Do You Remember 1980? Because We Sure Don’t

Peter J. Wallison at The Wall Street Journal:

In the rapturous days after Barack Obama’s victory and the Democratic congressional sweep that accompanied it, House Financial Services Committee Chairman Barney Frank declared that the new Congress would enact a “new New Deal.” Few people really thought at the time that he or his party meant this seriously. After all, the original New Deal—as anyone who has read history knows—failed to revive the economy.

Indeed, the modern era of rapid economic growth commenced after both Democratic and Republican presidents undertook to lift costly and stultifying New Deal regulations. The deregulation of trucking, railroad and airline rates produced lower prices for travelers and lower costs for consumers. The deregulation of interstate voice and data communication fostered the growth of the Internet and the cellphones that are ubiquitous today. The deregulation of oil and gas prices eliminated shortages and gas lines; and the deregulation of fixed commissions for securities trading led to markets where shares can be traded literally for pennies.

But Barney Frank was right. The signature initiatives of the Obama administration were very much in the mold of the old New Deal—the heedless spending, a stimulus plan focused on government employment, a health-care program that brought one-sixth of the economy under government control, and now the financial regulatory bill that would control another sixth. It will be years before the damage can be undone.

Richard Green on Wallison:

Using the National Income and Products Account, I looked at real annual GDP growth between 1933 and 1980 (the stultifying years) and 1980 to 2009 (the “rapid economic growth” years). Between 1933 and 1980, GDP grew by about 8-fold, or more than 4 percent per year (actually 4.5 percent per year). Between 1980 and 2009, real GDP did slightly better than doubling, or 2.7 percent per year.

I try to respect people whose points-of-view differ from mine, but who decides to let this guy waste ink?

Paul Krugman:

Green points out that growth has actually been slower since the big rightward shift circa 1980. But what he doesn’t seem to realize is that Wallison is just following the party line. Read almost any conservative commentator on economic history, and you’ll find that the era of postwar prosperity — the gigantic rise in living standards after World War II — has been expunged from the record.

You can see why: the facts are embarrassing. Here’s a rough-cut version. The blue line, left scale, shows median family income in 2008 dollars; the red line, right scale, shows the top marginal tax rate, a rough indicator of the overall stance of policy. Basically, US postwar economic history falls into two parts: an era of high taxes on the rich and extensive regulation, during which living standards experienced extraordinary growth; and an era of low taxes on the rich and deregulation, during which living standards for most Americans rose fitfully at best.

DESCRIPTIONCensus, Tax Policy Center

This does not, to say the least, make the case for free-market orthodoxy. So a large part of the right has invented an alternative history in which the good years came after, not before, the Reagan revolution. Hey, that’s what should have happened; who you gonna believe, the doctrine or your own lying eyes?

More Krugman:

Unfortunately, some of the comments indicated that my point didn’t get across. So, a few notes:

1. This is not meant to show a causal relationship. I used the top marginal tax rate as an indicator of the changing policy climate, with the sharp drop as conservative ideology took hold; the point then is that contrary to myth, the good years came before that shift, not after.

2. I used a logarithmic scale for income because in that case the slope of a trend line represents the rate of growth; for those wishing I’d shown growth rates instead of levels, they’re right there if you just lay something straight along the blue line.

3. No need to use a comparable scale for the top tax rate; see 1.

4. Family size etc.: this is complicated, yet simple. One one hand, yes, families have gotten smaller, so on a per capita basis we’ve done better. On the other hand, the typical family’s income gains since the 1970s largely reflect women entering the paid work force, so if you look at income per hour it’s actually worse than the median income. The key point, however, is that by any measure the first half of the postwar era was much better than the second half.

5. International competition etc.. In general, having your trading partners reduced to rubble is NOT good for your standard of living, so the idea that postwar prosperity was made possible by the wreckage of WWII is odd. Anyway, the United States did very little trade in the postwar generation, relative to GDP. This was not an export-led boom.

The basic point I was trying to make is that the US economy did very well with tax rates and levels of regulation (and strong unions) that, according to modern mythology, should have been crippling. That’s why conservatives have invented an alternative history in which it never happened.

