Abolish the Fed

by Don Boudreaux on August 4, 2009

in History, Monetary Policy

The great scholar of money and banking, George Selgin, has this splendid op-ed in yesterday’s Christian Science Monitor.  Here are some key paragraphs:

But consider: the US economy has actually grown less rapidly since 1914 [the year the Federal Reserve began operation] than it did before. And inflation has been much worse, despite both the Civil War, which featured the nation’s worst inflation, and the Great Depression, which featured its severest deflation!

What’s more, the frequent downturns before 1914 were due, not to the lack of a central bank, but to foolish government regulations. Topping the list were bans on branch banking, initiated by state governments and then incorporated into federal banking law. The bans propped up thousands of undercapitalized and under-diversified banks – banks unfit to survive major local shocks, let alone macroeconomics ones. They also caused bank notes – competitively supplied counterparts of today’s Federal Reserve notes – to trade at discounts whenever they traveled far from the solitary offices of banks that issued them.

During the Civil War, state bank notes were taxed out of existence to make way for those of new national banks. Because national banks had to accept one another’s notes at full value, their currency was uniform. But national bank notes had to be backed by government bonds.

That requirement, designed to bolster the Union’s finances while the war raged on, proved disastrous afterward, when government surpluses led to a halving of the federal debt, and to a corresponding shortage of bonds for securing bank notes. The resulting currency panics – in 1873, 1884, 1893, and 1907 – prompted the Fed’s establishment.

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{ 58 comments }

sandre August 4, 2009 at 6:28 pm

Excellent article.

Dave August 4, 2009 at 6:37 pm

“the US economy has actually grown less rapidly since 1914 [the year the Federal Reserve began operation] than it did before”

I’m not defending the Fed, but this comparison may be unfair for the simple logic that it is harder to grow from a larger base GDP (more accurately, it’s harder to grow from a larger annual GDP per capita base rate). It could be the same reason that emerging economies grow faster than developed economies (generally speaking). It’s not that we necessarily want the institutions and structure associated with the faster growth. For instance, you probably would not want to emulate China’s economic policies in the US just because they have higher GDP growth rates – tt’s just easier to grow when your GDP is closer to 0. So for me, that particular point isn’t so relevant. I do think there are big problems with the Fed though.

sandre August 4, 2009 at 6:51 pm

The reason why emerging economies grow faster is because they don’t have huge government welfare states. They don’t waste money on empire around the world. Countries like Singapore, Hong Kong grow in high single digit rates most of the time, despite the fact that their GDP percapita is much higher than most of the countries in the West.

Anonymous August 4, 2009 at 8:55 pm

Good point. But the question is – are people in Hong Kong and Singapore happy and free despite lack of welfare state?

sandre August 4, 2009 at 11:53 pm

How do we measure happiness! Do you believe all the lies and stats that the various studies puke out from their “happiness research”?

Anonymous August 5, 2009 at 12:03 am

I don’t know since every person’s definition of happiness differs. Left-wingers apparently think they know what makes every person happy.

Justin P August 5, 2009 at 12:18 am

You can’t measure happiness. It’s a fundamentally immeasurable quantity, since my definition of happiness is completely different from yours. I might be completely and utterly happy punching old ladies in the face, and I hope you didn’t. =)

Dave August 4, 2009 at 9:13 pm

I’m certainly not going to argue in favor of a welfare state, but you can look at China’s government spending as a share of GDP compared to the US and Singapore here.

And China tends to have higher GDP growth.

So, my point here is that while I agree that a welfare state (as proxied by government spending as a % of GDP) can be a drag on growth, it doesn’t by itself appear to limit growth. I don’t want to simplify this too much: there are likely many factors that contribute to GDP growth rates. But I would suspect that starting from a low base, along with a movement toward freer trade will probably result in higher growth rates than what we see today in wealthy countries. You can think of this as a form of diminishing returns: after some of the low fruit has been picked in helpig to make a population wealthier, it becomes more difficult to continue that pace of increased wealth. I suspect as Hong Kong and Singpore’s GDP/capita approach that of the US, we’ll see their trend growth slow down. They may even eventually pass us in this measure, but I doubt they will keep up any pace near 10% per year.

Also, it seems that Singapore and Hong Kong have gone through some extended periods of stagnation in GDP per capita. I wonder how much simply recovering from such a long stagnation has allowed them to grow quickly as they catch up with the rest of the world.

sandre August 4, 2009 at 11:51 pm

The GDP figures you quoted seem to be wrong. I looked at the Stats provided by Singapore GOvt. Singapore’s GDP in US$ is over 37,000 per capita and over $52,000 in singapore dollars.

