There are a lot of ways to think about what's happened to the flattening of median American income growth. One of the most interesting is Cowen's stagnation hypothesis, which attributes the lack of wage growth to not generating enough job-creating innovation. I like some parts of that hypothesis -- although I prefer to look at changes to political systems and developments in the global economy -- but there have been other things going on as well. One of them is this:
I want to focus on the period ending around 2000. If you go from the early-1970s trough to the late-1990s peak, the U.S. added about 9 percentage points of its labor to the workforce in about 30 years. At current population levels, that's about 30 million people. Even if you go from 1970 peak to the 2000s average, it's about 15 million people or so. Often these would be members of disadvantaged groups, such as women and minorities, whose wage potential would be lower than that of white males that were already in the workforce, so we're adding a bunch of relatively low salaries to our statistics over that stretch.
Looked at that way, it's almost impressive that median wages have been flat. If there had actually been stagnation, median wages would have gone down as more people got added to the labor force at low wages.
Or, instead of looking at median individual wages, we could look at median household wages:
As you can see, until the 2000s we had pretty strong growth that was actually accelerating over time. This doesn't consider everything -- more two-worker households means greater expenses for child care, etc. -- but we generally think employment is good for its own sake. It yields psychological benefits, allows greater flexibility for satisfying preferences and tastes, etc. In terms of social justice, excluding fewer women and minorities from pursuing the good life is also a good thing.
If we're thinking about trends in the U.S. economy over the past few decades we might consider it good news that we've been able to integrate more people into the workforce and that household incomes have increased. That's not stagnation. That's improvement.
This only gets us up to the 2000s, and it doesn't tell us anything about the future, but it's a component of the U.S.'s postwar economic history that doesn't get talked about enough.
Jobs in the tradable sector were added primarily in high-value services. They were lost in manufacturing, through outsourcing of the lower value-added components of the value chain to other countries.
The net effect has been that of the 27.3 million jobs created in the American economy from 1990 to 2008, only 662,000 new jobs were added by the tradable sector. That is only 2.3 percent of total job creation in the economy.
I assume that's gross, not net. This is in line with my view of (no) Great Stagnation, and see also this post from Will Wilkinson. Here's another worrying bit from Reinhardt:
Thus it is not surprising that ... close to 98 percent of the 27.3 million new jobs in the American economy in the last two decades were created in the nontradable sectors, led by government and health care in first and second place.
These two sectors alone accounted for 40 percent of the total job growth over the last two decades. They were followed by retailing and construction, both of which grew on the back of heavy debt financing and a real-estate bubble.
The American people look to the president and Congress to create jobs — or, more precisely, to create the economic conditions in which job growth occurs.
At the same time, the American people now look to the president and Congress to rein in government spending in general and health-care spending in particular, at a time when a sizable deleveraging by consumers and business has sharply put the brakes also on retailing and construction.
So how can these desiderata –- creating jobs and, at the same time, cutting back on government and health care spending –- add up to a rosy future jobs picture? Can any government actually deliver on these conflicting goals?
I'm slowly being persuaded by Karl Smith's argument that a construction boom is looming, and Ryan Avent's general optimism about the economy. I still believe that trade is a large net plus for the US. But the US economy has been shifting over the past two decades, and it will continue to do so. I expect GDP growth to rebound from its current doldrums, but not necessarily in an especially egalitarian way. These shifts and changes lead to political shifts too, and we've been witnessing those as well. It may be awhile before we find the new equilibrium -- I suspect it involves a shift to more social democracy -- and in the meantime we may be in for some more pain.
Daniel Davies and Alex Tabarrok objected to the graphs of GDP I included in this post on The Great Stagnation. Specifically, they didn't like the fact that the hypothetical lines I drew reflect constant linear growth rather than constant percentage growth. I.e., I didn't compound the growth when i drew those lines. They're right that the latter is a better measure of trend (it's what is used in almost all statistical analyses), so here's a new graph that takes that into consideration.
This graph shows the actual GDP per capita growth (circles) for the US, OECD, and entire world. The lines that begin in 1974 reflect what GDP per capita would look like if it had continued to grow at the 1960-1973 rate*. Note that a "Great Stagnation" hypothesis would expect significantly weaker growth post-1973, not the same amount and certainly not more. So the fact that the US was above the trend line until the early 2000s provides fairly strong evidence that if we're in a Great Stagnation it's more recent than Cowen argues, and doesn't correlate with stagnating median incomes all that well. In fact, the US does better than either the OECD or the globe, if "better" is defined as "closest to 1960-1973 trend", although the OECD trend line is quite a bit steeper**.
Anyway, just wanted to make sure I didn't leave the impression that my main point (about distribution) relies on faulty extrapolation.
*Specifically, I regressed a year counter on the log of GDP per capita (constant dollars, via WDI) from 1960-1973. The coefficient estimate represents the average growth in GDP per capita per year during that period. I then took that coefficient estimate and added it to 1973's GDP per capita to get 1974's predicted point, added the same constant to the predicted 1974 to get the predicted 1975, and so on.
**Of course the US is a big part of both OECD and world economies; if you removed the US from those groups the US would likely look still better in comparison. Although in the OECD's case, they added some countries during the series (e.g. Mexico, Slovakia) with lower per capita GDP than more established industrialized countries.
