The Free Thinker

Over-Interpreting the Golden Age

It has long been customary for conservatives to look back to the 1950s as a Golden Age. Lately, this has become a habit among economists who are somewhat heterodox and/or left-leaning. Thus, Paul Krugman, in The Conscience of a Liberal, appeals to the 1950s as a better, more egalitarian time, with high taxes and more equality. Dani Rodrik, in The Globalization Paradox, holds up the Bretton Woods regime of the post-WWII years as an era of "moderate globalization," in favorable contrast to the "hyper-globalization" that began in the 1980s and accelerated in the 1990s. Robert Skidelsky, in Return of the Master, dates the decades immediately following WWII as an era when Keynes was the "coach," and contrasts them favorably to the time since then.

Skidelsky, by the way, makes the indefensible move of dating the end of the Keynesian era from 1973 in order to make the Keynesian era look good. Actually, the 1970s were the heyday of Keynesianism: it was 1971 when Nixon said "I am now a Keynesian." It was with Volcker and Reagan that Keynesianism began to be eclipsed, and it was only in the 1990s that a new anti-fiscal-policy consensus seems to have emerged. Include the 1970s and the Keynesian era doesn't look so good. But I digress.

All these authors use the post-WWII boom to support their view, by showing that growth was quite strong in that period. Generally, they are advocating a position which there are good theoretical reasons to believe to be anti-growth. Thus, Keynesianism discourages savings, which in the medium to long run must discourage investment, which slows growth. Again, globalization of finance and trade should yield benefits from diversification, economies of scale, comparative advantage, and so on which should raise the level and (at least in the short run, perhaps permanently) growth rate of GDP per capita, as well as (arguably) a more equal distribution of GDP globally. And Krugman's proposed high tax rates should obviously be expected to reduce the incentives to work, trade, save, and invest which grow the economy. Instead of acknowledging and responding to strong theoretical arguments that their preferred policies are anti-growth, they make the empirical point that when the policy regime was closer to their desiderata, growth was strong. It's rhetorically effective. But it will not do.

Two objections must be made. First, there are some big, obvious reasons for the strong post-WWII boom, and once these big, obvious reasons are considered, it's not clear that there's anything left to explain. Second, if one allows an atheoretic, empirical appeal to the 1950s and 1960s to count as a valid argument, one legitimizes other arguments that have the same form.

The big obvious reasons for the post-WWII boom are:

1. Recovery from the war (and depression). World War II was enormously destructive. So was the Great Depression before it. By the end of World War II, the world was a lot poorer than it knew how to be. You could get a lot of growth just by returning to normalcy at that point. (This argument applies especially in Asia and Western Europe, but in America too.)

2. Demography. Because of the baby boom after World War II, the population was unusually young. Young people tend to learn, or "accumulate human capital," faster, and consequently enjoy rising productivity. Also, with a smaller population of old people to support, it was much easier for governments to balance their books, with money to spare for public works projects.

I think there's also a third, subtler reason for the post-WWII boom: the West was still benefiting from the technological momentum of the late 19th and early 20th centuries, the golden age of innovation, the factory etc., the Age of Henry Ford, which had peaked in the 1920s, but had continuing to cast up new technologies which the conditions of depressions of war had not been able to exploit. A lot of low-hanging fruit had, so to speak, grown on the technology tree which a nation distracted by depression and war had not been able to exploit.

All this suggests that by the 1970s and 1980s growth had become a lot harder. Recovery from the war was complete, we were pushing up against technological frontiers, and demography was less favorable. So to compare the growth rate in 1980-2007 with that of 1945-1980 (even if you don't cheat by throwing the 1970s into the later period!) is not really a fair comparison. A growth slowdown was inevitable. Good thing Thatcher and Reagan came along, or it might have been a lot worse! (As, in fact, it was in France, Germany, and later Japan-- anywhere that didn't make a turn towards free markets about that time.)