Dave August 5, 2009 at 12:43 am

The figures you quote sound like they are adjusted for purchasing power parity. The ones that Wolfram Alpha quotes are for official exchange rate conversions (they are also for 2005). My copy of the Economist’s Pocket World Figures is in line with Wolfram Alpha. You can see here that the two methods can make quite a difference.

But the broader point is: would you suggest that the primary driver of growth across countries is merely a lack of welfare programs? To what degree do you think it’s true?

My small base theory is sort of easy to understand, but is obviously not the whole story (it’s an “all else equal” story). For instance, poor African countries don’t seem to be able to grow quickly out of poverty for several reasons despite their low base. But this has to do with a lack of freedom, rule of law, and property rights (and maybe other structural problems) as best I can tell. But I’m not sure you would call them welfare states either.

The original point was that just because the United States growth rate was higher before the Fed than after its founding is not in and of itself evidence that the Fed has slowed growth over its existence (even if the idea is ultimately true). I assume you would agree with that, perhaps pointing to the increased welfare programs that have been implemented since the Fed’s founding as being another important difference in the pre- and post- Fed Americas.

Anonymous August 7, 2009 at 5:57 pm

I’d use a revealed preference definition (would more people rather leave or arrive there?), and its proxy of real estate values. By those standards, HK and Singapore do mighty well.

Anonymous August 4, 2009 at 10:40 pm

Selgin’s point about growth during the 19th vs. 20th century cannot be immediately dismissed on grounds of the GDP/head base. Keep in mind that in 1776 the American colonies were probably the wealthiest place on earth. The U.S. was up against the frontier of technology and the division of labor throughout the period Selgin cites.

it is curious that growth in the west accelerated from the reformation to 1914, and then slowed. I think the impact of WWI and the end of the first era of globalization makes estimating the effect of central banks very hard.

Dave August 5, 2009 at 12:48 am

Yes, I agree that it’s hard to tease out what affects growth. And as I just wrote in another comment, the idea that the Fed really was a drag on growth may in fact be true. But comparing those two periods while ignoring other important differences won’t yield a definitive answer. It’s too simple, in my view, and doesn’t strengthen the case against the Fed, for which there are many more concrete points.

Anonymous August 4, 2009 at 6:55 pm

If the Fed and federal banking laws were abolished what would prevent the reemergence of the state banking laws that Selgin writes about? Would these attempts be prevented by “asset currency” measures?

Anonymous August 4, 2009 at 7:55 pm

Selgin has written a lot of interesting material about free banking, and especially the success of free banking in Scotland during the 17th and 18th centuries. One salient feature of Scottish free banking was that all of the banks had unlimited liability. Does anyone know if Selgin considers unlimited liability to be a necessary feature for successful free banking?

Anonymous August 4, 2009 at 8:52 pm

What do you mean by unlimited liability? Please give an example.

Anonymous August 4, 2009 at 9:03 pm

During the Scottish free banking period partners in a bank were personally liable for the bank’s debts if the bank itself was unable to meet them. I’m not sure how well this would sit with modern sensibilities, so I was wondering if Selgin thought it was an indispensable part of free banking.

Anonymous August 4, 2009 at 9:28 pm

I don’t see how that scales to multi-trillion banking industry. However in a nascent banking industry, I can see how being personally liable as the bank owner will motivate you to make smart loans and not go for the quick buck. That speed-bump precludes any fast economic growth, which I would think Prof Boudreaux would be against. You take away limited liability and Corporate America falls down like a house of cards.

Anonymous August 5, 2009 at 4:57 am

It’s a common distinction today. A sole proprietor or partnership have unlimited liability, meaning the company owner’s are personally liable for actions against the company.

Corporations and limited liability companies (LLCs), on the other hand, have a sharp distinction between the owners and the company. In those cases, personal assets are held as separate and protected against action against the company.

Imagine being a shareholder of AT&T, which makes you a part owner, and having lawyers go after your house and savings after a successful lawsuit against AT&T.

Anonymous August 5, 2009 at 5:21 am

To give you an example of how easy a multicurrency society could be, consider that there is toll road company in your city with one of those automatic RF or license plate camera toll booths you see so much of these days. Imagine they tell you that they don’t take USD. They only take TollTokens, their own private currency. When you set up your automatic account with them, you set it up to buy a certain amount of TollTokens every time your account goes empty. The Toll company site has instantaneous exchange rates (how many USD to by a TollToken) online. Depending on the exchange rate, one time you refill your account it is $23.55. Another time it is $32.62.

The point is, you buy the TollTokens when you want to purchase the toll companies services, and the toll company always lists the current price (in USD, grams of gold, etc).

It is very easy to understand on a transaction level, so it is very easy to use. The only time it is complicated is if you are a currency speculator. Then you must constantly keep track of the changing rates so that you can speculate or find mismatches to profit from (just like currency traders today).