Tyler Cowen's The Great Stagnation has gotten a lot of attention for both its form and content. (I.e., there's more than a little irony in the fact that a book alleging that technological progress has markedly slowed was the first notable electronic-only book, although it has since been released in pulp-and-glue as well.) In the video above he presents his main thesis at TEDxEast. For those unaware, the argument runs basically like this: since 1973 or thereabouts, there has been a slowdown in median American income growth, and that trend has increased in the past decade. That slowdown is mostly attributable to a decline in technological innovation. We've reaped the gains of past innovations -- cars, planes, electricity, plumbing -- but haven't made many new ones. We tweak the old innovations to our advantage -- we've made cars safer and added GPS -- but those are marginal improvements, not fundamental advances. The exception is the internet and communications more generally, but while those improve quality of life they do little to improve typical incomes.
Cowen's argument has bothered me on a number of levels. First, I think he understates the real, and monetary, value of the internet and improved communications technology for standards of living. Second, I think he makes a mistake by looking almost entirely at the U.S., and almost entirely at median income. I want to focus on the second of these, placing it in the context of the first.
I'm really late to this party... Cowen's book has been covered by everyone in the blogosphere and almost everyone in the corporate press, so I'm sure someone has written more or less exactly what I'm about to write, but I've haven't seen it in quite this form before. So to see why I think Cowen's thesis is wrong, or at least incomplete, let's start with some global data.
This graph shows global real gdp per capita from 1960-2009 (blue line). I've highlighted 1973's income level -- $1,148 -- to show what the world looked like around the time that Cowen thinks the Great Stagnation started in the US. In the following 35 years, per-person income increased by nearly 800%. If the pre-1973 trend had continued (red line), that number would be more than halved. If growth post-1973 had stagnated, we'd be below the red line. But that didn't happen, as we can see from this series. First, global growth in the 1970s was faster than in the 1960s. And while that trend wasn't consistent through the 1980s and 1990s (dark green line), global GDP growth in the 2000s was the fastest during the period. In fact, by the end of the decade we'd caught back up to where we'd be if the 1970s trend had been consistent, before the financial crisis knocked us back a bit. But the story here is of pretty rapid growth on a global scale that actually accelerated in the most recent decade. No Great Stagnation, on a global level at least.
Cowen agrees that global growth has been strong as other countries adopt the innovations the U.S. has already exploited. This "catch-up" growth may be fine for developing countries, which have a lot of low-hanging fruit, but he wants to focus on those at the edge of the technology frontier, especially the US. So let's look at what's happened to US growth over the same period.
The green line represents approximately where US incomes would be if we had stayed at the pre-1973 rate of growth. Average incomes would be less than half what they are now. If the economy had stagnated, as Cowen claims, average incomes would be below the green line. Instead, the rate of US growth actually increased over that period, at a more rapid pace even than the increase in global growth depicted in the first graph. This doesn't look like stagnation at all, much less a Great Stagnation. So what is Cowen going on about?
Ah, the picture looks a bit different if you compare mean GDP/capita to median GDP/capita. Before 1973 the two tracked each other very closely. Post-1973, mean GDP/capita (the white circles) kept growing at roughly the pre-1973 trend rate, while median GDP/capita (black diamonds) stagnated. But the economy overall did not. Just median incomes. That indicates, to me, that Cowen's preferred causal mechanism -- a stagnation due to slowdown in innovation -- is missing what's actually happened. There's been enough growth, it just hasn't gone to the median earner. The result has been higher inequality.
Why has that happened? Theories abound. Some political scientists have recently made the case that rising inequality is a result of wealthy groups hijacking politics for their own economic benefit. In other words, the distribution of growth is zero-sum, and it's been redistributed towards the wealthy in the form of tax cuts, decline in union membership, erosion of the welfare state, and deregulation. I think there's something to that, but I think it's too focused on developments specific to the US. To get the whole picture, I think we need to situate the US in a global context.
It's difficult to find reliable estimates of global median income in a time series (in fact I couldn't... pointers welcome), but indications are that inequality is increasing within many countries, and across them as well. This is also not consistent with Cowen's argument, since the movement towards the technology frontier in the US was associated with rising median income, not rising inequality. If that's the process that rapidly-growing economies like China and India are in, then we should see less inequality, not more. And if the Great Stagnation is something that afflict the US specifically, we might expect the gap between the US and the rest of the world to narrow, not widen.
So I think a more nuanced theory is needed. Specifically, we need to be able to explain two things: stagnating median, but not mean, incomes; global, not just local, trends. So what do we know about the major ways in which the global economy has changed over the past 40 years? I think three things are most relevant:
1. The global economy has become more integrated. This is partially due to politics, as more countries opened their economies to trade and investment. Average tariff rates have fallen dramatically during the GATT/WTO tenure. Capital accounts have been opened by many countries. Additionally, technological improvements have lowered transaction costs. International trade and investment have increased dramatically as a result. The consequence of this movement is a larger (global) market with more middle- and high-income consumers, and increased competition in production. This leads to point #2.