The other problem is that if your argument is "growth was better in the 1950s and 1960s, we're not sure why, but it might be x" then you open the door to arguments like the following:

1. The civil rights movement caused the growth slowdown. The system of racial segregation before the mid-1960s was ugly, but efficiently protected the social capital of the white bourgeoisie, while the breakup of that system through anti-discrimination of laws was invasive and highly inefficient, depriving firms of quick, rough-and-ready methods of gauging employee compatibility. The cost of racial justice-- perhaps one well worth paying!-- was slower economic growth and rising economic inequality.

2. Feminism and the entry of women into the workforce caused the growth slowdown -- or perhaps, to be more exact, the productivity slowdown, by increasing the denominator of productivity statistics, person-hours of work, without increasing the numerator proportionally. Housework and breadwinning are complements. A man is both more able and more motivated to do good work on the job if a housewife is making his meals, cleaning his clothes and his house, and raising his kids. Breadwinners for a family are likely to place more value on cash relative to the intrinsic rewards of fun or interesting jobs, and that helps productivity, too. Also, when men's and women's roles are more clearly defined and prescribed by society, economic complementarity in marriage is much easier to acheive (just as it's easier to shop for electronics when all houses are equipped with the same style of plug). The cost of women's liberation and gender equality-- again, perhaps one well worth paying!-- was slower economic growth and rising income inequality.

3. The cultural and sexual revolution of the 1960s caused the growth slowdown. Tradition isn't always right but it tends to carry with it a lot of the moral values-- honesty, self-reliance, hard work-- that parents try to inculcate in children. The rebelliousness of the 1960s undermined these values, and made it distasteful to young people to emulate old heroes of industry like Henry Ford. They wanted to be rock stars instead. And the sexual revolution in particular diverted a lot of energy, for better or worse, into hedonistic sexual pursuits.

Now, I'm not endorsing (1), (2), or (3). And I think it would be very difficult to develop these speculations into rigorous theories that could stand up to critical testing and also perform well empirically, not just in "explaining" (or being consistent with) one or two big macro facts, but in detail. But I think it would be pretty easy to write books that developed these themes (and others) in an atheoretic way, and then pre-empt objections with a hand-waving appeal to empirical history. Such books are unlikely to be written, or at least unlikely to be read, because they are politically incorrect, but it's much more satisfying to say to such arguments, "No, your appeal to the 1950s and 1960s growth record in support of your argument is not persuasive, because that's sufficiently well explained by demography and the recovery from wartime destruction that there's really no mystery left to solve." And that's the same answer I'd give to Rodrik, Krugman, and Skidelsky.

Why the West Invented Modernity (Comments on Joel Mokyr)

An excellent lecture by Joel Mokyr, highly informative and fascinating. A few remarks.

1. Guilds.I was struck by how positive Mokyr is about guilds. G.K. Chesterton would be pleased. I had thought of the guilds as basically rent-seeking organizations that inhibited progress, and to some extent they were. Adam Smith wasn't very positive about the apprenticeship system either. But Mokyr argues that one of the big European advantages was that they had high-quality craftsmen, and that, in turn, had a lot to do with the guilds. It's one thing to invent stuff, it's another thing to make it. If you don't have people who are dexterous with their hands, you probably can't get your inventions to work. Other civilizations would sometimes even have the same technology-- gunpowder, for example-- but the quality was much lower. Here is Chesterton:

