But the post-2008 recovery brought no such boom. Instead of accelerated growth, Obama’s first term witnessed a rate of economic expansion far below the long-term average. Today, the American economy is still smaller than it would have been, had the crash…

Read More: Was Larry Summers Right All Along?

You might also like