Tag: economic growth

Cutting Government the Canadian Way

I blogged about how Canadian government spending cuts since the mid-1990s coincided with strong economic growth.

Let’s take a closer look at the spending cuts. The chart shows Canadian federal spending from 1984 to 2009 in actual, or nominal, dollars. Spending includes all “discretionary” and “entitlement” programs, as we would call them, but excludes interest payments. (Data are here).

Spending peaked in the early 1990s, and it relied on massive deficit finance. As a result, interest costs were spiralling out of control. The prime minister and his finance minister–members of the center-left Liberal Party–decided to reverse course and start cutting.

They cut spending from $123 billion in in 1995 to $111 billion in 1997, a 10 percent reduction. Then they held spending at roughly the lower level for another three years. With the Canadian economy growing–due to pro-market reforms such as free trade with the United States–this amount of restraint was enough to start a virtuous cycle of falling interest costs and a shrinking government as a share of GDP.

Cutting total non-interest spending by 10 percent would be like cutting President Obama’s 2011 annual budget by $360 billion. Cato analysts could do that pretty easily, but for some reason American politicians–even of the conservative variety–so far seem to be alot more spineless than the politicians elected by Celine Dion and Anne Murray.

Canadian spending did grow during the past decade, but much less than U.S. government spending. Between 2000 and 2009, total Canadian federal spending increased 47 percent, but total U.S. federal spending rose 97 percent.

From a libertarian point of view, Canada’s spending cuts were modest. But the Canadian experience illustrates that a lot of progress can made if even modest cuts are made and then spending is constrained to grow at a slower rate than the overall economy.

For more on the Canadian fiscal reforms, see The Canadian Century by Brian Lee Crowley, Jason Clemens, and Niels Veldhuis.

Media Feeds America’s Skepticism about Trade

As usual, Dan Griswold does an excellent job today correcting fallacies about trade and the trade deficit that continue to be perpetuated in the mainstream media (particularly at the Washington Post).  

I just want to add my two cents without belaboring any of Dan’s succinctly-made points.  (Besides, I’ve harped on and on and on and on and on about the problem of trade reporting this year.) It’s a shame that so much time and energy has to be diverted to cleaning up messes left by reporters and editors, who should know better by now.

The bottom line is that neither imports nor trade deficits cause U.S. job loss or slower economic growth.  If anything, the charts below (all compiled from BEA and BLS data) support the conclusion that imports and the trade deficit rise when the economy is growing and creating jobs, and they both fall when the economy is contracting and shedding jobs. 

Don’t Be Afraid of the Chinese Economic Tiger

The news that China has surpassed Japan as the world’s second-largest economy has generated a lot of attention. It shouldn’t. There are roughly 10 times as many people in China as there are in Japan, so the fact that total gross domestic product in China is now bigger than total gross domestic product in Japan is hardly a sign of Chinese economic supremacy.

Yes, China has been growing in recent decades, but it’s almost impossible not to grow when you start at the bottom — which is where China was in the late 1970s thanks to decades of communist oppression and mismanagement. And the growth they have experienced certainly has not been enough to overtake other nations based on measures that compare living standards. According to the World Bank, per-capita GDP (adjusted for purchasing power parity) was $6,710 for China in 2009, compared to $33,280 for Japan (and $46,730 for the U.S.). If I got to choose where to be a middle-class person, China certainly wouldn’t be my first pick.

This is not to sneer at the positive changes in China. Hundreds of millions of people have experienced big increases in living standards. Better to have $6,710 of per-capita GDP than $3,710. But China still has a long way to go if the goal is a vibrant and rich free-market economy. The country’s nominal communist leadership has allowed economic liberalization, but China is still an economically repressed nation. Scores have improved, but the Economic Freedom of the World report ranks China 82 out of 141 nations, just one spot above Russia, and the Index of Economic Freedom has an even lower score, 140 out of 179 nations.

Hopefully, China will continue to move in the right direction. That would be good for the Chinese people. And since rich neighbors are better than poor neighbors, it also would be good for America.

When Keynesians Attack, Part II

I’m still dealing with the statist echo chamber, having been hit with two additional attacks for the supposed sin of endorsing Reaganomics over Obamanomics (my responses to the other attacks can be found here and here). Some guy at the Atlantic Monthly named Steve Benen issued a critique focusing on the timing of the recession and recovery in Reagan’s first term. He reproduces a Krugman chart (see below) and also adds his own commentary.