And an explosion in the number if different currencies like that would make it easy for people to both diversify, and to move out of a currency that is being mismanaged.

When it came time to pay taxes, or when you want to by Treasuries, you will be happy to see the conversion rate from your private currency to the mismanaged inflated government currency.

UPDATE: sorry I posted this in the wrong spot. I meant it later under the currencies discussion.

Gary Chartier August 4, 2009 at 9:09 pm

Limited liability seems pretty mischievous under any circumstances when people don’t explicitly contract for it. It ought to be the default option. (This would mean it might be available sometimes in contract, but obviously couldn’t be in tort, which seems all to the good.)

seanooski August 5, 2009 at 12:56 am

I should think that growth rates optimally increase and decrease as the market dictates. I have trouble understanding why fast growth always equals good, and slow growth is always bad.

Anonymous August 4, 2009 at 9:32 pm
Bret August 4, 2009 at 11:02 pm

Two things give me great concern when talking about abolishing the Fed. First, it’s interesting to point out that free banking has worked in the past (Scotland, for example), but that was then, this is now. Things are simply more complicated.

Second, the question that doesn’t seem to be answered is how to get from here to there. Clearly, abolishing the Fed tomorrow wouldn’t be wise, but I haven’t seen a plan of how to phase out the Fed. Even Selgin (I think) has proposed nominally have the Fed maintain a base currency, but have everything else free.

I think that abolishing the Fed could be a fatal mistake – or, perhaps, thinking that you’ve thought through all the complexities adequately could be a Fatal Conceit.

sandre August 4, 2009 at 11:50 pm

Hayek has written on free banking and competing currencies in his book “Denationalization of Money”, available as a download at this link
http://www.iea.org.uk/files/upld-book431pdf?.pdf

In addition, Jesus deSoto ( a rothbardian ) has written about this transition in his book “Money, Bank Credit and Economics Cycles”. It is available as a free PDF download on mises.org. For now, the link doesn’t seem to work. It is an enormous book with over 100 pages dedicated to this subject.

Ron Paul has suggested that instead of eliminating central bank overnight, his proposal would be to remove the legal tender laws, and remove all taxes on gold and silver and let the market do the trick over time.

I am sure there are other works on this topic possibly by Larry White or George Selgin.

Justin P August 5, 2009 at 12:24 am

Paul’s idea makes the most sense. Gold as a medium of exchange was international. Bank notes were honored because they could be exchanged for the set amount of gold. Which in turn meant that reputation was everything. In our current system, reputation is meaningless.

Anonymous August 5, 2009 at 5:05 am

Gold is fine, and if US history is any example, it may be better to use a single commodity rather than a mixture (read about US bimetallism).

But a better solution is simply to revoke Lincoln’s legal tender laws, and ALLOW clearly labelled unregulated caveat emptor “freebanks” to evolve in parallel to the current Federal Reserve system. Then leave it up to the freebanks to come up with their own currency ideas.

And with today’s electronic currencies, having a multiple currency system could be almost seemless, compared to antebellum US.

Justin P August 5, 2009 at 12:33 am

The Fatal Conceit was the notion that men could understand and tweek such a complex system as money and the economy by fiat in the first place. I don’t see how you can say that the system is too complicated for the market to handle, which by definition is also complex and vast system, yet seem completely fine with the notion that a board consisting a just a few individual have all the knowledge necessary to govern not only the banks but the entire economy. Google, Ben Burnanke was wrong on youtube to a montage of clips showing Ben consistently wrong on the economic situation.

The Fed has failed at it’s original mission, to protect the value of the dollar and stop bubbles. It has devalued the dollar to a pittance of its pre-1913 levels. It helped cause the Great Depression, 1970′s stagflation and the housing bubble.

Gil August 5, 2009 at 6:14 am

“it is curious that growth in the west accelerated from the reformation to 1914, and then slowed.” – jpirving.

Uh huh. Most people would notice more changes in the standard of living in the West from 1900 to 2000 than 1800 to 1900.

But the talk of multiple currencies! Yikes! Who wants go from one place to another and constantly exchange currencies on the go? Heaven forbid some people may not even recognise certain currencies! Why not have a single currency based on gold weights whether it be in literal chunks of bills representing a fixed weight of gold? Sheesh!

George Selgin August 5, 2009 at 2:07 pm

Some readers seem to think that you need a central bank to have uniform currency. That just isn’t so–though it’s something central bankers want people to believe! As my article suggests, the lack of a uniform currency in the antebellum U.S. was a peculiar result of laws against branch banking. Where banks that issued their own notes were allowed to branch freely (e.g. Scotland and Canada), banknotes tended to trade at uniform par or face values–they were, in other words, just as good as the gold or silver money that they stood for.