2. The US's post-WWII advantage was conducive to broad-based growth. The US share of global manufacturing was nearly 50% immediately after the war. The other industrialized economies were mostly decimated by the war, and many countries had not yet industrialized. For an American worker during this period, a high marginal product (relative to a foreign worker) did not require large amounts of human capital. Relatively low-skilled workers could mix with (non-human) capital in fairly lucrative ways. In a sense, the median American worker was able to collect rents from the rest of the world from 1945-1973, because the de-industrialization in Europe and pre-industrialization in much of the rest of the world operated as barriers to competition. By the early 1970s those advantages had waned, and trade agreements made it difficult for the US to protect domestic workers. The increased competition from workers in Europe and the Asian NICs (which shifted to export-biased development in the 1960s-70s) led to the US's share of global manufacturing output to fall to 20-25% by 1973, where it has stayed more or less ever since. This hit high-wage/less-skilled workers in tradable industries the hardest, since those were the workers that would face international competition directly. It isn't surprising that incomes would stagnate as those "rents", born of circumstance, are competed away.
3. These same processes benefit high-skilled workers with lots of human capital, as did the technological improvements, particularly in information technology and communications. The rise of the rest has increased the market into which they can sell their labor (demand curve shifts right), but the high skills required to compete with them provide a continuing barrier to entry (supply curve sticks). Compensation for those high-skill workers (and innovators) goes up, but is stuck for everyone else. We get a weak version of "superstar economics", where the highly-skilled are able exploit lower transaction costs to sell into an ever-enlarging global market, while the lower-skilled face increased competition. It's a two-track economy.
Cowen dismisses globalization-rooted theories of the Great Stagnation (around minute 12 in the video above), but (to my knowledge) he hasn't dealt with the sort of mechanisms I'm discussing in any kind of detail. Somewhat bizarrely, Cowen also claims that modern innovations (the internet, satellite-based telephones) have not contributed to GDP very much. But then how to explain how GDP growth, and total worker productivity, have increased post-1973 at the same rate as pre-1973? Median incomes have stagnated because those innovations, unlike previous innovations in manufacturing, do not require the mobilization of huge numbers of workers to increase output. A few computer programmers or financiers can create generate output on their own.
There's another aspect to this that I think Cowen has missed. Increased inequality and a move to a superstarish economy should create more of an incentive for innovation, not less. And while Cowen complains that scientists are no longer heralded by society as they once were, innovators most definitely are. We make movies about them and their social networks, and then give awards to the movies. We make them the richest people in the world. And, contra Cowen, we have seen a lot of innovation in the past 35 years. Cowen focuses on innovations in two major areas that led to the pre-Stagnation growth: transportation and energy. He may be correct that innovation in transportation has declined, although the rise in high-speed rail (outside the US) might be one counterpoint), but part of that is because innovations in communication and information technology has made transportation less necessary. In terms of energy, there have been more breakthroughs in new energy sources from 1980-now than there was from 1945-1973.
There's more I could discuss, but this is long enough. So in short: I do not see a world economy that has stagnated overall. I don't even see a US economy (pre-2008) that has stagnated. I see a redistribution from a certain class of American workers to workers with similar skills in other countries, and to workers with very high skills in the US that can market those skills to a global economy. This doesn't have to be a bad thing, if the government can respond by encouraging innovation by high-skilled workers, and even encourage a lot of compensation for them, but provide for the rest with a fairly robust safety net. And, in fact, the major political cleavages of the present focus on precisely these issues. The political battles aren't about stagnation, but about distribution.
UPDATE: A few folks thought the graphs above are misleading, and they've got a point. So rather than just draw some lines in Powerpoint, I did a more reasonable comparison here. It doesn't change the substantive conclusion of this post, but it was worth doing.
Historical Evidence on the Finance-Trade-Growth Nexus Michael D. Bordo, Peter L. Rousseau NBER Working Paper No. 17024 Issued in May 2011
We study linkages between financial development, international trade, and long-run growth using data since 1880 for seventeen now-developed “Atlantic” economies and a set of cross-country and dynamic panel data models. We find that finance and trade reinforced each other before 1930, but that these effects did not persist after the Second World War. Financial development has positive effects on growth throughout the sample period, while trade affects growth strongly and independently after 1945. We attribute the rising importance of trade in explaining growth to major post-World War II changes in tariffs and quantity restrictions associated with the GATT, the establishment of the European Common Market, and the gradual elimination of capital controls after 1973. The findings are robust to the use of ‘deep’ fundamentals such as legal origin and indicators of the political environment as instruments for financial development and trade. Financial development, however, is more closely linked to these fundamentals than trade.
When all the debate over whether financial innovation added any value to society was going on, and folks like Volcker were saying that there was no evidence that it did, I always wondered what the evidence was. I've always thought that countries with deep, liquid financial markets had better economic performance than those that did not. I've always thought that financial innovation helped to create deep, liquid financial markets. Not sure this paper will settle that question, but it's worth a look.
We are rightly concerned about the economic doldrums in the U.S. and Europe, but we shouldn't forget that elsewhere progress marches on. Via the Economist, which adds:
MUCH has been written about the rise of the BRICs and Asia’s impressive economic performance. But an analysis by The Economist finds that over the ten years to 2010, six of the world’s ten fastest-growing economies were in sub-Saharan Africa. On IMF forecasts Africa will grab seven of the top ten places over the next five years (our ranking excludes countries with a population of less than 10m as well as Iraq and Afghanistan, which could both rebound strongly in the years ahead). Over the past decade the simple unweighted average of countries’ growth rates was virtually identical in Africa and Asia. Over the next five years Africa is likely to take the lead. In other words, the average African economy will outpace its Asian counterpart.
