The new Rubinomics

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At Barack Obama's press conference to announce his dozen-strong transition economic team, the faces behind him had a distinctly Clintonite look—including former treasury secretaries Robert Rubin and Larry Summers. Dotted among them were a few faces from the party's left, including Clinton's Labour secretary Robert Reich. But they looked isolated amid the centrist economists and big-name CEOs. Was this, some liberals asked, the change we voted for?

The appearance of Rubin and Summers at the heart of Obama's economic team brought to the surface an old split in the Democratic party, often obscured during the campaign, between economic centrists and liberals. At the beginning of the 1990s, Rubin and his allies worried that excessive public spending and a ballooning deficit would lower American savings and, ultimately long-term growth. The victory of "Rubinomics" came when Clinton sided with Rubin over liberals like Reich, and prioritised deficit reduction over public investment.

But the economic crisis has forced deficit hawks to put their concerns aside. Republicans and Democrats alike understand that the US economy is heading for a very serious recession. And with little scope for further cuts in interest rates, the priority will be to pass the second major fiscal stimulus package in under a year, which Obama wants finished before his inauguration. The only debate is how big it should be. Obama wants $175bn. Martin Feldstein, a top Reagan economic adviser, thinks he should double that, while Goldman Sachs say that it may take up to $500bn to stave off a slump.

Whatever the size of the boost, Obama will soon find money tight in other areas. The recession will claim new victims, with America's lumbering "big three" car giants especially vulnerable. The housing market continues to plunge, and mortgage relief for struggling homeowners will be a priority. Expensive plans to reform the nation's healthcare and energy systems come next, and will be politically difficult to delay. All of these will probably push up borrowing further.

Facing this economic crisis, Democrats have called an economic truce. The day before the election, Rubin co-authored a New York Times article with respected liberal economist Jared Bernstein, also an adviser to Obama. They argued that the crisis should allow Democrats to move beyond "false" disagreements between their two economic camps. But, underneath, their agreement reflects a deeper rethinking of the old Rubin consensus. Both the credit crunch and a number of economic debates over the last few years have moved the Democrats' economic thinking to the left.

There are three aspects to this. The first concerns prosperity. During the 1990s, most Democrats agreed with JFK that a rising economic tide lifts all boats. This was true under Clinton. But during the Bush years fast growth failed to raise the incomes of most Americans. More specifically, productivity rose quickly while average wages stayed flat, and median incomes fell by around $1,000. Moreover, robust economic growth didn't seem to translate into strong job creation, as had generally been the case in the past.

Second, inequality is a greater concern. During Bush's presidency, the economy certainly grew, but only the millionaires' yachts seemed to rise with it. The figures were so stark that the normally centrist Larry Summers noted in October 2008 that since 1980 "those in the top 1 per cent have gained about $600bn. Those in the bottom 80 per cent have lost about $600bn." He went on to argue that inequality was now "a critical problem of legitimacy" for America's social contract.

This dynamic, in turn, has put pressure on another element of the Rubin consensus: free trade. Trade liberalisation was an article of faith to the Rubin crowd, who viewed passing Nafta as a signature achievement. But the social cost of globalisation has started to trouble them. Two influential articles focused concerns. In 2004, Nobel laureate Paul Samuelson argued that trade depressed wages; and in 2006, economist Alan Blinder argued that millions of American white-collar jobs could soon disappear abroad. The free trade consensus began to look more fragile.

Many of Obama's policies reflect these three changes to the Rubin consensus. Reforms to troubled health, pensions and energy systems should lower costs on businesses and allow them to raise wages. Obama's pledge to cut taxes for 95 per cent of Americans seemed a nifty ploy to wrongfoot Republicans. But it was also designed to redress inequality—to help "Joe the plumber" rather than "Joe the hedge fund manager." Centrists worried during the campaign that Obama was caving in to rising anti-trade sentiment. Yet, his moves reflect the balance of evidence that gains from trade are, at best, spread unevenly.

But despite the new, more liberal consensus, old tensions remain, and are likely to resurface when the immediate crisis passes. The Rubinites still hanker for a return to sound finances. Rubin and Bernstein's article noted that "one of us [Rubin] views long-term fiscal deficits—in combination with a low national savings rate, large current account deficits and foreign portfolios that are heavily over-weighted in dollar-dominated assets—as a serious threat…The other views these economic relationships as much weaker." Concerns about an ever-larger deficit are likely to return, especially as it tops the symbolic barrier of $1 trillion in 2009.

On the other side, liberals have neither parked their suspicion of the market, nor forgotten their desire for more social investment. Liberal economist Dean Baker views the centrists with suspicion, saying: "Rubin, and Summers might appear chastened. But in the 1990s, they wanted to liberalise everything. Rubin even stopped efforts to regulate collateralised debt obligations (CDOs). These guys were wrong on almost everything." Baker wants Obama to ignore the deficit, and press on with even bolder investments in health and energy.

Which way will Obama jump in the long run? Most signals suggest liberals will be disappointed. Obama's background in Chicago, his two books and his public speeches all suggest moderation and pragmatism. But liberals can take heart. Even before the credit crunch, the debate had moved their way. And in today's crisis, the centrists' arguments are irrelevant; even Rubin isn't a Rubinite any more. But once we are through the worst, Obama will be fiscally orthodox. He has thrown his lot in with the borrow-and-spend crowd only for the time being.

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