Anonymous August 5, 2009 at 2:43 pm

error

Anonymous August 5, 2009 at 2:47 pm

So you are saying that in those instances there was de facto but not de jure uniform currency because par value was maintained?

Currency declines in value with distance from its issuing institution, so widespread branch banking helps preserve par value?

Is there a similar distance effect with, e.g., USD in China or other remote places?

Anonymous August 5, 2009 at 9:59 pm

I find it especially interesting that Canada ultimately moved toward an inflationary Central Bank despite a robust, largely panic-free system. My guess based on this article and other reading is that it was to appeal populist anti-creditor sentiments amid the global downturn. There’s a tyranny of the majority inherent in this situation where the number debtors inherently outweighs the number of creditors.

Since the money supply in Canada shrank by 13%, I assume there was nominal deflation which may have increased real burden on debtors with fixed nominal debts.

My question is, why did the money supply in Canada contract if no banks failed? Shouldn’t economic uncertainty have driven up the demand of money and lead the free banking system produce more to meet demand? Maybe (probably) I’m confused about the forces that drive the demand for money. If there had been no contraction, would the siren call of the inflationists have been effective?

Name August 6, 2009 at 3:31 pm

I’ve been waiting 2 days for a post! do you guys not love us anymore?

SunnyMolini August 6, 2009 at 7:07 pm

As a divergent issue. How could it be possible, with the world as fully explored as it is, to create a new nation for the purpose of rebuilding social institutions from scratch? There have been huge leaps in understanding of social science since the days of Locke and Smith.

Does the human race really have to wait until we can colonize other planets before we can start experimenting with new social orders again?

Anonymous August 7, 2009 at 7:50 am

The long term trend does seem to be in the right direction. Most of man’s history is dominated by citizens’ brutal subjugation to the state, so fascists and socialists are really nothing new. They are just the dregs of ages past, clutching desperately at liberty’s fracturing chains as it carries man into the future.

Anonymous August 7, 2009 at 4:37 am

From 1790 – 1914:
Real GDP growth: 4.04%
RGDP/capita: 1.37%

From 1914 – 2008:
Real GDP growth: 3.43%
RGDP/capita: 2.20%

The first period is one of higher population growth than the second. The average person became richer at a much faster rate in the second period. If per capita GDP had grown as slowly as it did in the period before the Fed, GDP would a little less than half what it is today. Where would that put the U.S.? It would put us about 40th in the world in per capita GDP about equal to countries like Estondia, Portugal, and Hungary.

Doesn’t sound so good now, does it?

Anonymous August 7, 2009 at 7:35 am

I haven’t checked your numbers, but it is an interesting point if true.

The last great wave of immigration (as a % of US population) ended in 1910. A large % influx of poor would tend to bias down the GDP/cap. So calculating over a time interval ending with that influx would bias those interval numbers down (pre-1910). It would also bias upward GDP/cap intervals starting with that influx (post-1910). Economics never has a shortage of confounders, but this one seems particularly germaine.

Perhaps a more interesting and less empirical question is: What theoretically is the expected relationship between population and GDP? All else being equal, would you expect the difference in growth rates to be constant over time (GDP/cap % fixed)? Or would you expect the rate spread to grow over time (GDP/cap % grows). The former strengthens your point, the latter weakens it.

I can understand population growth being exponential, and GDP therefore also being exponential, but I can’t think of any reason to expect one rate relationship over another, as long as both rates are positive.

Anonymous August 7, 2009 at 3:26 pm

“Or would you expect the rate spread to grow over time (GDP/cap % grows).”

The power of a good night’s rest. Of course RGDP/cap should grow. Think comparative advantage. Specialization permits increased productivity. When two people cooperate for mutual benefit, they each increase their productivity. 10,000 isolated communities of 100 specialists will be less productive than one community of 1,000,000 specialists each cooperating for individual advantage.

So, the real GDP growth rate is expected to *progressively* exceed the population growth rate in a free trade community, ceteris paribus. That is, the spread between the two rates should widen.

So, even without the Fed we would’ve expected RGDP/capita to grow beyond 1.37%. What you need to look at is the acceleration rate of GDP. You need more time points in each interval. Compute RGDP growth rate for several subintervals before 1914 and also after 1914 and see if the expected rate of growth of RGDP/capita was maintained.

Anonymous August 7, 2009 at 5:26 pm

The data are at (www.measuringworth.com).

Here is dividing pre-1914 and post 1914 into two equal periods

1790 -1852, 1852 – 1914, 1914 – 1961, 1961 – 2008

Real GDP per capita 1.36% 1.38% 2.23% 2.17%

So growth rate of RGDP/capita growth rate will prove to be very difficult to pin down. It is the change in a trend line and likely to be very small compared to the changes in the GDP/capita series.