Reagan’s first big tax cut was signed in August 1981. Over the next year or so, unemployment went from just over 7% to just under 11%. In September 1982, Reagan raised taxes, and unemployment fell soon after. We’re all aware, of course, of the correlation/causation dynamic, but as Krugman noted in January, “[U]nemployment, which had been stable until Reagan cut taxes, soared during the 15 months that followed the tax cut; it didn’t start falling until Reagan backtracked and raised taxes.”

This argument is absurd since the recession in the early 1980s was largely the inevitable result of the Federal Reserve’s misguided monetary policy. And I would be stunned if this view wasn’t shared by 90 percent-plus of economists. So it is rather silly to say the recession was caused by tax cuts and the recovery was triggered by tax increases.

But even if we magically assume monetary policy was perfect, Benen’s argument is wrong. I don’t want to repeat myself, so I’ll just call attention to my previous blog post which explained that it is critically important to look at when tax cuts (and increases) are implemented, not when they are enacted. The data is hardly exact, because I haven’t seen good research on the annual impact of bracket creep, but there was not much net tax relief during Reagan’s first couple of years because the tax cuts were phased in over several years and other taxes were going up. So the recession actually began when taxes were flat (or perhaps even rising) and the recovery began when the economy was receiving a net tax cut. That being said, I’m not arguing that the Reagan tax cuts ended the recession. They probably helped, to be sure, but we should do good tax policy to improve long-run growth, not because of some misguided effort to fine-tune short-run growth.

The second attack comes from some blog called Econospeak, where my newest fan wrote:

I’m scratching my head here as I thought the standard pseudo-supply-side line was that the deficit exploded in the 1980’s because government spending exploded. OK, the truth is that the ratio of Federal spending to GDP neither increased nor decreased during this period. Real tax revenues per capita fell which is why the deficit rose but this notion that the burden of government fell is not factually based.

Those are some interesting points, and I might respond to them if I wanted to open a new conversation, but they’re not germane to what I said. In my original post (the one he was attacking), I commented on the “burden of government” rather than the “burden of government spending.” I’m a fiscal policy economist, so I’m tempted to claim that the sun rises and sets based on what’s happening to taxes and spending, but such factors are just two of the many policies that influence economic performance. And with regard to my assertion that Reagan reduced the “burden of government,” I’ll defer to the rankings put together for the Economic Freedom of the World Index. The score for the United States improved from 8.03 to 8.38 between 1980 and 1990 (my guess is that it peaked in 1988, but they only have data for every five years). The folks on the left may be unhappy about it, but it is completely accurate to say Reagan reduced the burden of government. And while we don’t yet have data for the Obama years, there’s a 99 percent likelihood that America’s score will decline.

This is not a partisan argument, by the way. The Economic Freedom of the World chart shows that America’s score improved during the Clinton years, particularly his second term. And the data also shows that the U.S. score dropped during the Bush years. This is why I wrote a column back in 2007 advocating Clintonomics over Bushonomics. Partisan affiliation is not what matters. If we want more prosperity, the key is shrinking the burden of government.

Last but not least, I try to make these arguments to the folks watching MSNBC.

When Keynesians Attack

If I was organized enough to send Christmas cards, I would take Richard Rahn off my list. I do one blog post to call attention to his Washington Times column and it seems like everybody in the world wants to jump down my throat. I already dismissed Paul Krugman’s rant and responded to Ezra Klein’s reasonable criticism. Now it’s time to address Derek Thompson’s critique on the Atlantic’s site.

At the risk of re-stating someone else’s argument, Thompson’s central theme seems to be that there are many factors that determine economic performance and that it is unwise to make bold pronouncements about Policy A causing Result B. If that’s what Thompson is saying, I very much agree (and if it’s not what he’s trying to say, then I apologize, though I still agree with the sentiment). That’s why I referred to Reagan decreasing the burden of government and Obama increasing the burden of government — I wanted to capture all the policy changes that were taking place, including taxation, spending, monetary policy, regulation, etc. Yes, the flagship policies (tax reduction for Reagan and so-called stimulus for Obama) were important, but other factors obviously are part of the equation.

The biggest caveat, however, is that one should always be reluctant to make sweeping claims about what caused the economy to do X or Y in a given year. Economists are terrible forecasters, and we’re not even very proficient when it comes to hindsight analysis about short-run economic fluctuations. Indeed, the one part of my original post that causes me a bit of regret is that I took the lazy route and inserted an image of the chart from Richard’s column. Excerpting some of his analysis would have been a better approach, particularly since I much prefer to focus on the impact of policies on long-run growth and competitiveness (which is what I did in my New York Post column from earlier this week  and also why I’m reluctant to embrace Art Laffer’s warning of major economic problems in 2011).