When we pass from the strictly educational hierarchy to the strictly egalitarian ideal, we find again that the remains of the thing to-day are so distorted and disconnected as to be comic. There are City Companies which inherit the coats of arms and the immense relative wealth of the old Guilds, and inherit nothing else. Even what is good about them is not what was good about the Guilds. In one case we shall find something like a Worshipful Company of Bricklayers, in which, it is unnecessary to say, there is not a single bricklayer or anybody who has ever known a bricklayer, but in which the senior partners of a few big businesses in the City, with a few faded military men with a taste in cookery, tell each other in after-dinner speeches that it has been the glory of their lives to make allegorical bricks without straw. In another case we shall find a Worshipful Company of Whitewashers who do deserve their name, in the sense that many of them employ a large number of other people to whitewash. These Companies support large charities and often doubtless very valuable charities; but their object is quite different from that of the old charities of the Guilds. The aim of the Guild charities was the same as the aim of the Common Land. It was to resist inequality—or, as some earnest old gentlemen of the last generation would probably put it, to resist evolution. It was to ensure, not only that bricklaying should survive and succeed, but that every bricklayer should survive and succeed. It sought to rebuild the ruins of any bricklayer, and to give any faded whitewasher a new white coat. It was the whole aim of the Guilds to cobble their cobblers like their shoes and clout their clothiers with their clothes; to strengthen the weakest link, or go after the hundredth sheep; in short, to keep the row of little shops unbroken like a line of battle. It resisted the growth of a big shop like the growth of a dragon. Now even the whitewashers of the Whitewashers Company will not pretend that it exists to prevent a small shop being swallowed by a big shop, or that it has done anything whatever to prevent it. At the best the kindness it would show to a bankrupt whitewasher would be a kind of compensation; it would not be reinstatement; it would not be the restoration of status in an industrial system. So careful of the type it seems, so careless of the single life; and by that very modern evolutionary philosophy the type itself has been destroyed. The old Guilds, with the same object of equality, of course, insisted peremptorily upon the same level system of payment and treatment which is a point of complaint against the modern Trades Unions. But they insisted also, as the Trades Unions cannot do, upon a high standard of craftsmanship, which still astonishes the world in the corners of perishing buildings or the colours of broken glass. There is no artist or art critic who will not concede, however distant his own style from the Gothic school, that there was in this time a nameless but universal artistic touch in the moulding of the very tools of life. Accident has preserved the rudest sticks and stools and pots and pans which have suggestive shapes as if they were possessed not by devils but by elves. For they were, indeed, as compared with subsequent systems, produced in the incredible fairyland of a free country.

Without endorsing this word for word, I wonder if Chesterton was onto something here. I could put it in terms MacIntyre might like by saying that the guilds learning to value practices for their own sake, and not merely for the extrinsic rewards associated with them.

2. European space. Mokyr emphasizes the importance of political fragmentation, and in particular, the ability of the leading intellectuals, when persecuted in one place, to move somewhere else. I agree! And that's yet another reminder of how valuable it would be today to abolish the barbarous passport regimes which shackle and smother the human race and declare open borders. But there's another point here: even though Europe was politically fragmented, yet it was a unified cultural space. Europeans could talk to each other. They could travel and feel more or less at home. Prestige in Paris meant prestige in London and prestige in Berlin. There was a shared cultural frame of reference. That European space was a cultural unity made possible the respublica litteraria of the Enlightenment, but what made it possible; why was Europe a cultural unity? The answer to that lies deep in the Middle Ages, in the missionaries who brought Christianity to the far corners of the continent, in the monasteries that Christianized Europe and preserved literacy in Latin and mastered the ancient literature in the ancient languages, in the internationalism of the university of Paris and the Dominican and Franciscan orders, and so on. In short, it was the work of Christianity and the Church. The remarkable thing about this is that because the Church is not a temporal, political order (despite the efforts of a corrupt papacy to make it one, for a time), this unity did not depend on any regime. So it made possible political-fragmentation-admist-cultural-unity, which is precisely the fortunate arrangement that made the Enlightenment possible.

