Barro on Economic Recovery: Market or Government Led?

Markets trump government in the ability to create wealth and prosperity through individual liberty and responsibility.  That is the reason that nearly all economist strongly support reliance on markets for the provision of goods and services.  It is ironic that many who profess a desire to see our nation rely more on market and less on government ordering of resource allocation do not fully understand the vitality of markets.  True the unemployment rate has stagnated at 9.7% as the recession is ending but rather than taut the ability of markets to adapt, they instead focus on problems government policies have caused and argue that the economy will not recover.

The economy will recover because of market adaptation.  Entrepreneurs will find profitable opportunities.  Investment will increase.  Unemployment will eventually fall and full employment will be reached.  Market led growth is not the question.  The question is did the Troubled Asset Relief Program (the bailout), the American Recovery and Reinvestment Act (the stimulus), health care reform, and other measures helped or hindered the recovery?

Robert Barro, one of the nation's best macroeconomists, provides some insights gleaned from studying how policy impacted economic recovery and growth during the Great Depression and WWII in "The Lessons of the Great Depression" published by FiveBooks. 

The first histories, often written by New Dealers, summarize the Great Depression as starting with the market crash that was greeted by a hands laissez-faire guided inspired policies of the Hoover administration, and ending with the transformation of the economy by the Roosevelt administration.  A variation of this history is that Roosevelt's fiscal policy was sound but too small and that the large deficits created by WWII finally lifted us out of the Great Depression.  Is a sound economy as simple as active fiscal policy?
Barro offers a different view.

It’s clear that a lot of the policies that were put into place were negative, but as to sorting out how important they were, that’s a much more challenging question. And I think Roosevelt at the time recognized ex-post that some of the things he tried were failures and then his attitude was, “OK, it’s a failure. I’ll stop doing it.” Which is actually pretty positive.

For example, some of the things he did was try to organize labour unions and also businesses essentially promoting monopoly – I don’t think that was a plus. He was trying really hard to keep wages and prices from falling with direct influence and that was a negative. The effect of the expenditure programs is less clear. In the mid-1930s with the New Deal there was an unusual amount of infrastructure-type of expenditures. But it’s not actually big enough to sort out in a statistical sense – to figure out how much it mattered in terms of the recovery after the trough in 1932-33. I don’t think we know that that was a mistake, but it’s not clear that it was all that important.

He notes that war expenditures were large enough to be statistically measurable. 

I don’t think you can reliably say what the effect is. But conceptually you’d expect the wartime spending to have a bigger effect for various reasons on the GDP than the equivalent amount of expenditure in a non-war situation. And the wartime effect you can estimate pretty precisely, and the multiplier is clearly less than one, even in World War Two – it’s in the order of 0.6, 0.7, something like that.

Barro does not believe that the stimulus was good policy.

I think the stimulus package was very stupid; it was awful. It’s just a tremendous waste of money and it’s going to cause some trouble in terms of a bigger public debt; it’s just wasting resources. But the more important thing is the financial system, and the housing related aspects. So on that, despite a lot of floundering around, mostly I think what they were doing is in the right direction. I think they made a big mistake by not bailing out Lehman Brothers – I think they recognized that two days later. That was Paulson’s individual fault and responsibility from what I can gather.

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Sowell on Interventionist Policy

Thomas Sowell is a great writer and one of my favorite economists. His latest book is "Intellectuals and Society." In "Massive Government Intervention Drove U.S. Deeper Into Depression," an Investors Business Daily editorial, he offers the hypothesis that government intervention may deepen and lengthen economic downturns. He presents historical evidence to support his position comparing the stock market crashes of 1929 and 1987. His hypothesis is similar to Higgs' "Regime Uncertainty" (see "The Crisis Paradox). Key sections of Sowell's article articulating the conventional wisdom concerning Roosevelt's interventions and Sowell's dissent read

Many saw in the Great Depression the failure of free market capitalism as an economic system and a reason for seeking a radically different kind of economy — for some Communism, for some Fascism and for some the New Deal policies of Franklin D. Roosevelt's administration.