We've featured Hans Rosling and his cool data visualizations on this blog multiple times. Now he's got his own BBC show, "The Joy of Stats", which airs on December 7th on BBC4. Unfortunately, it does not appear that it will be shown outside the UK, but here is the preview:
Tyler Cowen gave a talk at UNC today, in what appeared to be a class taught by Mike Munger. It was open to the public, so I went. Cowen introduced it as a mix of his last book and what will become his next one. The former considered micro and micro-micro economic development; the latter concerns the macro economy. He closed by discussing implications for the American political economy.
Cowen began by arguing that the most notable economic developments in the U.S. in recent times has been the ability to collect and manipulate information, especially what he calls "cultural information". The ability of individuals to collect and readily access culture at very low marginal cost through social networking and digitized media has allowed us to create our own economies. These have dramatically improved our quality of life, but unlike previous inventions they have not increased GDP by much or employed many people.
Then he shifted to his macro view, which is most heavily influenced by two events: the stagnation of median wages since 1973, and the financial crisis. The former indicates, to Cowen, that we haven't been as innovative as we thought. Most of the important inventions (which he loosely defines as mixing fossil fuels with machines) occurred well before 1973, and we've spent the time since making marginal improvements to the same technologies. As we've done so we've increased productivity, and that's why everyone has a refrigerator and a telephone. But we haven't really come up with new innovations; we've just improved the old ones. The exception to the rule -- information technology -- has improved quality of life but not measured GDP.
Cowen brings this together by saying that he is a "utility optimist" but a "numbers pessimist". He thinks that we'll continue to improve the ways we can collect and manipulate information and this will have important real benefits for people, but they will not create many jobs or provide a large boost to GDP. He says that we cannot expect to maintain a trend rate of real GDP per capita growth of 3% a year; 1% -- which is more than what the median earner has had since 1973 -- is the new normal. That doesn't mean we're stagnating; it just means that we have poor measures of progress. He recommends the Wolfers/Stevenson happiness research as an ongoing attempt at correction.
But this divergence between numbers and utility is where he sees the problem for political economy. Voters will demand 3%, rather than accepting 1% plus non-monetary improvements in standards of living. Politicians will thus promise 3%, and will pursue policies that generate it. That means encouraging a debt-based economy, encouraging too much consumption, and encouraging bubbles in asset prices that lead to financial crises. He didn't explicitly say it, but it sounds like he expects boom-and-bust cycles to continue until the American public is willing to accept 1% growth, or until we break through the "innovation plateau" that we've been stuck in since 1973.
I think I've summarized his argument correctly, and I'm sure he'll be writing much more about it in the future. I think it's a compelling story, but I'm not yet completely convinced. Here's how I see the world since 1973:
1. The natural advantages of the U.S. economy post-WWII had mostly dissipated by 1973. This was inevitable, indeed it was something the U.S. strove for, so the previously-high growth rates were simply not sustainable. This isn't about innovation; it's about competition. As W. Europe and and Japan "re-industrialized" and were able to productively mobilize labor, they narrowed the U.S.'s margins. At the same time, the U.S. had mostly already reaped most of the GDP benefits of mobilizing female workers and integrating minorities by 1973.
2. Somewhat related to #1, I think Cowen has the wrong level of analysis. While it may be true that median incomes have stagnated in the U.S. since 1973, real global GDP/capita has nearly doubled since 1973. Even allowing an increase in inequality, global median incomes has certainly increased markedly, probably well more than 3% a year. (A quick search didn't turn up a global median income growth time series, but I can't imagine this isn't true.) We would expect this to happen as more countries employ their populaces in industrialized work. In other words, the experience of the U.S. from 1900-1973 has become the experience of the world from 1973-2010. This has put pressure on American middle class wages, as we should expect it would: when the supply curve of less-skilled labor shifts right, the returns to less-skilled labor goes down. But the returns to more-skilled labor have not gone done, which is why the American mean and median have diverged.
3. I don't think the new normal has to be 1% growth. It could also be 3% growth, but not broadly dispersed. That has, in fact, been the story of American post-1973. Not all of that growth was a myth. After all, before we got the micro-micro innovations like Twitter and iTunes we also got the micro-macro innovations like the PC. These did raise the real productivity of the economy, but not necessarily for the factory worker or custodian. Those initial innovations made Bill Gates much richer in monetary terms than Joe the Plumber, but Joe the Plumber got psychic benefits that he would not have otherwise had. In Cowen's language, numbers and utility went up, but not necessarily in equal amounts for everyone. I don't see that that process has run its course. Facebook and Twitter may hire many fewer people than GM and Ford hired when they boomed, but Mark Zuckerberg is the youngest billionaire in history.