3. Slavery and the Middle Ages. One of the questioners near the end puts with peculiar eloquence how strange the rise of Europe is, when one considers how much more advanced the Muslim world was a few hundred years before, and challenges Mokyr to explain it. But this questioner very much overstates her case. As far as I understand, the Muslim Middle East was indeed richer in the high and late Middle Ages, but there were plenty of signs of Europe's coming ascendancy if one knew what to look for. The Muslim world absorbed Aristotle and to some extent responded to it, but much less creatively than the scholastic thinkers of medieval Europe. At the time of the Crusades, the Muslim states were indeed richer, but Europeans were by no means overmatched militarily. On the contrary, crusading knights were individually superior to their Muslim opponents, by a wide margin. Moreover, and very revealingly, the Muslims did not imitate the Crusader knights, even when it was clear that the knights were effective. They couldn't; they didn't have the cultural wherewithal to do it. The Crusader kingdoms were eventually overrun, but considering how disadvantageous was their position, with small contingent of "Franks" in a narrow strip of land surrounded by Muslim powers, that they lasted for a couple of centuries is suggestive of the precocious strength of Europe. The absence of slavery in western Europe, already an accomplished fact by 1200 or so, stands in stark contrast to the practice of slavery on an enormous scale in the Muslim world, and was a harbinger of the moral advantages and the greater freedom that Europe was steadily to enjoy and to increase in the centuries that followed. The Magna Carta was signed in 1215, and proto-parliamentary institutions appeared in several countries. Europe had the separation of Church and state, and its feudal social order contrasts sharply with the despotism that prevailed in the Muslim world. In fact, I don't know the history of the Islamic world all that well, but from what little I do know I've never heard of any blossomings of liberty or republicanism or representative government, such as exist all over the West, and even in the Russian city-state of Novgorod in the Middle Ages. As far as I know, the Islamic world was an unbroken record of tyranny for a thousand years.

If we imagine an astute observer in 1200, an observer who is somehow able to understand what an Industrial Revolution is apart from the particular history by which it occurred in the West, I think this observer could not only have forecast that it would occur in western Europe and nowhere else, but would have been surprised that it happened so late. Also, I don't think it would have happened anywhere else without the stimulus from Europe, or to be more exact, from Christianity, which is the key. Christianity contained moral forces that abolished slavery and softened despotism into lawful kingship. It contained the blueprints for an institution, the Church, which had an institutional life independent of the state, which could resist it, critique it, hold it accountable, though of course it often failed to do so. And it was able, to a greater extent than other forces in history, to create cultural unities broader than any particular polity, giving the human spirit more scope in which to develop.

In Defense of Usury Laws

I just put an ad on the site, for payday cash advances; you can see it if you scroll down a bit on the right. I had mixed feelings about putting it there; I don't need the money so badly at the moment and anyway it isn't much, but I was so curious about how advertising on blogs works that I wanted to do it just as an experiment. The thing is that I'm wary of payday lending. But I suppose it's an occasion for setting down my views on usury laws.

The medieval Catholic church forbade "usury," which at one point included all interest; Islam forbids it, nominally at least, to this day. Gottfried Feder, an ideologist of the Nazi Party, also passionately opposed interest, and abolition of interest was a Nazi slogan. The prohibition has been common to many civilization. To a contemporary economist, all this opposition to interest is nothing but a simple-minded fallacy. Interest seems "unfair" because the lender receives back "more" than he gives. But economists know that funds-at-time-t are not the same good as funds-at-time-t+1. Funds-at-time-t are typically more valuable, since the economy usually grows and there are always opportunities to invest. So the lender is not "exploiting" the borrower; they are engaged in a mutually beneficial exchange.

Recently, though, behavioral economists have started to observe that people tend to have "hyperbolic" preferences, a particular mathematical form of preferences over present and future consumption that is characterized by "time-inconsistency": one tends to favor consumption right now over future consumption in a way that is inconsistent with one's relative valuation of future dates that are far enough away so that one is not biased by the pressures and impulses of the moment. While I'm suspicious both of some of the methods by which this result is obtained and of some of the implications that are drawn from it, it's probably true that people have a systematic bias in favor of instant gratification, which it takes willpower to overcome.