Whatever the particular alternative favored by particular individuals, what was widely believed then and later was that the stock market crash of 1929 was a failure of the free market and the cause of the massive unemployment that persisted for years during the 1930s.

Given the two most striking features of that era — the stock market crash and a widespread government intervention in the economy — it is not immediately obvious which was more responsible for the dire economic conditions. But remarkably little effort has been made by most of the intelligentsia to try to sort out the cause or causes. It has been largely a foregone conclusion that the market was the cause and government intervention was the saving grace.

While unemployment went up in the wake of the stock market crash, it never went as high as 10% for any month during the 12 months following that crash in October 1929. But the unemployment rate in the wake of subsequent government interventions in the economy never fell below 20% for any month over a period of 35 consecutive months.

In short, though the stock market crash has been conceived of as the "problem" and government intervention as the "solution," in reality the unemployment rate following the economic problem was less than half of the unemployment rate following the political solution.

He enumerates how bad monetary policy, protectionist trade policy, doubling taxes on high income earners, and price fixing stifled economic recovery.

Next, Sowell describes Reagan's benign response to the 1987 stock market crash, the media's harsh criticism and the ensuing economic recovery.

There is of course no way to rerun the stock market crash of 1929 and have the federal government let the market adjust on its own to see how that experiment would turn out. The closest thing to such an experiment was the 1987 stock market crash, similar in size but not in duration to the 1929 collapse. The Reagan administration did nothing, despite outrage in the media at the government's failure to act.

"What will it take to wake up the White House?" the New York Times asked, declaring that "the president abdicates leadership and courts disaster." Washington Post columnist Mary McGrory said that Reagan "has been singularly indifferent" to the country's "current pain and confusion." The Financial Times of London said that President Reagan "appears to lack the capacity to handle adversity" and "nobody seems to be in charge."

A former official of the Carter administration criticized President Reagan's "silence and inaction" following the 1987 stock market crash and compared him unfavorably to President Franklin D. Roosevelt, whose "personal style and bold commands would be a tonic" in the current crisis.

The irony in this was that FDR presided over an economy with seven consecutive years of double-digit unemployment, while Reagan's policy of letting the market recover on its own, far from leading to another Great Depression, led instead to one of the country's longest periods of sustained economic growth, low unemployment and low inflation, lasting 20 years.

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Harkin on the Relationship of Men and Government

When I was in my early twenties and still a liberal Democrat I read "Capitalism and Freedom" by Milton Friedman and hated it.  On the first page he dissected President John Kennedy's statement, "Ask not what your country can do for you--ask what you can do for your country."  My friend and mentor Del Gardner, who had traveled with Milton Friedman as a graduate student at Chicago asked me the source of my disdain.  I said that Friedman had read too much into a plea for patriotism. 

Yesterday, I read a statement by Senator Thomas Harkin of Iowa ( Christina Crippes, "Harkin favors taxing stock transactions," The Hawk Eye, or Ryan J. Donmoyer, "Wall Street Transaction Tax Proposed by Democrats (Update4)," Bloomberg, December 3, 2009) who attempted to justify a tax on each transaction of stock, futures, options and swaps, by saying,

Let me put it bluntly, we need this revenue, which would amount to as much as $100 billion or more annually. We need it to reduce the deficit as well as to pay for new legislation to create jobs and put people back to work.  We need a shift of priorities to this: Ask not what America can do for Wall Street. Ask what Wall Street can do for America.