I don’t think looking at GDP series will lead to a very convincing argument to for or against the fed. Mostly, I wanted to point out that the data actually support the opposite of Selgin’s point, and I think that makes him look uninformed or disingenuous.

Anonymous August 8, 2009 at 3:40 am

Thanks for the link, and for running some more numbers.

“I wanted to point out that the data actually support the opposite of Selgin’s point”

Your second post of numbers lends some support to your assertion, but only because 2.23% from 1.38% seems like a lot larger jump than 1.38% from 1.36%. But I hope you realize that your first post did NOT have the data to illustrate your point, seeing as RGDP/cap is expected to grow with or without a Fed.

It is a little disturbing, however that RGDP/cap fell after 1960. It should not fall. It should not even stay the same. It should increase. It is suggesting that some negative economic factor is more than negating the positive productivity effect of adding more people to the trade pool.

What do you think about the idea of the immigration waves pulling down the 1914 data point, thereby biasing down 1.38% and biasing up 2.23% (i.e. the jump may not really be as big). Do you know of any data that would permit a rough calculation of that effect?

Anonymous August 8, 2009 at 4:36 am

“seeing as RGDP/cap is expected to grow with or without a Fed.”

I feel the need to point out at this point that this is your theory and not something the economics profession sees as generally true. In general, large countries don’t grow faster than small countries. In fact, population growth and growth rate generally have a negative correlation. It should be obvious that there are many counterarguments to your simple theory. For instance, governance may be difficult as countries get large (institutions more difficult to form). Also, there is the complicating factor of trade. Does Florida gain increased specialization or innovation if many people move in from Georgia? Probably not, as there is already a lot of trade between the states. And here is one adapted from a Bryan Caplan argument. Income is positively correlated with IQ, people with low IQs have more babies than high IQs, IQ is hereditary. So over time, the percentage of low IQ people increases, “ceteris paribis” RGDP will go down over time.

“It is a little disturbing, however that RGDP/cap fell after 1960. It should not fall.”

Don’t forget the old stand by, the Solow growth model. American growth is mostly driven by technological change–invention and innovation. This is quite prone to chance: penicillin, Einstein, Edison… history is riddled with examples of random occurrances or individuals with large effects, and there are many more we can’t observe.

Also, things like wars and oil shocks affect growth. Also, potentially population make up affects RGDP. If a baby is born, RGDP goes up, RGDP/capita goes down. If an immigrant comes to the US RGDP goes up, RGDP/capita could go up or down.

“What do you think about the idea of the immigration waves pulling down the 1914 data point, thereby biasing down 1.38% and biasing up 2.23% (i.e. the jump may not really be as big). Do you know of any data that would permit a rough calculation of that effect?”

I think it potentially explains some of the difference. If 1% of people are added with half the average productivity it lowers RGDP/capita a little less than half a percent. Do it again and gdp/capita is down 1% So low skilled waves could have a noticable effect. Though I doubt my numbers match the actual numbers very well.

Anonymous August 11, 2009 at 7:46 pm

RESET.

Okay. Your last reply persuades me that you are not being disingenuous.

“The status quo may not have productivity growth, thus preserving it will not lead to increased productivity. QED.”

Unfortunately QED requires that you don’t make a formal deductive error: from “may” not have growth one can only deduce “may” not lead to increased productivity. QED also requires that you don’t commit the informal fallacy of wrong conclusion: the existence of an exception has little bearing on the likelihood of an outcome.

Let us not forget that my assertion is that the expected result, all else being equal, of adding people to free trade, is an overall increase in productivity, compared to the nontrading state. As a simple illustration, I gave you the case of just two people.

We are, of course, talking about populations of people. So let me try this approach.

You have 1000 experiments each of which is simply as follows: Two people who are currently self-sufficient discover one another. They each are given the choice about whether or not they will trade with each other.

Let’s be clear:

1. The choice is left up to the individuals. We are not assuming any particular choice per se. We are assuming only that they are humans, acting as we expect humans to act.

2. The environments for the individuals may vary in a random or even haphazard way across experiments, but the environment immediately pre- and post-choice within each experiment is unchanged. Only the effects of the choice cause any change.

3. You don’t know the environments in which the experiments are taking place except to the extent the experiments are possible (the individuals have been self sufficient).

Now which of the following do you think is true?
A) It is most likely overall productivity would increase.
B) It is most likely overall productivity would decrease.
C) It is most likely overall productivity would not change.
D) Two or more of the above are equally likely.

Anonymous August 11, 2009 at 9:58 pm

“Unfortunately QED requires that you don’t make a formal deductive error: from “may” not have growth one can only deduce “may” not lead to increased productivity.”