But a blog post is no fun if you just indicate where you and a critic have common ground, so let me identify four disagreements that I have with Thompson’s post:

(1) To reinforce his warning about making excessive claims about different recessions/recoveries, Thompson pointed out that someone could claim that Reagan’s recovery was associated with the 1982 TEFRA tax hike. I’ve actually run across people who think this is a legitimate argument, so it’s worth taking a moment to explain why it isn’t true.

When analyzing the impact of tax policy changes, it’s important to look at when tax changes were implemented, not when they were enacted (data on annual tax rates available here). Reagan’s Economic Recovery Tax Act was enacted in 1981, but the lower tax rates weren’t fully implemented until 1984. This makes it a bit of a challenge to pinpoint when the economy actually received a net tax cut. The tax burden may have actually increased in 1981, since the parts of the Reagan tax cuts that took effect that year were offset by the impact of bracket creep (the tax code was not indexed to protect against inflation until the mid-1980s). There was a bigger tax rate reduction in 1982, but there was still bracket creep, as well as previously-legislated payroll tax increases (enacted during the Carter years). TEFRA also was enacted in 1982, which largely focused on undoing some of the business tax relief in Reagan’s 1981 plan. People have argued whether the repeal of promised tax relief is the same as a tax increase, but that’s not terribly important for this analysis. What does matter is that the tax burden did not fall much (if at all) in Reagan’s first year and might not have changed too much in 1982.

In 1983, by contrast, it’s fairly safe to say the next stage of tax rate reductions was substantially larger than any concomitant tax increases. That doesn’t mean, of course, that one should attribute all changes in growth to what’s happening to the tax code. But it does suggest that it is a bit misleading to talk about tax cuts in 1981 and tax increases in 1983.

One final point: The main insight of supply-side economics is that changes in the overall tax burden are not as important as changes in the tax structure. As such, it’s also important to look at which taxes were going up and which ones were decreasing. This is why Reagan’s 1981 tax plan compares so favorably with Bush’s 2001 tax plan (which was filled with tax credits and other policies that had little or no impact on incentives for productive behavior).

(2) In addition to wondering whether one could argue that higher taxes triggered the Reagan boom, Thompson also speculates whether it might be possible to blame the tax cuts in Obama’s stimulus for the economy’s subsequent sub-par performance. There are two problems with that hypothesis. First, a substantial share of the tax cuts in the so-called stimulus were actually new spending being laundered through the tax code (see footnote 3 of this Joint Committee on Taxation publication). To the extent that the provisions represented real tax relief, they were much more akin to Bush’s non–supply side 2001 tax cuts and a far cry from the marginal tax-rate reductions enacted in 1981 and 2003. And since even big tax cuts have little or no impact on the economy if incentives to engage in productive behavior are unaffected, there is no reason to blame (or credit) Obama’s tax provisions for anything.

(3) Why doesn’t anyone care that the Federal Reserve almost always is responsible for serious recessions? This isn’t a critique of Thompson’s post since he doesn’t address monetary policy from this angle, but if we go down the list of serious economic hiccups in recent history (1974-75, 1980-82, and 2008-09), bad monetary policy inevitably is a major cause. In short, the Fed periodically engages in easy-money policy. This causes malinvestment and/or inflation, and a recession seems to be an unavoidable consequence. Yet the Fed seems to dodge any serious blame. At some point, one hopes that policy makers (especially Fed governors) will learn that easy-money policies such as artificially low interest rates are not a smart approach.

(4) Thompson writes, “Is Mitchell really saying that $140 billion on Medicaid, firefighters, teachers, and infrastructure projects are costing the economy five percentage points of economic growth?” No, I’m not saying that and didn’t say that, but I have been saying for quite some time that taking money out of the economy’s left pocket and putting it in the economy’s right pockets doesn’t magically increase prosperity. And to the extent money is borrowed from private capital markets and diverted to inefficient and counter-productive programs, the net impact on the economy is negative. Thompson also writes that, “Our unemployment picture is a little more complicated than ‘Oh my god, Obama is killing jobs by taking over the states’ Medicaid burden!’” Since I’m not aware of anybody who’s made that argument, I’m not sure how to respond. That being said, jobs will be killed by having Washington take over state Medicaid budgets. Such a move would lead to a net increase in the burden of government spending, and that additional spending would divert resources from the productive sector of the economy.