4. If #3 is correct, then the political economy dimension becomes about distribution of monetary gains, not divergent perceptions of utility vs. numbers. Interestingly, this will not be a battle between capital and labor, but between labor and labor. (It doesn't take much capital to create Facebook; Zuckerberg did it in a few months on an IBM.) Maybe labor becomes more of a lottery. If that continues to happen, I'd expect the political equilibrium to be a strengthened welfare state. I don't think recent political swings necessarily contradict this, since the best political models are the most structural political models. Additionally, public anger over the bailouts is much stronger and deeper than many expected, and no one is interested in weakening the major entitlement programs.
I'll have to think about this more for than just an afternoon/evening to form stronger conclusions, but that's where I'm at now. Perhaps as Cowen develops his thesis more fully he'll address some of this, and especially consider if/how the story changes when we think globally. Either way I'm looking forward to seeing how his thoughts develop.
P.S. I live-tweeted the lecture, and asked the Twitterverse for questions. Daniel Davies asked me to ask Cowen what he thought of Keynes' "Economic Possibilities for Our Grandchildren". Cowen's response was essentially "It is one of the more interesting intellectual mistakes of the 20th century." I don't think Davies liked that response too much, but I'll let them speak for themselves if they like. I'd never read the essay before. It is interesting. And it is, I think, mistaken, although not entirely. A pdf is here.
So another way of stating China’s rapid growth recipe would be something like the following:
Have a succession of crazy autocrats, political chaos, and war savagely repress one of history’s most inventive peoples, along with not allowing one of the most successful trading diasporas in history to operate in China proper. Then have things calm down a bit and have somewhat less crazy rulers allow more of the people’s energy and creativity to burst out. Presto, the change from EXTREME NEGATIVE to LESS NEGATIVE is called a “growth rate,” and it will be high. Now accept worship from around the world.
More at the link. I hope to have more to say about the "somewhat less crazy" part of this over the next few days. But Easterly's point is that we should not be emphasizing how well China is doing under an autocratic system, but how poorly they have done. Look at these charts, created from Angus Maddison's data and pilfered from here:
The point is that China's economic performance has been so unbelievably poor over the past few centuries, almost against all odds, that any government just to this side of sado-masochistic could expect to produce short-run economic growth. That doesn't mean they are worthy of praise.
As an graduate of Econ 101 can tell you, gross domestic product is calculated according to a modest identity:
GDP = Consumption + Investment + Government + Exports - Imports
This measure of a nation's well-being is attractive for its simplicity, but it lacks nuance about the state of an economy. GDP does not measure the distribution of national income, the type of production or consumption, or the circumstances under which production and consumption take place. Today's GDP report illustrates some of this:
Growth in the last quarter was stifled by a 32.4 percent surge in imports, the largest since the first quarter of 1984, dwarfing a 9.1 percent rise in exports. That created a trade deficit, which sliced off 3.37 percentage points from GDP, the largest subtraction since the fourth quarter of 1947.
Obviously, a trade surplus would be better than a trade deficit, especially in terms of generating employment growth domestically rather than abroad. But exports did rise, at quite a healthy clip. They were just eclipsed by this whopping rise in imports — which are a sign that there’s still a lot of demand in the economy.
This is a subject which came up at the Treasury blogger meeting last week: while no one at Treasury is exactly overjoyed at seeing imports rising so much faster than exports, any sign of increased economic activity is being taken as a good sign. Certainly this kind of thing is preferable to seeing the opposite happen, where exports fall and imports fall faster. Even if that would have a better effect on GDP.
So the second quarter GDP revision looks pretty bleak -- 1.6% annualized growth rate, rather than the 2.4% that was originally reported, which itself was down from 3.7% in the first quarter -- and it certainly isn't great. But the rise in exports shows the the U.S. retains some competitiveness, and the rise in imports demonstrates the presence of consumer demand in the face of a weakened dollar.
This is also one piece of evidence that we are not in a paradox of thrift world, nor that the aggregate problem is nominal, not real. That's not proof of anything, but it is one point. It also demonstrates how important trade is for the well-being of the country, even if it has a nil or negative effect on GDP.
For some of these reasons, the French government created the Commission on the Measurement of Economic Performance and Social Progress, which included such luminaries as Joseph Stiglitz and Amartya Sen, to create a different measure. Their report is interesting, although i doubt GDP will be displaced as the most common unit of measure any time soon. GDP's benefit is its simplicity and universality, even if those attributes sacrifice some nuance in the process.
Emmanuel noticed the Dani Rodrik op-ed I quoted the other day, and went off:
It honestly bothers me that I was the first to notice this factual error. On the aforementioned webpage, there are supposedly 134 Facebook shares and 41 retweets, yet nobody bothered to flag this up. What worries me is that few folks are really that familiar with the literature or do not read closely enough.
This subject matter--the relationship between democracy and economic growth--has been researched to the point of becoming a cliche, but overall, econometric analysis yields a null result. There is, statistically speaking, no evidence that democracy has a direct impact on economic growth. None. Nada. Zip. Zilch. A paper that I can suggest for those unfamiliar with this area is Doucouliagos and Olubasoglu's meta-analysis--or an econometric study of studies--that provides a similar conclusion. (There's also a non-gated earlier version.) At best, democracy only has positive "indirect" effects, but it alone doesn't make it significantly more likely that economic growth will occur.
