Wednesday, November 27, 2013

What Do the 1950s and 1960s Teach Us About Economic Policy?

The 1950s and 1960s economy featured a much stronger role for unions, much higher marginal tax rates on wealthy individuals, much stronger regulation, and a much higher minimum wage (in real terms). What happened?

Well, as progressive economists often tell us, unemployment was fairly low, GDP growth was fairly high, and we had much less income inequality. Is this not a total refutation of neoliberalism and supply side economics?

Perhaps, but I don't see it that way (not surprisingly). To give a bit more perspective, since that time period, union membership has fallen from somewhere around 30 to 35% of the workforce to 10 to 15% of the workforce today. Top marginal tax rates ranged from around 70 to 90% in the 50s and 60s compared to tax rates ranging from 28 to 40% over the past few decades. The minimum wage would something like $22 (that's the number I've heard) had it kept up with productivity since 1960. Instead, it is $7.25 today. Another neoliberal policy, free trade, has also been expanded greatly since the mid 20th century.

On the other hand, the Great Society was not until the 1960s and thus the welfare state was a good deal smaller for most of the 1950s and 60s than it is today. Also, while we've seen many deregulatory initiatives in recent decades, we've also seen expanding regulation in many areas. So, the direction of regulatory policy is more debatable.

Still, all things considered, our economic policy has moved in a decidedly neoliberal direction since the mid century. Despite this, as is often mentioned, there is not a noticeable improvement in economic performance during this period, but there is a large increase in income inequality. 

The way progressives (and indeed most people who look at this issue) interpret this is that neoliberalism ultimately failed to enhance productivity. I think there are two ways to interpret this:

1.) The progressive narrative that neoliberal reforms simply took place due to a political shift and failed.

2.) Another possible explanation is that neoliberal reforms were in response to a bad economic performance and did improve economic performance relative to how the economy would have performed absent the reforms.

The basic disagreement here stems around what would have happened absent any economic reforms. The progressive narrative implies that, absent the reforms, our economy would have continued performing as strongly as it had in the 1950s and 60s. The competing narrative holds that, absent any reforms, there would have been a much more significant growth slowdown than there was.

Luckily, the neoliberal revolution was not strictly an American phenomenon and indeed happened across the developed (and even developing) world. Perhaps more importantly, some countries were much more aggressive in reforming their economies than others while some did not reform at all. This offers us something close to a natural experiment. 

If the progressive narrative is correct, countries with more aggressive reforms should not see any advantage in economic growth over the countries that reformed less aggressively or didn't reform at all. If the competing narrative is correct, the more aggressive reformers should she positive (relative) results.

Scott Sumner wrote a piece in 2010 looking at this very data. He compares the GDP per capita 
(and even provides a chart) over time between various countries and here is what he finds:

United States1.0001.0001.000
Hong Kong.547.845.948
Latin America

Note that four countries gained significantly on the United States, two were roughly stable (Australia and Japan) and the rest regressed. The four that gained were Chile, Britain, Hong Kong and Singapore. Of course, many poor countries also gained on the United States, but that's to be expected. As we will see, the relative performance of each of these economies is consistent with the view that neoliberal policies promote economic growth.

Britain: At the time Margaret Thatcher became Prime Minister in 1979, decades of statist policies had turned Britain into the sick man of Europe. The government owned the big manufacturing firms in industries such as autos and steel. The top individual MTRs on income were 83 percent on "earned income" and an eye-popping 98 percent on income from capital. Frequent labor strikes paralyzed transportation and led to garbage piling up in the streets of London. Much of the housing stock was government-owned. Britain had lagged other European economies for decades, growing far more slowly than most economies on the continent. Thatcher's reforms were among the most comprehensive in the world, and by the mid-1980s, Britain was growing faster than the other major European economies. By 2008, it had a higher per capita income than Germany, France, and Italy.

United States: The United States was doing better than Britain in 1980, but not particularly well. We had also been growing much more slowly than Europe and Japan. Unlike Britain, we were still richer than most other developed countries, and so many people viewed this convergence as partly inevitable (the catch-up from World War II) and partly reflective of the superior economic model of the Germans and Japanese. It was widely expected that Japan and Germany would eventually surpass the United States in per capita GDP. Paul Samuelson claimed in 1973 that Soviet GDP might surpass U.S. GDP as soon as 1990.5 Obviously none of this happened, and by the 1990s, the United States was growing faster than most major European economies.

Australia: A traditionally rich country whose commodity export model started to sputter in the 1970s, Australia began free-market reforms in the 1980s (under a left-wing government) and accelerated the reforms after the conservatives took power in 1996. After 1994, Australia's relative decline reversed.

Japan: Japan is just the opposite of Australia. Its free-market export model did very well in the post-war years and didn't hit a wall until about 1990. After that, domestic growth sputtered as Japan's dysfunctional government refused to reform its statist domestic economy.

