Divided We Stand, United We Fall

Why is unemployment lower today than at any time in nearly a quarter of a century?

In our book Out of Work: Unemployment and Government in Twentieth-Century America (New York University Press, 1997) written for the Independent Institute, Lowell Gallaway and I argue that unemployment tends to rise when policy “shocks” raise labor costs, and falls when there are no great policy disturbances to upset the natural tendency towards equilibrium in labor markets. Thus the National Industrial Recovery Act and the Wagner Act enormously raised costs during the New Deal era, thereby prolonging the Great Depression. There have been no great shocks to labor markets in the past few years in large part because divided government has prevented the Clinton Administration or the Republican Congress from implementing policies that would dramatically change the environment for labor.

Our thesis that governmental gridlock has positive economic effects is supported by a look at the evidence for the last generation. I took the years 1971 through 1997 and divided them into three categories: “gridlock,” “non-gridlock” and “ambiguous.” Gridlock years were those when the Presidency and Congress were in the control of opposite political parties: 1971-76, 1987-1992, and 1995-97. Non-gridlock years were years in which the Presidency and Congress were in the control of the same party (1977-80, 1993-94). The ambiguous years were 1981 through 1986, when the Republicans controlled the Presidency and part of Congress (the Senate), but did not have complete control.

When looking at three measure of economic well-being during the gridlock and non-gridlock years, without exception, the record is superior in the years of gridlock. The median unemployment rate was almost 15 percent lower in the years of split control than in the years when one party (in this case, the Democrats) had complete control. The stock market in the typical year rose nearly three times faster than when power was divided. Even inflation, nominally controlled by the supposedly independent Federal Reserve System, was lower in a typical gridlock year.

Using figures from the Bureau of Labor Statistics, Council of Economic Advisers and our own calculations, unemployment averaged 5.6 percent in gridlock years and 6.5 percent in others. Inflation was 4.4 percent in gridlock years and 7.8 percent in the others. The annual percentage change in the Dow-Jones industrial average was 12.1 percent in gricklock years and 4.3 percent in others.

Why? A lack of political control makes it difficult to pass legislation that significantly changes the status quo. Fiscal innovations (as the recent budget agreement points out) tend to be tepid rather than radical. Major new economic legislation is rare. Markets favor a certain, relatively unchanging policy environment to one where governmental activists are attempting new innovations in state control. The bold periods of innovation in twentieth century economic policy, such as the eras of the New Deal and Great Society, were always when a single party (the Democratic party in recent times) was in control. When the parties are jockeying for political power, the Federal Reserve does not have the concentrated power of the Executive and legislative branches of the government trying to divert it from its major goal of fighting debasement in the value of the currency.

We see this in labor markets. Absent a Republican Congress, even the relatively wimpish 105th Congress of 1997, Sen. Ted Kennedy, D-Mass., would no doubt get most of his wish of a $7.25 minimum wage. At the behest of the AFL-CIO, whose money is so vital to Democratic fortunes, a Democrat-dominated Congress might pass pro-labor legislation that would, for example, ban the use of replacement workers in strike situations. Both of these moves would raise the cost of labor, thereby reducing the quantity of it demanded.

In my view, the stock market boom of recent years arose because major legislative initiatives threatening returns on capital investment have been thwarted and prospects of legislative mischief are remote. From January 1993, when the Democrats assumed complete control of the federal government for the first time in 12 years, to January 1995, when they lost their domination, the Standard and Poor’s 500 stock index rose a paltry seven percent–little more than the rate of inflation. In the two and one-half years of divided government that followed, the index doubled. The threat of a completely socialized health care system was past. Business-bashing Labor Secretary Robert Reich was gone and Ira Magaziner, senior advisers to Clinton and chief architect of the president’s failed health-reform plan, was sent to the Clintonian equivalent of Siberia. A politically nimble president started acting like a Republican (“the era of big government is over”), even buying into capital-gains-tax reductions and continuing to favor low political barriers to the international movement in goods, ideas, capital and human resources, despite the opposition of economic nationalists and Neanderthals in both parties.

In times of national crisis, political unity is important. In an era of placidity, however, Lincoln’s injunction that “United we stand, divided we fall” does not hold: Long live gridlock!

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SOURCE: U.S. Bureau of Labor Statistics, Council of Economic Advisers, author’s calculations.