By Allen W. Smith, Ph.D.

            The roots of the Wall Street meltdown date back more than a quarter-century to 1981 when Ronald Reagan abandoned traditional economic theories, and launched the nation in a new direction based on the untested theory called supply-side economics.  There were many warnings at the time from economists and others that Reagan was leading the nation into dangerous uncharted waters, and Newsweek magazine stated in its March 2, 1981 issue, “Reagan thus gambled the future—his own, his party’s, and in some measure the nation’s—on a perilous and largely untested new course.”

            Supply-side theory, which soon became popularly known as “Reaganomics,” advocated large tax cuts and a major reduction in government regulation of business.  Reagan and his followers had blind faith in the concept that, if the government would just leave private business enterprises alone, a system of free markets would, by themselves, regulate economic activity in such a way that the common good would prevail.  This thinking was based on the “invisible hand principle” enunciated by Adam Smith in The Wealth of Nations published in 1776.  The problem with the analogy was that the characteristics of the American economy were not even close to those of the hypothetical economy that Adam Smith was describing in his book.  There was not sufficient competition in most American markets for self regulation to work.  Without some government policing of the operating practices of companies in many industries, greed and fraud were bound to prevail.  

            The Reagan administration claimed that they could cut tax rates by 30 percent and still collect more revenue than before the tax cut, and they argued that deregulation of business was the route to a better-functioning, more-productive economy.  Despite the warnings of top economists that the Reagan proposals amounted to voodoo economics that would lead to catastrophic long-term consequences, the fallacious policies were put into place and followed for the entire 12 years of the Reagan-Bush presidencies.  After an 8-year reprieve under the Clinton presidency, during which traditional economic theories were once again followed, George W. Bush reinstated the failed economic policies of his father and Ronald Reagan, and stuck with them throughout his presidency.  In all, the American economy has operated for 20 of the past 28 years under economic policies based on unsound theory that has been denounced by most mainstream economists.         

            Essentially, Reagan traded what he critically called the “tax and spend” policy of previous presidents for a new policy that could be aptly described as a “borrow and spend” policy.  Reagan’s huge tax cuts were not matched by corresponding spending cuts, so budget deficits began to soar and the national debt headed skyward.  The $1 trillion national debt that existed in 1981 represented the cumulative deficit spending of all previous presidents from George Washington through Jimmy Carter.  That debt was doubled to $2 trillion in just 5 years, and it was quadrupled to $4 trillion by the time George H.W. Bush left office in 1993.  Between 1981 and 1986 the United States was transformed from the world’s largest lender to the world’s largest borrower, and by 2008, the national debt reached $10 trillion. 

               The 1,000 percent increase in the size of the public debt between 1981 and 2008 was accompanied by a skyrocketing rise in consumer credit card debt and large increases in business debt.  Caution was thrown to the wind by the federal government, some businesses, and most consumers. The “buy now, pay later,” philosophy became more and more prevalent at the same time that government increasingly relaxed it role of policing financial institutions.  President Reagan made Americans feel good about living beyond their means.  With such national behavior, a day of reckoning was bound to come sooner or later.  By 2008, 27 years after the initiation of Reaganomics, the world was reaping the harvest of so many years of economic malpractice. 

Allen W. Smith is Professor of Economics Emeritus, Eastern Illinois University, and the author of five books, including The Looting of Social Security and Demystifying Economics.