Hong Kong and Singapore: These two countries top most surveys of "economic freedom" (which include size of government.) Both are in the process of becoming much richer than the United States. Some of that is due to their status as city-states. But even in larger developed economies, the population is mainly urban, and so Hong Kong's and Singapore's success is due to more than just demographics.

Canada: Canada is similar to Australia, except that it was not as statist as Australia in the earlier period, and its reforms occurred in the 1990s, when Canada began shrinking the size of government as a share of GDP, after having, in 1988, adopted free trade with the United States. These reforms were successful, as its decline relative to the United States was reversed, and Canada started catching up after 1994.

France and Germany: Both passed some reforms, but much less than Britain. They suffered a decline relative to both Britain and the United States. Note that the German data for the whole time period include the East, so their relative decline cannot be explained by the 1990 absorption of that less-productive region.

Italy: Italy instituted a few reforms, but has a significantly more statist model than most of Western Europe. Italy fell far behind Britain.

Sweden: Sweden had a bad recession in the early 1990s after having suffered decades of relative decline. It made major cuts in MTRs, privatized, and deregulated during the 1990s, and its relative performance improved after those reforms.

Switzerland: Switzerland has always been regarded as one of the most capitalist countries in Western Europe, but has also been among the least aggressive countries in terms of neoliberal reforms. That pattern would predict high levels of GDP/person, but relative decline vis-à-vis the United States And that is exactly what has occurred."

(There is more here)

The data seems to be much more in line with the neoliberal narrative than the progressive narrative. This, of course, begs another important question: if really high MTRs, really high minimum wages, and related policies hurt relative economic growth after 1980, how did the USA economy do so well with top tax rates in excess of 70% and a minimum wage over $20 in relative terms.

In my opinion, there is an often unacknowledged reality regarding economic policy and culture: a given policy could be good in one country at a certain point in time, bad in another country at a different point time, and really bad in yet another country at yet another point in time.

70% top tax rates and $22 minimum wages are the kinds of policies that are bad wherever tried. However, they would be much worse today than in the 1960s. Why?

I think a few forces since then have made these sort of economic policies go from moderately bad in the 1960s to very bad in the 2010s. One force is globalization. This is things like free trade, immigration, and the elimination of capital controls, all of which offer immense economic benefits.

However, they also make it easier for employers to find labor that is not subject to USA minimum wage laws. That could be foreign labor or (illegal) immigrant labor. It could also be machine labor.

The point is that in the 1960s, employers had fewer options when it came to labor that they valued less than the minimum wage.  That is not true today.

The same is true of taxes. In the mid 20th century, industry was not particularly mobile. People weren't particularly mobile. It was much harder to make investment or living choices based on tax regime. Still, even in in the 1950s and 1960s, there was significant investment in tax avoidance. This is made clear by the discrepancy between the high tax rates and (not so high) revenue as % of GDP. If high tax rates aren't even able to raise a lot of revenue, one wonders exactly what purpose they are serving.

Another issue is the rising role of startups. Back in the good old days (I'm told), there were a few companies that everyone worked for their entire life. They all joined the union and received a steady, stable paycheck.

Today, there is a heavy reliance on entrepreneurs and startups. New enterprises are much more difficult to startup in an environment of high taxes, high labor costs, and a large regulatory bureaucracy. Large, incumbent firms can absorb these costs more easily. An economy relying on these types of firms also involves less mobility.

An entrepreneur starting a new business is much more likely to take tax regime into account when choosing where to do business than an existing large business that already has a substantial infrastructure. In an economy that relies on the continuation of startups, tax regime matters a good deal more.

On a similar note, in the post industrial economy, people are often switching jobs. People are also competing with the entire globe when it comes to jobs. Strong labor unions were likely an inevitable casuality of economic progress.

The main point is that larger economic forces are pushing economic policy in a certain direction. In the modern world, economies with 70% top tax rates, $22 minimum wages, and powerful unions are simply not competitive economies.

People who supported these economic policies see this as a "race to the bottom". I tend to see it more as a "race to the top". Globalization has forced countries to adopt economic policies that are ultimately better for their people.

The 1950s and 1960s were something of a golden age for the American worker. However, all things considered, its a good thing that we left the economic policies of the mid 20th century in the mid 20th century.

UPDATE: I 'd also like to point out how the parameters of our debate have shifted. Even if President Obama could get his minimum wage and tax proposals through, we would be looking at a $9 minimum wage and a top tax rate around 45%. I'm not a fan of either of those proposals, but we are still looking at a minimum wage and top tax rate well below their level in the 1960s.

Republicans accepted the New Deal long ago and began trying to reform it instead of eliminate it. Democrats have done the same with regards to the (necessary) changes in economic policy that have taken place over the past 30 years.
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