In that case, lending at interest may, after all, be predatory in some cases, though certainly not in all cases: it frequently happens, too, that people have very good reasons for having different relative valuations of funds-at-time-t and funds-at-time-t+1, and that some people will quite rationally go into debt to finance some plan or project and be glad in the long run that they did. What you would want morality, and probably law too, to do is to discourage or forbid the kind of lending that exploits instant gratification, while tolerating and approving the kind of lending that finances valuable education and judicious entrepreneurship. The tools available to players in the sphere of private morality, especially churches as well as families, schools, clubs, etc., and those available to policymakers, are quite different. Private morality could exhort lenders to examine their consciences, to take into consideration the effects on their clients, etc.; and could try, perhaps, to identify exploitative lenders and shame, ostracize, and expose them. Policymakers have the difficult task of defining the legal boundaries of exploitative and entrepreneurial lending. No specific interest rate could mark the difference. A rational entrepreneur might sometimes have good reasons for borrowing at 10% or 20% or even 50%; a loan made at 7% might still be a case of instant gratification. Usury laws can presumably never be written just right and will always ban some good lending and permit some bad lending. But it's still probably worth having them on the books.

I don't vouch for the advertiser below; I know nothing about them. I'm just curious as to whether the mechanics of e-commerce, in whether money will actually show up in my PayPal account on the basis of having a link on my site. Another interesting thing: even though I haven't been posting here regularly, traffic doesn't seem to have gone down. I guess there's a certain inertia in internet traffic.

Drawing the Battle Lines

"Obama Gets Strong Support in Poll" (Wall Street Journal)

President Barack Obama enjoys widespread backing from a frightened American public for his ambitious, front-loaded agenda, a new poll indicates.

He is more popular than ever, Americans are hopeful about his leadership, and opposition Republicans are getting drubbed in public opinion, the new Wall Street Journal/NBC News poll suggests.

The poll found a sharp jump in the proportion of Americans who say the nation is "generally headed in the right direction" since Mr. Obama's January inauguration, a period when economic indicators and financial markets have suggested the opposite. The survey shows that 41% of Americans say the country is headed in the right direction, up dramatically from 26% in mid-January, before Mr. Obama took office, and up from 12% before the election.

The number who say the country is on the "wrong track" is still higher at 44%, but given the economic conditions, pollsters expected it to be much higher.

In the past, similarly sudden improvements in national mood were recorded only after national emergencies that prompted a rallying effect, such as the 2001 terrorist attacks. In this case, the boost is being driven by Democrats and other Obama voters who are pleased with the opening weeks of the administration. Overall, two-thirds of all Americans say they feel "hopeful" about Mr. Obama's leadership and plans, compared with 28% who say they feel "doubtful."

"US Stocks Drop 20% after Obama takes office" (Business Day):

One of the major measures of the health of US stocks, the Dow Jones Industrial Average, has fallen 20% since Barack Obama was inaugurated on January 20 - the fastest drop under a new president in almost a century.

Experts say investors may be worried Mr Obama’s stimulus measures won’t revive the economy anytime soon.

The 20.4% drop in the Dow is the steepest for a new administration in at least 90 years, according to data compiled by Bloomberg. The Dow tumbled 25% in 2009, its worst annual start, as unemployment climbed and bank losses increased.

Overnight, the Dow slid 4.1% to 6594.44, its 12th decline in 15 days, as the worst start to a year for US stocks deepened. The Standard & Poor’s 500 Index lost a further 4.3% to 682.55, extending its retreat to 19.7% since January 20.

"It’s the Obama bear market," said Dan Veru, who helps oversee $2.8 billion at Palisade Capital Management in Fort Lee, New Jersey. “We don’t know what the rules are in so many different areas the government is touching.”

These articles describe the two sides in the class war: it's those who answer poll questions against those who own 401(k)s and stocks.  Of course the groups overlap somewhat, but the point is that the median voter-- or answerer of poll questions-- owns a lot less stocks than the median shareholder (particularly if the median is wealth-weighted), so it's possible for Obama's popularity to rise even as he is probably chiefly responsible for the destruction of trillions of dollars of wealth since his election, or even in the briefer time since he took office.

In the short run, Obama's shrewd application of the Median Voter Theorem may pay political dividends, and it's even possible that his tax cuts and education and other benefits targeted to the middle class (not the poor) may yield net benefits to some of them.  In the long run, everybody loses from class war, because the class that is most vulnerable to class war-- investors, entrepreneurs-- is the one that drives most of the long-term increases in society's well-being.