Consider the theory: 2x > 0. I would say x, may not be positive, thus the theory is wrong. Any non-positive number is a counter example. All I needed was one to disprove the theoy, and I’ve found an uncountably infinite amount.

“QED also requires that you don’t commit the informal fallacy of wrong conclusion: the existence of an exception has little bearing on the likelihood of an outcome.”

There is no likelihood of an outcome as there is no probability distribution. You’d have to make some assumption about what x’s can be chosen with what frequency for me to tell you something about likelihood.

As for your example, I choose E) nothing can be said about likelihood. This is akin to asking, given 1000 randomly selected math problems what is the probability the answer will be positive. It’s a meaningless question, because there is no specified distribution from which we are drawing math problems. If we went to 1000 people on the street, almost all of the math problems would give positive answers. But that tells us nothing about the distribution of problems more generally. In the same way, what is the distribution two people can exist over all possible states and relative frequencies. It is a meaningless question.

The better way to proceed is just to put your assumptions forward first and make sure they prove your argument. For instance, Ricardo assumed two countries, within countries people were identical, across the two countries there were differences. Specifically, one country has an absolute advantage in wool and wine, but the other has a relative advantage in wine. Both countries have full employment and there are no transaction costs or transportation costs across countries. From here, he derives comparative advantage.

It’s an important theory that has earned Ricardo very deserved status in the profession. Does it actually describe the majority of international trade? No, it doesn’t. Under Ricardo’s theory trade comes from differences between countries, and countries specialize almost completely. In the real world, trade occurs most commonly between similar countries trading similar goods (US and Europe selling cars to each other) or countries geographically close (US and Mexico/Canada). So new trade theories evolved that better explained the real world. Does that mean comparative advantage has no effect? No, of course not, it just means its effect is in the context of other factors driving trade.

George Selgin August 8, 2009 at 11:10 am

Concerning growth in real per capita GDP, if you read my entire article, you’ll see that my remarks refer to a comparison between the 1854-1914 and post-1914 periods. I didn’t go back to 1790 because (1) the remark I was responding to refers to later data only, having been based on NBER recession data that only go back that far; (2) earlier GDP stats are very unreliable; and (3) the U.S. had quasi-central banks from 1791 to 1811 and again from 1816 to 1836.

Anonymous August 9, 2009 at 1:23 am

From (www.measuringworth.com)

From 1854 – 1914, RGDP/capita annualized growth rate is 1.36%.

From 1915 – 2008, RGDP/capita annualized growth rate is 2.21%.

Are you sure you weren’t using RGDP and not RGDP/capita? If you have different data from NBER, please let me know, I use this site frequently and would like to know if it’s wrong or disputed.

The text makes it sould like you just used RGDP, “the US economy has actually grown less rapidly since 1914 than it did before.”

Anonymous August 8, 2009 at 4:55 am

“not something the economics profession sees as generally true.”

I just can’t tell you how significant that is to me. ;->

Naturally there are many real and potential confounding factors. The c.p. excludes everything but the simple notion of a growing population of free traders. Certainly that would predict a growing RGDP/cap. One then has to ascertain the effects upon that growing base of those factors that aren’t really being held equal.

I have to say, though, that I don’t quite understand the point of declining IQ and technology.

Technology has been exploding in recent decades, especially since 1960. It should have the opposite effect that you describe.

The IQ effect you mention should always be at play. So productivity growth should not happen over human history, but of course the opposite is quite the case.

Additionally, you might expect that if IQ were dropping, then, c.p., productivity would fall. But the productive effects of trade exist to some degree regardless of IQ. So, with a growing trading population, it is not clear which effect would dominate.

Your point about political boundaries is a good one. Perhaps it is such restrictions on free trade that dampen RGDP/cap over time.

But it would appear that RGDP/cap really is dropping, so you are right that SOMETHING must be doing it. I just don’t see how the IQ and technology arguments can explain it.

Anonymous August 8, 2009 at 8:11 am

“The c.p. excludes everything but the simple notion of a growing population of free traders. Certainly that would predict a growing RGDP/cap.”

Again, no it doesn’t. I gave you several potential counterarguments. You concede the governance point, so I’ll move on to the other two.

The IQ point: The reason I put “ceteris parabis” in quotes was to emphasize that the argument holds everything else constant.

So this point: “The IQ effect you mention should always be at play. So productivity growth should not happen over human history, but of course the opposite is quite the case.” Isn’t valid, because technology growth was being held constant.

Try a thought experiment. Imagine there are two types of people smart and dumb. Only the dumb people have babies. The babies are usually dumb but sometimes smart. Obviously, over time there will be more and more dumb people than smart people. In fact the percent of smart people in the economy will approach zero over time. Now if technology is constant, the RGDP/capita will change from the average of the incomes of smart and dumb to just the income of the dumb people.

