Stuck in '89

One of history's great economic experiments ended 20 years ago. The odd thing is that we still haven't figured out what the results mean. The comparative experience of West Germany and East Germany during the Cold War was the stuff of terrible human drama. But it also added up to the closest thing that economists have had to a scientific trial with identical twins. The two countries provided the clearest measure of how well a "command" economy could perform against a market economy. Here were the same people from the same culture, starting from a virtual clean slate at precisely the same level of development after World War II—but under radically different forms of economic organization. On Nov. 9, 1989, the final test results were delivered by the thousands of East Germans who streamed across the border. One of the "twins" had produced the most vibrant economy in Europe; the other had become a place of darkness and dysfunction. Milton Friedman, the foremost champion of modern free-market thinking, later said that that the fall of the Berlin Wall was worth more than everything he had said and written. It was "undoubtedly the most influential action for the last hundred years because it put finis to an attitude," Friedman told C-SPAN's Brian Lamb in 1994. "The lesson from the fall of the Berlin Wall was that we have too extensive a government and we ought to cut it down." (Click here to follow Michael Hirsh. Article continued below)

That certainly was the ideological response of both politicians and economists. The abrupt and miserable end of the socialist experiment—it all happened so fast, with East Germany getting absorbed into West Germany on Oct. 3, 1990, and the Soviet Union disappearing a year later, on Dec. 26, 1991—shifted the axis of the economic debate sharply rightward. Economic thinking in the United States had already been moving that way, a response to stagflation and failures of big government here at home. But in the aftermath of the Cold War, it was anathema in Washington to advocate government solutions of any kind for anything. Moderate Republicans became small-government zealots and liberal Democrats turned into "Eisenhower Republicans," which is what Bill Clinton mockingly called himself.

That's where we still are today. To a striking degree the economic and political debate remains mired in 1989. As evidence, consider the reaction of the Republican Party to the Obama administration's policies on financial regulation, fiscal stimulus, and health care. The Republicans are using the vast bailout of the financial system begun by the Bush administration to justify holding "tea parties" and threatening an Ayn Rand-inspired "strike" against Washington. This is absurd, considering that what precipitated the biggest government intervention since the Great Depression was not too much but too little government—too meager regulation of a Wall Street that has run amok for two decades, drunk on out-of-control derivatives trading. The Republicans are also turning the debate over a "public option" in health care into yet another orgy of big-government bashing—as if the government were not already running Medicare.

The Democrats, for their part, haven't figured things out much better. They remain unduly in awe of Wall Street and fearful of tampering with the markets. Both the Obama administration and the Democratic-controlled Congress are taking an ultracautious approach to regulation of everything from bank size to derivatives trading. No one dares talk about the deeper problem—that a financial system whose role was once to be an intermediary for disbursing capital to the real economy has instead come to dominate the real economy. Doing something about that would require too much government intervention, after all. Treasury Secretary Tim Geithner, appearing on Meet the Press on Sunday, talked up the legislation on regulatory reform going through Congress. What he didn't mention is that legislation is even now getting drilled full of loopholes, thanks to intense Wall Street lobbying that is funded at least in part by taxpayer money. Pressed by host David Gregory, the reticent Geithner gave up his bottom line: he wants a giant insurer like AIG to get itself healthy enough "so the taxpayer can get out." When Gregory asked him, "After that you don't care what happens?" Geithner responded simply: "No." This is the same AIG that nearly brought down the financial system all by itself.

In other words, the idea of government minimalism still frames every debate. Is this wise? The great economist Paul Samuelson, writing a few years after the fall of the Wall on the 46th birthday of his classic economics textbook, cautioned that the Cold War was not the black-and-white contest of economies that it was made out to be. The end of the Cold War, Samuelson wrote, really only meant that "victory has been declared in favor of the market-pricing mechanism over the command mechanism of regulatory bureaucracy." The victor was not pure laissez-faire capitalism but the "mixed economy" that had dominated U.S. and Western capitalism for most of the Soviet Union's history, Samuelson said. In other words, markets modified by government taxes and government-orchestrated transfers of wealth to limit inequality, and government monetary and fiscal policies to curb recessions and inflation.

Worst of all, out of the Spirit of '89 came the pretense that banking should be treated like other sectors, though economists had long known that finance was a different animal. While financial markets were critical to the rest of the economy, they were also constantly subject to manias and panics. The pretense that we didn't have to worry about this difference has twisted our entire world out of shape. Under the tutelage of young free-marketers, foreign-exchange controls were lifted worldwide and a stream of private capital began circling the globe, fed by giant private and public funds hungry for yields. Pools of globalized capital began moving from country to country, creating one bubble after another depending on which one economy delivered up the best yields at the time. Various crises occurred—Mexico in 1995, Asia in '97-'98, and America in '08-'09—but otherwise no one thought too deeply about whether the global system they were creating was good or not. The growing power of finance capital over other sectors, not to mention Washington, explains a lot of the worst inequities in our world: why Wall Street has come to rule corporate performance on Main Street; why Wall Streeters earn robber-baron-size sums of money compared to everyone else; why the gap between executive and worker pay has grown so huge. But we're still not talking about that either.

Today, what once looked simple in the immediate aftermath of the fall of the Wall now looks much more complicated, for reasons that should be obvious. I am not advocating socialism; that's dead and gone. But it's long past time to move beyond the simplistic either-or proposition of the post-Cold War period. All government solutions are not hopeless; all bureaucrats are not Bolsheviks. Why can't we have an honest debate about that?