Cornell University psychologist Tom Gilovich makes one of the most useful observations I’ve encountered in some time. Here’s economist Robert Frank’s summary of Gilovich’s observation:
As the psychologist Tom Gilovich has suggested, someone who wants to believe a proposition tends to ask, “Can I believe it?” In contrast, someone who wants to deny its truth tends to ask “Must I believe it?"
As much as I’d like to deny that Gilovich’s observation applies to me, I can’t. It does apply. But now being aware, I at least try to take a more critical stance toward propositions that correspond closely to my priors, and to take a more forgiving stance toward propositions that contradict my priors.
I thought of Gilovich’s observation when I saw this graph in today’s Econoblog discussion between Brian Wesbury and Barry Ritholtz.
When I first saw this graph, I thought exactly what Brian Wesbury wants me to think: "Yep, the tax cuts that kicked in May 2003 spurred investment spending in the U.S." And perhaps they did. The data, as they say, will bear that interpretation.
But as I look more closely and critically I see that the trend of business investment from the depth of the downturn through today might not have had anything to do with the tax cut. Although still negative until the first quarter of 2003, business investment began to improve in the first quarter of 2002. Furthermore, note that business investment was higher in late 1999 and early 2000 than it has been at anytime since the May 2003 cut in taxes.
None of the above is to disagree with Brian Wesbury. I agree with him that these tax cuts likely explain much of the observed change in business investment over the past few years. But it’s interesting how ambiguous even seemingly unambiguous pictures and charts and graphs and historical anecdotes become if you look at them critically, trying your best to see in them not what you want to see but what someone with a view very different from your own wants to see.
I’ll not here allow myself to get sucked into the black hole of methodology, save to express agreement with Deirdre McCloskey (and here I paraphrase) that no one was ever convinced by raw data of the truth of a proposition that he or she did not already hold to be true. Data are important, but the theoretical filters in our minds are no less so.
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First and foremost I am as far from an econometrician as you can be and still run a regression every once in a while. But, I think the graph is misleading , to make a better case for the tax cuts they should have shown the entire time series, perhaps with an amplification of the last part. Without knowing how a recovery looks when it happens it is very hard to do the visual econometrics required.
Even nicer woud ofcourse have been an actual regression, there is such a thing as time-series analysis.
In fairness to Brian Wesbury and the Wall Street Journal, putting anything more complicated in an essay meant for popular consumption is to purchase greater accuracy at too high a price paid in lost interest and comprehension of readers.
"no one was ever convinced by raw data of the truth of a proposition that they did not already hold to be true"
This reminds me of advice I once read about (legal) brief writing (can't remember the source): First you must persuade the judge that your side is right. Then and only then should you cite the law.
Well OBVIOUSLY business investment can't continue shrinking 15% annualized every quarter as in Q4 2001, how long can that last? (Yes, forever … but you know what I mean.) Q2 2003 actually does mark a significant reversal from a brief era of shrinkage, snapping back to strong growth.
Unless I'm misreading the tables at BEA.gov, I think some of Wesbury's numbers are wrong or missed a revision. Nonetheless he has a good point. If investment falls 15% annualized, then falls 1%, then falls 1% again, that's NOT an improvement in my book — just the shallowing of a slope that is unsustainable.
And yes, business investment was very high through much of the 1990s — unsustainably high. Not hard to imagine why — computers, software, Internet explosion, wireless and fiber networks, etc etc. Lot of stuff was put in place then — way too much stuff, as we learned. But how long can business investment keep growing 15%, within an economy growing at 3 – 5%?
Apparently, til about the time business investment constitutes 12.5% of GDP. Then things crash. So maybe we should reframe the issue — who says such rapid growth in business investment is a good thing anyway?? Don't forget those scary evil "imbalances".
Tax cuts are more effective when tax rates are high. I think the case has been overstated for the effectiveness of future tax cuts. Back when rates were 50% or more there would have been more of a response. Just because the economy now responds after a tax cut does not mean it is exclusively due to the tax cut.
Don,
For some reason I would have expected you of all people to be a firm believer in Ricardian-equivalence. Thus, given that there has been no cut in goverment spending and a reduction in taxes isnt it just a tax shift not a cut? If that is in fact the case how on earth can that help the economy much?
I don't find the Ricardian-equivalence theorem compelling. More generally, I don't find rational-expectations theory compelling.
I certainly agree that the true annual cost of government is what government spends that year rather than what it takes explicitly in taxes that year — but this fact doesn't mean that individual investors don't respond to lower tax rates by investing more today.
Don, may I enquire why you dont find them compelling? A pointer to an article would be more than sufficient (this is for my own consumption, as I have conflicting views on the whole thing).
Considering only your comment about 1999 in that chart: One thing that we know was happening then was the replacement of PC's with updated "millennium-proof" machines and software.
Note that this would also at least partially explain the fall off in such investments after 2000 began.
The dominant factor explaining business investment is corporate profits growth and that more then explains the recent change in investments. However, if you look at the very strong rebound in profits the rebound in business investment has been modestly less then the traditional relationship would suggest. But the difference is not that significant and is explained by the unusual suge in oil company profits. By historic norms oil companies have been slow to spend their profits.
The rebound in profits can be partially attributed to the Keynesian portion of the tax cuts, but it is very difficult to attribute much of it to the supply side aspects of the tax cut — especially since the segments of the population that pay individual rather then corporate taxes account for such a small portion of business investment.
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