Does that mean you can’t have RGDP/capita growth if all things aren’t held equal? Of course not, you could still have technology based growth, and the technology growth could trump the IQ factor.

“Technology has been exploding in recent decades, especially since 1960. It should have the opposite effect that you describe.”

Don’t confuse technology with things that use microchips. The first shovel increased productivity much more than the first iphone, the first steamship and the first locamotive much more so than the first spaceship.

Technology is something that converts hours worked into GDP. It’s a stylized fact of the business cycle that hours worked per capita doesn’t change much over time, thus RGDP/capita should come close to mirroring productivity increases over time. But while that holds true in the post-WWII era, I don’t know if it holds true over the very long horizons we are considering.

Just remember all of these factors are happening all at once in the data.

1992 – 2000 was a technological boom time, with a lot of productivity growth. (RGDP/capita 2.49%)

1980 – 1992 had some financial turmoil, a major real estate bubble burst, not so much productivity growth (RGDP/capita 1.94%)

1972 – 1980 had large negative oil shocks, bad monetary policy, less productivity growth (RGDP/capita 1.86%)

And 2000 – 2008, it drops considerably to 1.21%, this is driven by the tails, 2003 – 2005 was 2.36%.

Anonymous August 8, 2009 at 12:45 pm

ME: “The c.p. excludes everything but the simple notion of a growing population of free traders. Certainly that would predict a growing RGDP/cap.”

YOU: Again, no it doesn’t. I gave you several potential counterarguments.

You gave me several confounders. I hate to take this back to such an elementary level, but that basic level was my point: Two people on a desert island who don’t know each other exist are trying to live. After a few years they discover one another and decide to work together for mutual benefit. You don’t think their production would stand to increase?

“Now if technology is constant, the RGDP/capita will change from the average of the incomes of smart and dumb to just the income of the dumb people.”

I think I see why we are talking past each other. You don’t seem to believe that cooperation and specialization increases productivity. My point was merely that if you go from 100 dumb people trading to 10000 dumb people trading, you would still expect RGDP/cap to increase. Maybe not as much as if those people were smart, but it would still increase. So you have that increasing productivity countering the effect of a growing proportion of dumb people. I don’t see how you can tell which is the more influential factor.

But a more obvious point is–do you really think that humans have been getting progressively dumber over the last 100,000 years?

“Don’t confuse technology with things that use microchips. The first shovel increased productivity much…”

But it should be cumulative. We didn’t lose the shovel when we found the steamship. And population growth shouldn’t detract from it–a shovel is no less useful to one person just because 100 other people have it. Whether technology growth after 1960 was more or less than before (I still suspect it was more), it most definitely should not have resulted in a fall, or even stagnation, of RGDP/cap.

You gave examples of setbacks in the post-1960 era, some of which I think ring true–particularly bad monetary policy. But those examples bolster Selgin’s point about the negative effect of the Fed on economic growth.

Anonymous August 9, 2009 at 1:15 am

“You gave me several confounders. I hate to take this back to such an elementary level, but that basic level was my point: Two people on a desert island who don’t know each other exist are trying to live. After a few years they discover one another and decide to work together for mutual benefit. You don’t think their production would stand to increase?”

You are making several assumptions to get to your conclusion. I’m attacking them. That is not something you can say ceteris parabis to and make go away. For instance, in your example, what if bargaining costs are very high–it takes time to haggle out a deal. Maybe one person is even deaf! What if they have to work on different parts of the island (maybe that’s where the coconuts are) and there are substantial transportation costs (coconuts are heavy!)

Ceteris Paribis is holding all other things equal. So we could ask, under these assumptions what happens as bargaining costs rise holding all other things equal?

On the other hand, I’m attacking the theory. I’m attacking the assumptions. The point is that the theory is not self-evident like you seem to think it is. It rests on several assumptions that may not be true.

“So you have that increasing productivity countering the effect of a growing proportion of dumb people. I don’t see how you can tell which is the more influential factor.”

I can’t, that was my point. The effect on my example could be offsetting the effect of your example. The point was your model makes simplifying assumptions that may not be true.

“But a more obvious point is–do you really think that humans have been getting progressively dumber over the last 100,000 years?”

No, but humans are probably dumber than they would be if birth rates were equal across incomes. There are obviously several confounding variables that push it the other way. One is evolution. Another (on smaller time horizons) is nutrition.

“But it should be cumulative. We didn’t lose the shovel when we found the steamship.”

But realize we are measuring growth of real GDP/capita, which is on a positive trend. Suppose an economy has no growth of any kind. The growth rate is 0. GDP is 100. Population is 1. Enter new technology. Shovel that increases GDP to 110. The growth rate is 10%. But the next year, the GDP is still 110, and the growth rate has fallen to 0. The insight is that when technological change is causing the growth, one needs change to continue to keep getting growth. If you have lots of great inventions one year and fewer in the next, the growth rate goes up and then down.