America's Dark Ages

"How Government Prolonged the Depression" (Wall Street Journal)

The New Deal is widely perceived to have ended the Great Depression, and this has led many to support a "new" New Deal to address the current crisis. But the facts do not support the perception that FDR's policies shortened the Depression, or that similar policies will pull our nation out of its current economic downturn.

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.

Even comparing hours worked at the end of 1930s to those at the beginning of FDR's presidency doesn't paint a picture of recovery. Total hours worked per adult in 1939 remained about 21% below their 1929 level, compared to a decline of 27% in 1933. And it wasn't just work that remained scarce during the New Deal. Per capita consumption did not recover at all, remaining 25% below its trend level throughout the New Deal, and per-capita nonresidential investment averaged about 60% below trend. The Great Depression clearly continued long after FDR took office.

Why wasn't the Depression followed by a vigorous recovery, like every other cycle? It should have been. The economic fundamentals that drive all expansions were very favorable during the New Deal. Productivity grew very rapidly after 1933, the price level was stable, real interest rates were low, and liquidity was plentiful. We have calculated on the basis of just productivity growth that employment and investment should have been back to normal levels by 1936. Similarly, Nobel Laureate Robert Lucas and Leonard Rapping calculated on the basis of just expansionary Federal Reserve policy that the economy should have been back to normal by 1935.

So what stopped a blockbuster recovery from ever starting? The New Deal. 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.

The most damaging policies were those at the heart of the recovery plan, including The National Industrial Recovery Act (NIRA), which tossed aside the nation's antitrust acts and permitted industries to collusively raise prices provided that they shared their newfound monopoly rents with workers by substantially raising wages well above underlying productivity growth. The NIRA covered over 500 industries, ranging from autos and steel, to ladies hosiery and poultry production. Each industry created a code of "fair competition" which spelled out what producers could and could not do, and which were designed to eliminate "excessive competition" that FDR believed to be the source of the Depression.

These codes distorted the economy by artificially raising wages and prices, restricting output, and reducing productive capacity by placing quotas on industry investment in new plants and equipment. Following government approval of each industry code, industry prices and wages increased substantially, while prices and wages in sectors that weren't covered by the NIRA, such as agriculture, did not. We have calculated that manufacturing wages were as much as 25% above the level that would have prevailed without the New Deal. And while the artificially high wages created by the NIRA benefited the few that were fortunate to have a job in those industries, they significantly depressed production and employment, as the growth in wage costs far exceeded productivity growth.

These policies continued even after the NIRA was declared unconstitutional in 1935. There was no antitrust activity after the NIRA, despite overwhelming FTC evidence of price-fixing and production limits in many industries, and the National Labor Relations Act of 1935 gave unions substantial collective-bargaining power. While not permitted under federal law, the sit-down strike, in which workers were occupied factories and shut down production, was tolerated by governors in a number of states and was used with great success against major employers, including General Motors in 1937.

The downturn of 1937-38 was preceded by large wage hikes that pushed wages well above their NIRA levels, following the Supreme Court's 1937 decision that upheld the constitutionality of the National Labor Relations Act. These wage hikes led to further job loss, particularly in manufacturing. The "recession in a depression" thus was not the result of a reversal of New Deal policies, as argued by some, but rather a deepening of New Deal polices that raised wages even further above their competitive levels, and which further prevented the normal forces of supply and demand from restoring full employment. Our research indicates that New Deal labor and industrial policies prolonged the Depression by seven years.

By the late 1930s, New Deal policies did begin to reverse, which coincided with the beginning of the recovery. In a 1938 speech, FDR acknowledged that the American economy had become a "concealed cartel system like Europe," which led the Justice Department to reinitiate antitrust prosecution. And union bargaining power was significantly reduced, first by the Supreme Court's ruling that the sit-down strike was illegal, and further reduced during World War II by the National War Labor Board (NWLB), in which large union wage settlements were limited by the NWLB to cost-of-living increases. The wartime economic boom reflected not only the enormous resource drain of military spending, but also the erosion of New Deal labor and industrial policies.