A flood of memories poured through my thoughts.  It has been a long while since I have been a liberal Democrat and almost as long since I began to enjoy Friedman's quote, but the accuracy of Friedman's vision again struck me.  Friedman wrote of Kennedy's statement,

Neither half of the statement expresses a relation between the citizen and his government that is worthy of the ideals of free men in a free society.  The paternalistic "what your country can do for you" implies that government is the patron, the citizen the ward, a view that is at odds with the free man's belief in his own responsibility for his own destiny.  The organismic, "what you can do for your country" implies that government is the master or the deity, the citizen, the servant or the votary.  To the free man, the country is the collection of individuals who compose it, not something over and above them.  He is proud of a common heritage and loyal to common traditions.  But he regards government as a means, an instrumentality, neither a grantor of favors and gifts, nor a master or god to be blindly worshipped and served. 

Can it be any clearer that Harkin views investors as servants or votary and the government as the master or deity?

Harkin seems to have as bad an understanding of the economics of the proposal as of the relationship between man and government stating a historical precedence for the tax rather than an economic justification.

Until 1966, the United States taxed all stock transactions and transfers. Indeed, Congress doubled the transaction tax rate during the Great Depression in order to finance economic recovery initiatives.

Someone might ask Senator Harkin why he wishes to emulate a policy enacted during the longest period of high unemployment in our nation's history.  He should know that if you want less of something you tax it.  To repeat a theme of an earlier post (The Crisis Paradox), Robert Higgs  wrote that regime uncertainty created by less secure property rights, higher taxes, and other measures is an explanation of the Depression's duration (Higgs, Robert, "Regime Uncertainty," The Independent Review, Vol. I, No. 4, Spring 1997). 
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The Forgotten Man and Health Care Reform

I must admit to occasional disappointment in the economic views of Americans expressed through surveys.  Many hold normative beliefs that are different than mine, and of course mine are correct.  More importantly, many opinions appear to be based on bad economic reasoning.  As our elected representatives debate health care reform, a Rasmussen survey as of January 4, 2010 finds that 42 percent support the legislation while 53 percent oppose, but how opinions shift based on the method of funding is the basis of my disappointment.  A Rasmussen Reports article based on a national survey in "Voters Agree Only on Taxing The Rich To Pay for Health Care Plan" finds that those surveyed are more likely to support health care reform if someone else, namely the "rich," pay for it and are more likely to oppose reform if they must pay or their potential benefits are cut.

When it comes to paying for the cost of the proposed health care reform plan, voters are okay with taxing the rich but strongly reject cuts in Medicare and excise taxes on “Cadillac” health plans provided by employers.

Sixty-four percent (64%) of all voters favor imposing an income tax surcharge on individuals who earn more than $500,000 a year and couples who earn more than $1 million a year. Just 35% are opposed.

However, a proposal to enact a significant excise tax on the most expensive health insurance plans provided by employers is supported by just 32% of voters. It is opposed by 59%...

Both versions of the legislation propose reducing spending on Medicare by several hundred billion dollars. Just 33% support this approach, while 57% are opposed.

I am reminded of William Graham Sumner's essay, "The Forgotten Man," reproduced in Amity Shlaes' memorable history of the Great Depression, "The Forgotten Man..."

As soon as A observes something which seems to him to be wrong, from which X is suffering, A talks it over with B, and A and B then propose to get a law passed to remedy the evil and help X.  Their law always proposes to determine...what A, B, and C shall do for X."  But what about C?  There was nothing wrong with A and B helping X.  What was wrong was the law, and the indenturing of C to the cause.  C was the forgotten man, the man who paid, "The man who never is thought of."

Some hold the normative belief that we, meaning the rich, should insure the poor and those who do not want to buy insurance at the going price.  There is no virtue in A or B as they bemoan C's greed while taking her money to help X who is ungrateful for the payment of medical services he now claims are his entitlement.  C's opinion is ignored or unimportant.

From a positive perspective, A and B seem to have forgotten that people respond to incentives.  X, the person suffering, has no incentive to conserve on the expenditures of medical services freely bestowed on him.  If costs are to be controlled, government health care regulators must do it.  The regulators will give these committees a pleasant name like the United Kingdom's National Institute for Clinical Excellence or NICE, but after the first death of a patient denied treatment by the the medical board, even if the denial is just and medially correct for "society," will be known as a death committee by that person's survivors.  These committees will serve us all.