As for the freedom-and-growth shtick, save it for Wolfowitz, Perle, and Feith. To state things correctly, authoritarianism may not necessarily be conducive to economic growth, but neither is democracy. There are many political recipes for economic growth, period.
I should say that I too noticed the part he's talking about, but didn't comment on it for two reasons: first, it wasn't related to the substance of my post; second, that the relationship between democracy and economic performance is controversial. While it may be true that democracy is not "directly" responsible for economic growth as Emmanuel says above, that does not preclude it from having an indirect effect. If growth comes from stable institutions that emphasize things like property rights, free markets, and rule of law. Consider this influential paper by Barro:
Growth and democracy (subjective indexes of political freedom) are analyzed for a panel of about 100 countries from 1960 to 1990. The favorable effects on growth include maintenance of the rule of law, free markets, small government consumption, and high human capital. Once these kinds of variables and the initial level of real per capita GDP are held constant, the overall effect of democracy on growth is weakly negative.
So after controlling for other effects, democracy does not tend to have an independent effect on growth. But where do those other things -- rule of law, free markets, small government consumption, high human capital -- come from? In general, they are strongly associated with democracy. Democracy could be working indirectly through those other variables to have an effect on growth. Perhaps that is why there is little evidence that democracy directly impacts economic growth rates but ample evidence that democracy and levels of economic development are very highly correlated. (In other words, richer countries tend to be the most democratic.)
There are other ways to read this, including dependency theory and other variants of Marxism, but the correlation remains. Perhaps to that end Rodrik amended the wording in his argument (see above link), but left this part in:
[Democracies] provide much greater economic stability, measured by the ups and downs of the business cycle. They are better at adjusting to external economic shocks (such as terms-of-trade declines or sudden stops in capital inflows). They generate more investment in human capital – health and education. And they produce more equitable societies.
If democracies generally produce those kinds of institutions, and those institutions produce economic growth, then is it really right to conclude that there is no relationship between democracy and growth? Probably not. In fact, that is the precise argument of Baum and Lake:
Democracy is more than just another brake or booster for the economy. We argue that there are significant indirect effects of democracy on growth through public health and education. Where economists use life expectancy and education as proxies for human capital, we expect democracy will be an important determinant of the level of public services manifested in these indicators. In addition to whatever direct effect democracy may have on growth, we predict an important indirect effect through public policies that condition the level of human capital in different societies. We conduct statistical investigations into the direct and indirect effects of democracy on growth using a data set consisting of a 30-year panel of 128 countries. We find that democracy has no statistically significant direct effect on growth. Rather, we discover that the effect of democracy is largely indirect through increased life expectancy in poor countries and increased secondary education in nonpoor countries.
This is also the conclusion of the meta-analysis Emmanuel cites above. None of that says that authoritarian governments cannot promote public health, property rights, rule of law, etc. Some authoritarian regimes, like Singapore, have done very well in this regard. China has obviously moved quite far in that direction as well. But if nothing else it appears that democratic regimes have been better able to build and maintain stable growth-promoting institutions over times. As a result, the richest countries in the world are all democratic.
At least that's my take. As I said I before, this stuff is controversial among social scientists. There are multiple ways to read the massive literature. But to claim without caveat that there is no relationship ("None. Nada. Zip. Zilch.") between democracy and economic growth is misleading at best.
They've revised upwards their projections for global GDP growth for 2010:
The IMF has revised upwards its forecast for growth in the global economy saying it is recovering faster than previously expected. It sees world growth bouncing back from negative territory in 2009 to a forecast 3.9 percent this year and 4.3 percent in 2011.
But there's a catch, isn't there? Yep, I knew it.
But the recovery is proceeding at different speeds around the world, with emerging markets, led by Asia relatively vigorous, but advanced economies remaining sluggish and still dependent on government stimulus measures, the IMF said in an update to its World Economic Outlook, published on January 26.
If you want more, the full report is here, and below there are some videos of IMF Managing Director Dominique Strauss-Kahn and Director of the IMF’s Monetary and Capital Markets Department Jose Viñals.
Nothing. And everything. William Easterly reviews an important new article:
Despite Climategate, even a superficial reading seems to indicate that there is enough evidence for effects of man-made activity on the climate.
Surprisingly, there is a lot less evidence for effects of man-made activity on something that actually is completely man-made: the rate of economic growth in each country.
I had this frustrating thought as I was reading an important new paper, “Determinants of Economic Growth: Will Data Tell?” [1]
The paper gives a conclusive and resounding answer to the question in the title: no.
It has taken economists a lot of hard work to attain this level of sublime ignorance. There were three steps in the the great History of Evolving Cluelessness:
1. Economists spent the past two decades trying every possible growth determinant in sight. They found evidence for 145 different variables (according to an article published in 2005). That was a bit too many in a sample of only about one hundred countries. What was happening is there would be evidence for Determinants A, B, C, and D when tried one at a time to explain growth. But the evidence for A disappeared when you also controlled for some combination of B, C, and D, and/or vice versa. (Interestingly enough, foreign aid never even merited inclusion in the list of 145 variables.)
2. The Columbia economist Xavier Sala-i-Martin and co-authors ran millions of regressions on all possible combinations of 7 variables out of the many possible determinants of growth. Skipping a lot of technical detail, they essentially averaged out the millions of regressions to see which determinants had evidence for them in most regressions. There was hope: some were robust! For example, the idea that malaria prevalence hinders growth found consistent support.