The moral of the story, though, is to let Richard Rahn publicize his own work.

Responding to Paul Krugman and Ezra Klein

I seem to have touched a raw nerve with my post earlier today on my International Liberty blog,  comparing Reagan and Obama on how well the economy performed coming out of recession. Both Ezra Klein and Paul Krugman have denounced my analysis (actually, they denounced me approving of Richard Rahn’s analysis, but that’s a trivial detail). Krugman responded by asserting that Reaganomics was irrelevant (I’m not kidding) to what happened in the 1980s. Klein’s response was more substantive, so let’s focus on his argument. He begins by stating that the recent recession and the downturn of the early 1980s were different creatures. My argument was about how strongly the economy rebounded, however, not the length, severity, causes, and characteristics of each recession. But Klein then cites Rogoff and Reinhardt to argue that recoveries from financial crises tend to be less impressive than recoveries from normal recessions.

That’s certainly a fair argument. I haven’t read the Rogoff-Reinhardt book, but their hypothesis seems reasonable, so let’s accept it for purposes of this discussion. Should we therefore grade Obama on a curve? Perhaps, but it’s also true that deep recessions usually are followed by more robust recoveries. And since the recent downturn was more severe than the the one in the early 1980s, shouldn’t we be experiencing some additional growth to offset the tepidness associated with a financial crisis?

I doubt we’ll ever know how to appropriately measure all of these factors, but I don’t think that matters. I suspect Krugman and Klein are not particularly upset about Richard Rahn’s comparisons of recessions and recoveries. The real argument is whether Reagan did the right thing by reducing the burden of government and whether Obama is doing the wrong thing by heading in the opposite direction and making America more like France or Greece. In other words, the fundamental issue is whether we should have big government or small government. I think the Obama Administration, by making government bigger, is repeating many of the mistakes of the Bush Administration. Krugman and Klein almost certainly disagree.

Uncertainty More Than Anecdotal

During a recent CNBC debate on federal spending, I argued that government policies are creating uncertainty in the business community. Businesses are reluctant to invest or hire because they’re concerned that the president’s big government agenda will mean higher taxes and more onerous regulations.

I mentioned that every business owner I’ve spoken with has expressed this concern. In fact, the owner of the TV studio I was in told me that he wants to hire more employees but is afraid he may have to turn around and fire them later on thanks to Washington. My debate opponent dismissed my argument on the basis that “you cannot conduct macroeconomic policy by anecdote.”

Unfortunately, there is plenty of evidence to support my concern beyond what I’ve heard from folks in the business community. Yesterday, the chairman of the Business Roundtable, which the Washington Post calls “President Obama’s closest ally in the business community,” said that the president and his Democratic allies are creating an “increasingly hostile environment for investment and job creation.”

From the article:

Ivan G. Seidenberg, chief executive of Verizon Communications, said that Democrats in Washington are pursuing tax increases, policy changes and regulatory actions that together threaten to dampen economic growth and “harm our ability … to grow private-sector jobs in the U.S.”

“In our judgment, we have reached a point where the negative effects of these policies are simply too significant to ignore,” Seidenberg said in a lunchtime speech to the Economic Club of Washington. “By reaching into virtually every sector of economic life, government is injecting uncertainty into the marketplace and making it harder to raise capital and create new businesses.”

Big businesses aren’t the only ones complaining. Surveys of small businesses conducted by the National Federation of Independent Business continue to point to government taxes and regulations as their single biggest obstacle.

Even the Washington Post’s editorial page is now acknowledging that government-induced uncertainty is an issue:

But as analysts ponder the mystery of weak private-sector hiring despite signs of economic growth, it’s worth asking what role is played by government-induced uncertainty. With the federal government promoting major changes in health care, financial regulation and energy law, it wouldn’t be surprising if some companies are more inclined to wait and see than they might otherwise be. And that’s especially true when they look at looming American indebtedness and the effect that could have on long-term interest rates.

The uncertainty caused by expanding government that we are facing today isn’t a new phenomenon. Economist Robert Higgs coined the phrase “regime uncertainty” in a study that showed that FDR’s anti-business policies prolonged the Great Depression. Had the Roosevelt administration heeded the “anecdotes” from the business community in the 1930s, perhaps the country could have been spared some pain. Let’s hope history doesn’t repeat itself.