C and her contribution to the market economy really are forgotten.  Do A, B or X believe that C will do nothing to protect her interests?  She will invest less because her income has fallen and because of greater uncertain about her future tax burden.  The economy suffers when investment falls and the rich are an important part of investors.  If A, B, and X are lucky, some of her investment might slide into the underground economy to avoid taxation, but that will lower government tax receipts.  C might also spend more time at the beaches and ski resorts and less time working.  She might hire an accountant or lawyer to help her avoid taxes if they are not at the beaches or ski resorts because of their reduced incentive to work. 

We like the goods and services that high income earners provide including medical care.  We like the innovation that their investments fund.  We need more of them.  Why do we treat them so badly through the federal tax code?
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The Crisis Paradox

Robert Higgs offered the "Crisis Hypothesis," that the supply of and demand for government oversight and control of a market economy increases in times of crisis, in "Crisis and Leviathan."  Rahm Emanuel turned this hypothesis into the political dictum, "Never let a crisis go to waste."  I believe that the dictum is widely accepted.  Higgs offered another hypothesis, that increased government oversight and control during the Great Depression dampened investment resulting in what he terms, "the Great Duration," in "Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed after the War" (The Independent Review, Vol. 1, No. 4, Spring 1997).  I synthesize the two hypotheses into the Crisis Paradox: crisis is the best time politically and the worst time economically to enact fundamental economic reform.

Gary S. Becker, Steven J. Davis, and Kevin M. Murphy describe the motivation of "Liberal Democrats" to enact economic reform and its consequences in "Uncertainty and the Slow Recovery" in the Wall Street Journal, January 3, 2010.  Their analysis could be squeezed into the Crisis Paradox.  Their take on the motivation of the reform is that,

...Liberal Democrats won a major victory in the 2008 elections, winning the presidency and large majorities in both the House and Senate. They interpreted this as evidence that a large majority of Americans want major reforms in the economy, health-care and many other areas. So in addition to continuing and extending the Bush-initiated bailout of banks, AIG, General Motors, Chrysler and other companies, Congress and President Obama signaled their intentions to introduce major changes in taxes, government spending and regulations—changes that could radically transform the American economy...

The authors give several examples of major reforms that are one of two causes for the current prolonged recession (the other is the severe financial crisis) including large increases in marginal tax rates for higher incomes, the introduction of cap-and-trade legislation, tougher enforcement of antitrust laws, health care reform, and possibly more politicized monetary policy.  They briefly describe the state of the economy which I quote in part...

Business investment in the third quarter of 2009 is down 20% from the low levels a year earlier. Job openings are at the lowest level since the government began measuring the concept in 2000. The pace of new job creation by expanding businesses is slower than at any time in the past two decades and, though older data are not as reliable, likely slower than at any time in the past half-century. While layoffs and new claims for unemployment benefits have declined in recent months, job prospects for unemployed workers have continued to deteriorate. The exit rate from unemployment is lower now than any time on record, dating back to 1967.

According to the Michigan Survey of Consumers, 37% of households plan to postpone purchases because of uncertainty about jobs and income, a figure that has not budged since the second quarter of 2009, and one that remains higher than any previous year back to 1960.

Becker, Davis, and Murphy summarize their findings.

In terms of discouraging a rapid recovery, other government proposals created greater uncertainty and risk for businesses and investors.

These facts suggest that it was a serious economic mistake to press for a hasty, major transformation of the U.S. economy on the heels of the worst financial crisis in decades. A more effective approach would have been to concentrate first on fighting the recession and laying solid foundations for growth. They should have put plans to re-engineer the economy on the backburner, and kept them there until the economy emerged fully from the recession and returned to robust growth. By failing to adopt a measured approach to economic policy, Congress and the president may be slowing the economic recovery, and thereby prolonging the distress from the recession.

