Nobel Laureate Edward Prescott takes an Hayekian approach to macro in this commentary at the WSJ:
The sky is not falling. No need to panic and start
playing around with all sorts of policy responses. Despite the
impression created by some economic pundits, the U.S. economy is not a
delicate little machine that needs to be fine-tuned with exact
precision by benevolent policymakers to keep from breaking down.
Rather, it is large and complex, with millions of people making
billions of decisions every day to improve their lives, the lives of
their families and the health of their businesses.On the one hand, it’s difficult to screw up all these
well-intentioned people by crafting bad policy, but, on the other hand,
it is of course entirely possible to do so. And once things are broken,
they are much harder to fix. For example, all those doomsayers
predicting a recession will get their wish if taxes are suddenly
raised, new productivity-strangling regulations are enacted, the U.S.
turns against free trade, or some combination thereof. Otherwise, we
should expect 3% real growth, based on 2% increases in productivity and
1% population growth. This economy is fundamentally sound.
Read the whole thing.
Podcast RSS Feed
Full EconTalk Text
{ 19 comments }
Huh… it's locked
Maybe it will show up, in a few days, as free, on OpinionJournal.com
Prescott apparently wrote: "all those doomsayers predicting a recession will get their wish if taxes are suddenly raised, new productivity-strangling regulations are enacted, the U.S. turns against free trade, or some combination thereof."
I cringe when someone I like writes something like this. What if taxes are raised, new regulations are enacted, and free trade is restricted, but the economy doesn't go into recession? Then Prescott's prestige and future advice are discounted. I can't count the "I told you so's" when Clinton's tax increases didn't devastate the economy. In fact, even today, advocates for raising taxes point to that.
I think the economy is robust and adaptive enough to continue to grow at least some in the face of government imposed adversity. The problem is that these sorts of things are death by a thousand cuts, where each incremental adverse change is hardly discernable in the empirical data.
Bret,
Great point. He's making the theoretical point about the general nature of economy-wide policy-making. But it's worded as if it's a prediction. If you asked him, he'd say it's a true statement. Which it is. But it's prone to being used for strategic purposes as you point out.
Bret,
I think Prescott is using the word "combination" to imply "at least one". It's true Clinton's tax hikes didn't send the economy into recession, but trade became much more free in the 90s due in part to NAFTA and China's impending entry into the WTO. And the non-large increase in "productivity-strangling regulations" were offset by Al Gore's invention of the Internet.
One thing I find puzzling is this – the size of government (in absolute terms, certainly, but also with respect to the portion of GDP it consumes) has expanded incredibly over the last two centuries – its intrusiveness seems to have expanded, too, although that's a general sense I have, not something I've quantified. Yet the annual rate of growth of real per capita GDP today is at least as high as, and apparently higher than, it was in the past.
Why?
Morgan,
I just took a look at the Fed's data on real GDP since 1947 and there is no trend upward in terms of year to year growth. In fact, the year to year growth stat goes up and down cyclically but on the whole has a very flat trend line since 1947. Perhaps pre-1947 will illuminate your question further.
But whether there is a correlation of government intrusiveness to GDP growth won't tell you all that much. There have many "improvements" in economic freedom in the past 200 years that surely mitigate the negative ones. An easy example of a positive economic freedom is the Internet. It would take a heck a lot of government interference for the nation to have reduced growth while businesses moved from pencils to computers to networks. But there are also "financing" improvements such as credit cards, various mortgage plans, huge competition in banking, and in general increased velocity in money, etc. We have no idea what GDP growth would have been if there with those improvements but not the added government burden.
My point is that we can't do any ceteris paribus comparisons over the past 200 years. I'm sure that many people would suggest that if the government was the proportionate size in 1800 that it is now the country would not have experienced such economic growth as it has. (Didn't some researcher show that the British in 1776 taxed the colonists less than current Washington D.C. taxation?) It makes me think that government intrusions are more acceptable (to some) when money can move freely, but I doubt you could lay 45% tax burdens during times when money had low velocity and still expect the economy to grow.
"We have no idea what GDP growth would have been … with those improvements but not the added government burden."
Good point.
Can't we be reasonably sure that GDP growth would have been slower if the government burden had been greater? 20th century experiences of other nations seems to confirm that.
python:
You do have to go back farther to see the increasing rate of growth – type "what was the GDP then" into google to get straight to eh.net's figures back to 1790 (which include estimates for the earlier years, I assume).
"We have no idea what GDP growth would have been … with those improvements but not the added government burden."
That's true. But if government interference in the economy has acted as a stronger and stronger break on growth over time, yet the annualized rate of growth has been at least steady, then ceteris paribus growth would be "superexponential". There's probably a real term for it, but what I mean is that the exponent increases over time.
Which is possible, I guess. It's a possibility with huge implications in the long run. Do you think that's what's really going on? Or could this all be an artifact of slowing population growth?