3. This new paper by Ciccone and Jarocinski found that every time the growth data are revised, or if the sample is changed to another equally plausible one, the results vanish on the “robust” variables and new “robust” variables appear. Goodbye, malaria, hello, democracy. Except the new “robust” determinants are no longer believable if minor differences between equally plausible samples changes what is robust. So nothing is robust.
There is more at the link, including whether we should think of the growth literature as GrowthGate.
Ed Glaeser wants to know why Argentina's economy hasn't performed better over the past 100 years, and prints this graph:
He interprets it thusly:
Schooling is measured by the share of the relevant populations that was enrolled in primary, secondary or tertiary schooling. Argentina [in 1990] may have been rich, but it was not that well-educated. In 2000, Argentina was doing about as well as would be expected based on its education levels in 1900. Long-run national success is built on human capital, both because of the link between schooling and technology and because of the link between education and well-functioning democracy.
I mentioned this to a fellow grad student (who is Argentinian) and she thought Glaeser was crazy. She argued that correlation doesn't equal causation, and it is certainly plausible that the causal direction runs the other way (i.e. the poor economic performance led to lower public revenues which then led to less investment in education). She also half-jokingly recommended that I re-read some dependency theory to understand why regions are clustered at the top and bottom of the above graph.
To me, either Glaeser or my classmate could be correct. They could just as well both be incorrect. There's been a lot of political instability in Argentina over last century, right? Perhaps that instability is driving both results. Any of these interpretations are plausible, and just looking at the above graph doesn't help us eliminate alternative hypotheses.
Of course, Glaeser could just respond by arguing that education is also highly correlated with well-functioning democracy, so maybe low education levels explain the political instability as well. But if that story doesn't ring true to my classmate, who is very smart and surely knows more about her country than Glaeser does, then I'd have to wonder. Besides, if political elites knew that their hold on power would be strengthened by limiting opportunities for education, then maybe they'd... limit opportunities for education.
What's the point? Well, there's several. One is that we can learn quite a lot by examining cross-sectional correlations. But another is that correlations alone won't take us all the way to understanding. And the third is that it's really really hard to figure out what's gone on in Argentina over the past 100 years.
The increase in income inequality has led some to fret about the shrinking middle class in America. See, e.g., this piece by Krugman from a few years back. And the data actually do show that the middle class is shrinking, at least if measured by static income groups. But not because of rising income inequality:
The middle classes fell too, though by less. The sum total across the $35K to $75K categories fell by 5.4 percentage points. In other words: the net movement of households was an 11.5 percentage point gain in households above $75K and a net reduction of 11.5 percentage points in houses below $75K. So the percentage above $75K rose from 18.9% to 30.4%. That is, it increased by over 50%.
Let me repeat that: over 30% of US households in 2006 earned above $75K compared to under 20% in 1980. Over the same period, the percentage of US households earning under $35K fell from 42.8% to 36.7%. Fewer households are poor, fewer are middle class, and a hunk more are above $75K. (And in case you were wondering, those general trends hold for black and hispanic households too - with the percentage of black households under $35K falling by 10.9 percentage points and the number above $75K increasing by 8.9 percentage points, for example.)
Yes, those numbers are adjusted for inflation (2006 dollars) but they are not adjusted for the decline in household size or the real improvement of much of what we buy (i.e. a $1,000 computer in 1995 is much worse than a $1,000 computer in 2009 even though they show up as the same thing in the data). These would both understate the improvements in life quality, perhaps by quite a lot.
This gets at the eternal "absolute vs. relative gains" debate: in absolute terms, America has done very well in the past 30 years. We have more wealthy people and fewer poor and middle-income people. On the whole, the rising tide has lifted all boats. But it has lifted some boats much faster than others. Normative political economy is largely determined by which of the two is deemed more important.
What do these countries have in common? One major theme is that they tended to have lower financial vulnerabilities due to more restrictive regulation and less developed financial markets, as well as larger and stronger domestic markets that sustained domestic demand. Moreover, they had the resources to engage in countercyclical fiscal and monetary policies, actions that were not possible in past crises. In contrast, countries that borrowed heavily to finance domestic consumption in the days of easy money are now facing sharp economic contractions. Despite the relative strength of these countries, however, their ability to return to sustained growth will depend on structural reforms that support consumption.
(bold added)
Drawing any particular set of policy recommendations from this list risks selecting on the dependent variable. Plenty of countries with less developed financial markets and strict regulation have done very, very poorly in this crises (c.f. most of E. Europe and many export-biased economies in Asia, Europe, and the Middle East). The second component -- "larger and stronger domestic markets that sustained domestic demand" -- may be more important, but there are plenty of counter-examples there are well. Another key may be found in Roubini's discussion of Latin America:
Brazil and Peru stand out for their relatively healthy fundamentals and financial systems. Both countries have benefited from being relatively closed economies and from having diversified export markets and products. They also took advantage of the boom years (2003-08), reducing external vulnerabilities and increasing savings (fiscal and international reserves). By the time these the crisis hit, both countries had well regulated financial systems that saved them from being contaminated by toxic assets. The fact that their domestic credit markets are at an early developmental stage, so consumption is not very dependent on credit, helped them shelter internal demand.