As always, I encourage you to read the complete article.  I have rearranged a couple of paragraphs to fit the "Crisis Paradox," and the squeezing may detract from their writing and analysis.
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Barro And The Probability Of A Depression

"What Are the Odds of a Depression?," an article written by Robert Barro, and published in today's Wall Street Journal is making the blog rounds today (HT Greg Mankiw, and RealClearMarkets). I like the article for many reasons, two of which I will name.

He gathers data to answer a question or hypothesis, and I like his data.

We also {in addition to U.S. data] assembled long-term data on GDP, consumption and stock-market returns for 33 other countries, sometimes going back as far as 1870. Our conjecture was that depressions would be closely connected to stock-market crashes (at least in the sense that a crash would signal a substantially increased chance of a depression).

Barro provides statistically generated information about a current problem of great interest, the probability of the U.S. falling into a depression, defined as a fall of at least 10% of GDP.

In the end, we learned two things. Periods without stock-market crashes are very safe, in the sense that depressions are extremely unlikely. However, periods experiencing stock-market crashes, such as 2008-09 in the U.S., represent a serious threat. The odds are roughly one-in-five that the current recession will snowball into the macroeconomic decline of 10% or more that is the hallmark of a depression.

The bright side of a 20% depression probability is the 80% chance of avoiding a depression. The U.S. had stock-market crashes in 2000-02 (by 42%) and 1973-74 (49%) and, in each case, experienced only mild recessions. Hence, if we are lucky, the current downturn will also be moderate, though likely worse than the other U.S. post-World War II recessions, including 1982.

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A Political Scientist and the Great Depression

I have made many posts featuring economists who offer opinions about economic policy and its impact on resolving the Great Depression.  I asked Mike Campenni, who teaches government at McLennan Community College, and is trained as a political scientist for some thoughts about the Roosevelt administration and its policies.  Mike comments are expressed below. 

Economics is a science. Its subject matter consists of proven theories, theories in various stages of development and testing and the search for better understanding. And just as economics is far removed from economic punditry, politics is also both a topic of study and the domain of pundits. Luckily for economists their subject seems too complex for superficial discussion. If only political scientists were so lucky!

To the dismay of all the US, and indeed the entire world, we are falling into a severe economic downturn. Economists would point out that it is a well proven point that markets constantly enter periods of adjustments. In simpler times, the adjustments were shorter and often passed below the radar screen of most people. Today, we live in an increasingly complex world with ever greater economic interdependency. Subsequently, market adjustments take longer and are usually more painful for wider swaths of society. Our present situation is just one such adjustment.

But today we live in a far different world. Governments who allow too much pain to fall on their citizens often fall politically in a democracy, and by revolution in more authoritarian societies. Subsequently, it has become the norm for governments to intervene and attempt to mitigate economic pain.

So here we are today in the midst of one of the most severe economic downturns in recent history. By most accounts it is the worst downturn since the Great Depression. Popular history would say that the Great Depression was cured by the heroic efforts of FDR with his New Deal legislation. Economists studying the New Deal would probably say that the New Deal at best had a mixed record. They would probably point out the Great Depression was only cured by the huge stimulus package known as World War II. Maybe the New Deal didn’t end the Great Depression and it did take a war, but people only remember FDR and his policies. They say that he saved the country. And maybe he did.

It is hard to make people understand today about the Great Depression. Imagine 25% un-employment rates and 30% under-employment rates. Imagine banks going bankrupt where customers lose all their savings overnight. And imagine a time when people didn’t have any safety nets like social security, welfare or un-employment compensation. Imagine betting on a local church group setting up a soup line to feed your family. It was just these kinds of things that made FDR and his New Deal Legislation successful. It really saved the US from potentially system changing political dynamics.