Scott Sumner:

Suppose you had gotten a room full of economists together in 1980, and made the following predictions:

1.  Over the next 28 years the US would grow as fast as Japan, and faster than Europe (in GDP per capita, PPP.)

2.  Over the next 28 years Britain would overtake Germany and France in GDP per capita.

And you said you were making these predictions because you thought Thatcher and Reagan’s policies would be a success.  Your predictions (and the rationale) would have been met with laughter.  Indeed around that time most of the top British economists signed a petition asserting that Thatcher’s policies would fail. For those of you not old enough to remember 1980, let me explain why.  Labour rule of Britain had reduced their economy to a shambles.  The government ran the big manufacturing corporations and labor unions were running wild.  They had 83% MTRs, 98% on capital.  There was garbage piling up in the streets of London.  Britain had been the sick man of Europe for decades, growing far more slowly than Germany, France and Italy.  The US wasn’t doing as badly, but certainly wasn’t doing that well either.  We had also been growing much more slowly than Europe and Japan.  Unlike Britain, we were still richer than most other developed countries, so this convergence was viewed as partly inevitable (the catch-up from WWII), and partly reflecting the superior economic model of the Germans and Japanese.

Now let’s look at what actually happened over the next 28 years.  All GDP per capita data are from the World Bank, and are normalized as a fraction of US GDP/person:

Country       1980        1994      2008

USA              1.000      1.000    1.000

Australia      .841        .770      .837

Canada        .905        .818      .843

Britain         .688         .705      .765

France         .780        .730      .713

Germany     .803        .812       .763

Italy             .756        .754      .675

Sweden       .868        .777      .794

Switz.          1.146      .987       .915

Asia

HK                .547      .845        .948

Japan          .732      .815         .736

Singapore   .577      .899       1.064

Latin America

Argentina     .395     .300       .309

Chile            .210     .251        .311

Note that four countries gained significantly on the US, two were roughly stable (Australia, Japan) and the rest regressed.  The four that gained were Chile, Britain, Hong Kong and Singapore.  Of course lots of poor countries gained on the US, but that’s to be expected.  But I will show that the performance of every single country on the list is consistent with my view that the neoliberal reforms after 1980 helped growth, and inconsistent with Krugman’s view that they did not.

Krugman makes the basic mistake of just looking at time series evidence, and only two data points:  US growth before and after 1980.  Growth has been slower, but that’s true almost everywhere.  What is important is that the neoliberal reforms in America have helped arrest our relative decline.  The few countries that continued to gain on us were either more aggressive reformers (Chile and Britain), or were developing countries that adopted the world’s most capitalist model. (According to every survey I have seen HK and Singapore are the top two in economic freedom.)

Krugman responds:

We can try to parse whether that’s true — but in any case it’s not a response to my original point. That was about the claim, quite common on the right, that the US economy was stagnant until Reagan did away with those nasty New Deal policies — a claim that is simply, flatly, false. The era of strong unions, high minimum wages, high top marginal tax rates, etc. was also a period of rapid growth and rising living standards. That doesn’t prove causation; it does disprove the widespread dogma that these things are always economically devastating. And it’s telling that so many on the right have airbrushed the whole postwar generation out of history.

Given all that, what do we learn from the fact that since 1980 the United States has more or less maintained its relative GDP per capita, after substantial decline previously? Well, that’s not a simple story. Part of the answer is that our relative decline for 30 years after WWII largely reflected technological catchup by others; by the 80s that catchup was largely over, with all advanced nations at roughly the same technological level, so there was no reason to expect faster growth in Europe and Japan.

There’s also an issue of labor-leisure choices. In the 70s the long-run trend of taking productivity gains out partly in the form of shorter working hours came to an end in the US, while continuing elsewhere. What that’s about is the subject of dispute, but it’s important to understand that a large part of the GDP difference between the US and Europe reflects that choice. France, in particular, is a country with about the same level of technology and productivity as America, but with roughly 25 percent lower GDP per capita; this mainly reflects longer vacations and earlier retirement, which may or may not be bad things, but are not a straightforward case of inferior performance.

But back to the original point: where this all started was with the common assertion that the US economy was a failure until Reagan came along. This should be true, according to doctrine — so that’s what people believe happened, even though it didn’t.