Chile has also done fairly well during the crisis by pursuing robust counter-cyclical policies, made capable by years of extreme prudence during good times. But note two of Roubini's observations about Brazil and Peru: they are relatively closed economies with poor access to credit. These are bad things that stymie economic growth (in normal times at least), make their citizens poorer, and lead to more unequal societies. In this event these circumstances led to some insulation from the global meltdown, but that is mostly a result of being somewhat disconnected from the global economy. If such policies persist in the future, they will lead to stagnant growth and underperformance.
Just look at the list. Other than China, India, and Egypt, almost every country had underwhelming growth before the crisis, and that trend could easily resume after the global recession reverses. So we should learn our lessons from countries that have shown resiliency, but we should not necessarily hold up the countries on Roubini's list as exemplars of economic performance.
We are rich enough. Economic growth has done as much as it can to improve material conditions in the developed countries, and in some cases appears to be damaging health. If Britain were instead to concentrate on making its citizens' incomes as equal as those of people in Japan and Scandinavia, we could each have seven extra weeks' holiday a year, we would be thinner, we would each live a year or so longer, and we'd trust each other more.
Epidemiologists Richard Wilkinson and Kate Pickett don't soft-soap their message. It is brave to write a book arguing that economies should stop growing when millions of jobs are being lost, though they may be pushing at an open door in public consciousness. We know there is something wrong, and this book goes a long way towards explaining what and why.
Via Yglesias, who claims that equality leads to growth (which may or may not be true) but dances around the main point which is exemplified by the part I bolded: in the absence of growth, everybody is made worse off, but the people at the bottom of the social scale suffer disproportionately. When growth suffers, those with the fewest skills and lowest levels of education are the first ones to lose their jobs and homes. As Krugman noted the other day, the American economy requires a 2% growth rate just to maintain a constant employment rate, and faster growth rates are strongly associated with lower unemployment. This is especially true for those at the bottom of the social scale (including, as Yglesias mentions, unskilled immigrants from poor countries).
But even if all of that were not true, this argument still makes no sense. Whether equality fosters growth (as Yglesias maintains) or growth fosters equality (as I suspect), the richest countries in the world tend to be the most equal. The map above shows Gini coefficients for the world in 2007-2008, as reported in the U.N. Development Report (click here for a larger version). A higher Gini coefficient refers to a more unequal society. So what do we see? Countries that are rich tend to also be more equal than countries that are poor. And how to do you get rich? There is only one way: economic growth. So perhaps the best way to address within-country inequality is spend more effort trying to maximize growth. If we seek to address between-country inequality, then our only alternative is a pro-growth strategy for the developing world. And in recent times, the most successful growth models for emerging economies is to be export-led. But who buys the exports? The developed world. And how can the developed world afford to buy those exports? I think you can see where I'm going with this.
Of course, I haven't mentioned the importance of absolute as well as relative levels of wealth, the underrated benefits of compounding growth rates, the social (in)justice of legislating the preferences of some (for more leisure relative to income, say) as mandates for others, the importance of incentives, or the sheer unholy slap-your-forehead dumbness of Hanley's second sentence: "Economic growth has done as much as it can to improve material conditions in the developed countries."
Matthew Yglesias reads Charles Kenny and decides that policy is overrated:
One point Charles Kenny makes in The Success of Development that I’ve also seen argued convincingly in other contexts is that public policy choices seem to matter less than people would lead you to believe. This is a particularly striking fact:
Looking more broadly at the experience of the communist bloc under communism, over the period 1950-1988, no East European country grew as slowly as the UK, Mexico, Switzerland, Colombia, the US, Australia, India, New Zealand, Peru, Chile, Argentina or Venezuela.
People sometimes about the poor policy choices that led to Argentina’s poor growth performance in the 20th century. But it’s hard to make the case that Argentina was following worse policies during this period than Poland. Also: “Between 1928 and 1937, at the same time as farms were brutally collectivized, famine killed as many as 10 million people in the Ukraine, and Stalin‘s great terror was unleashed, the Soviet Union was the fastest growing country in the world.”
NB: I am not advocating Stalin-style economic policies.
This is the wrong way to look at things. Another way to look at it would be to say that no Western European country but the UK and Switzerland had lower growth rates than countries in the Soviet bloc. Still another would way to look at it would be to compare broader aggregates over time, rather than individual cases, to see larger trends. This approach is most appropriate when one is trying to compare economic systems, as Kenny and Yglesias seem to be doing:
As you can see, the "West" outperformed everyone else in the second half of the 20th century, and the difference is not subtle.
But Kenny's broader point is that we have yet to find some magic combination of policies that are easily exportable and automatically lead to lots of economic growth. This is true. As Kenny wrote in an earlier paper [pdf]:
In short, the last six years has not changed the basic conclusion that the growth literature has taught us much less about how to get rich than it has about who is already rich. There is nothing particularly new in recent growth theory, but perhaps that is no surprise because there is remarkably little new in growth, either –the rich today are by and large those who were rich yesterday. That there might not be a holy grail of growth policy, however, is no reason for people of economic faith to stop looking, so no doubt the next six years will see another 13,000 articles on the subject to review.