Did the New Deal work in terms of economics? Perhaps it did not. But widespread news coverage of hundreds of thousands of Americans working on dams and roads, and more still building parks and buildings and electrifying the countryside made people think that things were getting better. Retirees getting a check from social security helped take the edge off because they mostly still lived with the family—and any income helped. Mothers getting welfare to feed their kids helped and a new thing called unemployment compensation gave people a chance to get on their feet. And regulating Wall Street made people get their faith back in the financial institutions of the country. And just as hope keeps people from despair, confidence is something to build upon.

That’s the real message that needs to come from Obama and his team. We are doing the things that need to be done to give people hope and to restore confidence in our economic system. It really doesn’t matter too much if they are the right prescriptions economically—they key is that they need to be politically correct. And that’s why we need to put politics aside. We need to build confidence…and hope. That’s what politics is all about.

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Majority View of Economists on the Great Depression?

In recent weeks, I have heard many non-alarmist economists use the describe our current economic state as a depression. In a recent post, titled, "Deficit Spending on Infrastructure in a Depression--Posner," Richard Posner frequently refers to the current depression. At the Myron Scholes Global Markets Forum, Robert Lucas at one point stated that the current economic situation is not as bad as the Great Depression, and at another, referred to it as a depression.[1] Now dubbed Dr. Doom for predicting the financial collapse, Nouriel Roubini at the World Economic Forum in Davos was described by Bloomberg [2] as,

...more pessimistic than economists elsewhere. The IMF forecasts global growth of 0.5 percent this year and bank losses from toxic U.S.- originated assets of $2.2 trillion. By contrast, Roubini sees the global economy shrinking this year, and banks writing down at least $3.6 trillion -- compared to the $1.1 trillion disclosed so far.

The Great Depression has probably been studied more by economists than any other event in U.S. history, and with the unraveling of the financial system and deepening of the recession, it is again of interest. I believe that Harold Cole and Lee Ohanian, writing for the Wall Street Journal summarize the majority opinion of the affect of policy on the economy during the Great Depression.[3]

The goal of the New Deal was to get Americans back to work. But the New Deal didn't restore employment. In fact, there was even less work on average during the New Deal than before FDR took office. Total hours worked per adult, including government employees, were 18% below their 1929 level between 1930-32, but were 23% lower on average during the New Deal (1933-39). Private hours worked were even lower after FDR took office, averaging 27% below their 1929 level, compared to 18% lower between in 1930-32.

Some New Deal policies certainly benefited the economy by establishing a basic social safety net through Social Security and unemployment benefits, and by stabilizing the financial system through deposit insurance and the Securities Exchange Commission. But others violated the most basic economic principles by suppressing competition, and setting prices and wages in many sectors well above their normal levels. All told, these antimarket policies choked off powerful recovery forces that would have plausibly returned the economy back to trend by the mid-1930s.

[1] I am not aware of any economic distinction between the words depression and recession. While taking an undergraduate history of economics class, the professor, who shall remain nameless in case my memory is faulty, said that the word glut was used to describe a downturn in the business cycle until a particularly bad downturn at which point it was replaced by the word depression. Similarly, after the Great Depression, the depression fell into disrepute and was replaced by recession. I don't know if the history is correct, but I like it.

[2] Kennedy, Simon. "Roubini Sees Global Gloom After Davos Vindication (Update1)" Bloomberg, January 30, 2009.

[3] Cole, Harold and Lee Ohanian. "How the Government Prolonged the Depression," Wall Street Journal, February 2, 2009.

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Yet Another Reason for the 1937-38 Depression

Tyler Cowen, in a New York Times column, offers yet another explanation for the depression within the depression. (HT to Cafe Hayek)

A study of the 1930s by Christina D. Romer, a professor at the University of California, Berkeley (“What Ended the Great Depression?,” Journal of Economic History, 1992), confirmed that expansionary monetary policy was the key to the partial recovery of the 1930s. The worst years of the New Deal were 1937 and 1938, right after the Fed increased reserve requirements for banks, thereby curbing lending and moving the economy back to dangerous deflationary pressures.

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