Reihan Salam:

Sumner tried to contrast U.S. growth performance relative to other societies. But I actually think Sumner could have gone further than he did. The logic of conditional convergence suggests, as I’ve argued earlier, that Europe and Japan should have grown faster than the U.S., as ideas and capital flowed relatively freely across the OECD throughout this period and there was a great deal of room for the non-U.S. OECD to embrace productivity-enhancing managerial innovations. Krugman disputes this:

Part of the answer is that our relative decline for 30 years after WWII largely reflected technological catchup by others; by the 80s that catchup was largely over, with all advanced nations at roughly the same technological level, so there was no reason to expect faster growth in Europe and Japan.

I’m not sure this is true. Krugman is very familiar with the failures of the Japanese retail sector. And of course the U.S. saw considerable productivity gains in this sector throughout the 1990s. “Roughly at the same technological level” might be right, but the fact that the U.S. still had a higher level of GDP per worker hour than all but a handful of high-unemployment OECD economies suggests that there was still room for technological catchup, if we use the term technology broadly.

Krugman goes on to discuss, very rightly, the labor-leisure tradeoff.

France, in particular, is a country with about the same level of technology and productivity as America, but with roughly 25 percent lower GDP per capita; this mainly reflects longer vacations and earlier retirement, which may or may not be bad things, but are not a straightforward case of inferior performance.

I find it very peculiar that Krugman is using France as his example, given that France went through a series of transformative neoliberal reforms during the 1980s as well. I strongly recommend reading Perry Anderson’s brilliant 2004 essay on postwar France in the London Review of Books.

Over twenty years, liberalisation has changed the face of France. What it liberated was, first and foremost, financial markets. The capital value of the stock market tripled as a proportion of GNP. The number of shareholders in the population increased four times over. Two-thirds of the largest French companies are now wholly or partially privatised concerns. Foreign ownership of equity in French enterprises has risen from 10 per cent in the mid-1980s to nearly 44 per cent today – a higher figure than in the UK itself. The rolling impact of these transformations will be felt for years to come. If they have not yet been accompanied by a significant rundown of the French systems of social provision, that has been due to caution more than conviction on the part of the country’s rulers, aware of the dangers of provoking electoral anger, and willing to trade sops like the 35-hour week for priorities like privatisation. By Anglo-American standards, France remains an over-regulated and cosseted country, as the Economist and Financial Times never fail to remind their readers. But by French standards, it has made impressive strides towards more acceptable international norms.

And how about those strong French labor unions?

Under the Fifth Republic, the French have increasingly resisted collective organisation. Today fewer than 2 per cent of the electorate are members of any political party, far the lowest figure in the EU. More striking still is the extraordinarily low rate of unionisation. Only 7 per cent of the workforce are members of trade unions, well below even the United States, where the comparable figure (still falling) is 11 per cent; let alone Austria or Sweden, where trade unions still account for between two-thirds and fourth-fifths of the employed population. The tiny size of industrial and political organisations speaks, undoubtedly, of deep-rooted individualist traits in French culture and society, widely remarked on by natives and foreigners alike: sturdier in many ways than their more celebrated American counterparts, because less subject to the pressures of moral conformity.

Granted, I’m being unfair here: I am analyzing France as though it were an actual country rather than an abstraction conjured up by “so many on the right” or “so many on the left,” some of my favorite interlocutors.

Let’s return to one of Krugman’s observations.

The era of strong unions, high minimum wages, high top marginal tax rates, etc. was also a period of rapid growth and rising living standards.

Krugman helpfully notes that the international context was important, though of course his interpretation of that international context is somehwhat idiosyncratic — i.e., there was little room for catchup growth in Europe and Japan post-1980, a pretty remarkable statement. My sense that Europe and Japan are ahead of us in some technological domains (broadband penetration comes to mind) while we’re ahead in many other domains, many of which fit under the rubric of managerial innovations that enhance capital productivity.

Will Wilkinson:

Taken together, this pair of outstanding posts by Scott Sumner and Reihan Salam seems to me a pretty decisive rebuttal to Krugman’s preferred narrative about the relationship between economic policy and American growth.

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