Anonymous August 11, 2009 at 4:54 am

“So we could ask, under these assumptions what happens as bargaining costs rise holding all other things equal?”

The answer: Almost certainly nothing, since people usually don’t choose to act in ways that make them worse off.

You seem to forget that each party has a veto–each can choose to continue as they were, or to proceed with cooperation. That is, after all, what is meant by “free trade”. You have to wonder why they would’ve chosen cooperation if they thought they would be worse off.

It is not a matter of whether or not a counter example can be imagined, but given these circumstances, how likely do you think it would be that people would make a choice to be worse off than they already are?

I find it very interesting that you take this stance. What are your thoughts on comparative advantage? Do you think it is a false theory? Do you think that specialization contributes to wealth? What do you think is the ultimate source of wealth creation? What is the source of the unprecedented wealth creation in countries with a greater capitalist presence?

It seems we have found a point of fundamental disagreement between us. I’m looking forward to your answer, but I think that will be end of the discussion as it seems the walls are closing in on this discussion rapidly.

“No, but humans are probably dumber than they would be if birth rates were equal across incomes.”

So your dumbing down rule works sometimes but not others? During times of bad nutrition it doesn’t work, otherwise it does? Human evolution 100K years ago caused it to not work then, but to work now?

Anonymous August 11, 2009 at 5:28 am

“So your dumbing down rule works sometimes but not others?”

You seem to not understand that many different forces can be acting on something at one time. Consider an object traveling at a certain force in one direction. If the object travels into the wind, it will travel slower. If it travels with the wind, it will travel faster. The wind could be a large or a small effect depending on how fast the object is traveling and how aerodynamic it is. Does it make any sense to say, “oh, you say the wind can move objects, but I threw a baseball into the wind and it went just fine. So where is this wind thing?”

“”So we could ask, under these assumptions what happens as bargaining costs rise holding all other things equal?”

The answer: Almost certainly nothing, since people usually don’t choose to act in ways that make them worse off.”

Again, you aren’t thinking about the assumptions you are making. If trading gains each X units of welfare, but the bargaining costs or transportation costs are much higher than X, then they aren’t better off trading. They’re worse off.

There could be a huge population of Martians with a vast supply of oil or diamonds with a huge demand for salt water, and we still wouldn’t have any gains from trade with them, because the transportation costs would be so high.

Anonymous August 11, 2009 at 7:14 am

“Again, you aren’t thinking about the assumptions you are making. If trading gains each X units of welfare, but the bargaining costs or transportation costs are much higher than X, then they aren’t better off trading. They’re worse off.”

I think you didn’t read my whole post. My point, once again, is that they are not worse off, if they do not do it. It seems your confusion is a little deeper than I thought. Do you know what it means to have a choice? Do you think that when people have a choice, they generally choose for, or against, their personal best interests?

Anonymous August 11, 2009 at 7:24 am

Um, yes, and yes, but you are veering very far off course.

BTW, the answer is as bargaining or transportation costs rise trade will decrease and could stop between the two individuals (often called autarky in economic models). In other words, costs affect the equilibrium, BECAUSE people persue their self-interest.

Anonymous August 11, 2009 at 7:32 am

“Um, yes, and yes”

Okay, so if you think people usually choose in their best interests, how can you think the choice to maintain the status quo unless a mutually beneficial alternative exists, does not on the whole lead to increased productivity?

Anonymous August 11, 2009 at 5:58 pm

Don’t you see Y does not follow from X?

If you lay out the argument, you’ll see that it requires many assumptions that may or may not hold. This is a perfect example of why modern econ is done rigorously with math and formal proofs. What “sounds true” does not necessarily logically follow.

Anonymous August 11, 2009 at 6:16 pm

I am trying to lay out the argument and you keep dodging it. I can’t tell if it is because you don’t understand, or because you’re trying to avoid it. If you want to have a discussion,please respond directly to my post, otherwise I’ll assume discussion is not your interest and stop wasting my time.

Anonymous August 11, 2009 at 6:44 pm

I would be happy to discontinue the discussion, because if this is you doing your best to lay out your argument, you have a long way to go before you can enter a serious economic discussion.

“Okay, so if you think people usually choose in their best interests, how can you think the choice to maintain the status quo unless a mutually beneficial alternative exists, does not on the whole lead to increased productivity?”

But here is the simplest way to show that your argument does not follow.

The status quo may not have productivity growth, thus preserving it will not lead to increased productivity. QED.

If you’ll notice, the texture of the discussion thus far has been, you posit a theory, I produce a counter example, you not understand and rinse and repeat.

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