John Dewey:
I think it's tough to say what growth would have been based on what other countries have experienced, because there have been massive coincident changes – world wars, expanding welfare states, "catch up" phenomena and so on.
I'm not sure that recent per capita growth in the EU hasn't been comparable to that in the US (total growth has certainly been slower over the last decade or so, but by a factor similar to the difference in population growth, I think).
But then, given that most EU nations (and the EU as a whole) lag the US by substantial margins in GDP per capita, you could argue that they ought to be catching up rapidly.
Doesn't government intrusion falsely inflate GDP sometimes, which would appear to counteract its negative effects on growth?
I'm thinking of things like the TSA at airports. I assume that their activities show up as billions of dollars worth of GDP, even though with a market driven airport security system consumers would certainly choose a security service that was much more efficient.
In a mostly free economy, where imposed government services have some statistical cost, even though there is no freely chosen market price, don't these services show up as "GDP" regardless of their true value?
Well, Sweden and Germany both had the highest standards of living in the world right up until each country elected a far larger and more intrusive government with taxes need by such a government. A similar correlation is seen in comparing the economies of Britain and a British colony, Hong Kong. I believe Hong Kong had a third of Britain's per capita income right after World War II and, in 1980, actually had a higher per capita income than Britain. The big difference was that Britain elected one an extremely socialist government while Hong Kong kept its free economy.
The tax increases in the early 1990s are a far cry from the socialist governments that have stagnated economies in Europe, especially considering NAFTA and the capital gains tax cuts that proceeded the late-90s boom.
Same thing with another boom used by liberal economist to show how taxes somehow don't limit growth, the 1950s. While the US government did have a top marginal rate of 90 percent in the 1950s, the government and its regulations were much less intrusive than today's US government.
Can anyone explain the source or reasoning behind Prescott's claim that "Theory and practice tell us that the optimal amount of public debt that maximizes the welfare of new generations of entrants into the workforce is two times gross national income, or GDP." I'd be grateful. It makes no sense to me that any quantity of debt is good or bad; only how well the borrowed sums were used determines that.
Morgan,
I'm not sure if anyone is still following this thread, but I just calculated the real GDP growth numbers using the data set that you mentioned. (I had seen that set 2 days ago, but wasn't sure I trusted the numbers.)
And I reach the same conclusion as the other data set. That annual growth is not higher now than it was in the past. The slope of the annual growths is very flat, but it is slightly negative. My analysis was to calculate the yearly growth by a simple Year2/Year1, then to plot those points as the Y values for each Year from 1790 to 2005. The trend line is very flat, and won't cross to negative until 2500 or so.
I'm not sure where you get the idea that growth is higher now. As further evidence, if you calculate the necessary growth rate from 1790 to 2005 you get 3.805%. Meaning, on average, real GDP has grown 3.8% since 1790. For comparative purposes, the rate has been 2.98% since 1990, 3.1% since 1980, 3.1% since 1970, 3.38% since 1950, 3.27% since 1900, 3.63% since 1850.
To test my math, using the data set you mention, 1790 real GDP is 3.60 and 2005 real GDP is 11048.6. Do the calculation 3.60*(1+.03805)^215, and you will get 11046 (close enough for my tastes).
python:
I'm still getting a positive slope. Are you looking at growth of real GDP or GDP per capita? It's the per-capita figures I'm looking at.
Trailing 20-year annualized per capita growth has been almost uniformly over 2% since 1941 (with a brief dip between 1962 and 1965), while it was rarely above that from 1810-1941. I get a slope of +0.00008/year, and with the exception of the huge swings induced by the Great Depression and WWII, it's a pretty steady climb.
Sorry, to be clear, that's +0.008% per year.
Morgan,
I've been looking at real GDP, but not per capita. I will look at the same numbers again tonight with per capita.
As far as the government intrusion/burden side, did you find data which showed the total burden back to the 1800s? I don't think income tax rates are sufficient.
Python:
I didn't find total burden back to colonial times. In fact, now that you mention it, I was unjustifiably focused on federal taxes (which have increased dramatically), assuming that states have not lowered their effective tax rates over time.
The federal government collects something like 18.5% of GDP now, up from almost nothing (about 1%) in the early 1800s and 8% pre WWII.
States and localities collect 9-10% on top of that. I suspect that's more than it was in the past (I can't recall a state or local tax rate ever dropping), but don't have a data source.
Yikes! That means our governments collect roughly $12,133 for every man, woman, and child in the country (18.5% of GDP collected at the federal level and 9.5% at the state/local level = 28% of a $13 trillion GDP, divided by our nice, round, 300 million population).
Do we get that much good out of it?
I think there is no absolute relationship between government size and growth.More importantly,we should consider the quality of government,including the way to collect money and the way to spend.