The real explanation of the Great Depression rather pulls the raison d'etre out from under Keynesian theory.

The Late, Great Clinton-Bush Economy

Nato, in a comment, quotes a bunch of statistics and draws the conclusion that "Bush II beats Bush I, but both his terms have been worse than the next worst results in the last half century (Nixon/Ford)."  He doesn't say where he got the data, and given that there are a lot of ways to muddle numbers, color me skeptical.  It may be true, though, for the simple reason that Bush took office at the height of a probably unsustainable bubble-boom that was already bursting.  When the economy has grown as much as it did in the 1990s, just to sustain the new levels would be something to be grateful for; to make further progress is an achievement.

Anyway, because GDP growth statistics are affected by business cycles, they're not a good measure of the core growth of the economy.  The best indicator of long-run growth is the productivity trend.  Behold:

Source: BLS.

Fast productivity growth started under Clinton, not Bush.  It's often attributed to computers, but that doesn't explain why (a) computers were pervasive ten years before the productivity acceleration started (this used to be called the "Solow paradox"), and (b) the productivity acceleration didn't show up in most of Europe or Japan.  A McKinsey study, The Power of Productivity, attributed about half the productivity acceleration to Wal-Mart.  My pet theory, which I'd like to explore empirically sometime, is that welfare reform was the cause: it gave people more of a reason to work, and also created a ratchet effect as welfare-leavers created competition for low-end jobs and made the people who had previously worked those jobs work harder to compete.

If productivity is growing so fast, why haven't incomes been rising?  We've all heard the muttering on the left about how incomes have been stagnant for a generation.  I was always puzzled by this claim since it contradicts just about all the personal experience of the economy of myself and anybody I know.  This Minneapolis Fed study seems to say the claim is just wrong: "Middle Americans' incomes rise substantially even while income inequality increases."  (That increase in income inequality may be in the process of reversing itself now, the way the financial sector-- a source of huge salaries and an important driver of income inequality-- is getting hammered.  Not that this is a good thing, but we might as well look at one of the bright sides of the recent chaos.)

While productivity is most important for long-run growth, unemployment seems to be the most important feel-good factor, at least until pretending the economy was bad (and blaming "Kansas" for not noticing) became a pastime of prosperous Bush-haters.  There's a reason for this: Americans don't like welfare, but we do believe in a social safety net of sorts, and that is jobs.  When everyone can get a job, we feel like a just society; when there aren't enough jobs to go around, we don't.  The chart below shows unemployment in the years 1970-2007, also from the BLS.  

Economists do not typically regard 0% unemployment as possible: someone is always "between jobs."  Near-zero unemployment rates are thought to be unsustainable.  The "non-accelerating inflation rate of unemployment" is generally thought to be around 5%, give or take.  From 1975 to 1987, the unemployment rate was always over 6%.  It fell below 6% after 1995 and has been below that ever since (except briefly touching it in 2003).  

These two indicators, productivity growth and unemployment, show the continuity of the Clinton-Bush economy, and how it differs from what came before.  Nato writes that "if the economy under Obama is worse than it has been under Bush, it will be fairly amazing and very disappointing."  I'm afraid I must disagree.  What is amazing, or at least striking, is the strong performance of the economy in 1995-2007.  Not that I think it's a fluke: I think prosperity is normal as long as wise policies are in place.  Wise policy, however, is rare.  The experience of the 1930s and 1970s show that full employment and ongoing improvement in productivity are not inevitable.  I'm afraid I don't see Obama as having the inclination or capacity to run a full-employment economy.  He has things on his website like this:

Raise the Minimum Wage: Barack Obama and Joe Biden will raise the minimum wage, index it to inflation and increase the Earned Income Tax Credit to make sure that full-time workers earn a living wage that allows them to raise their families and pay for basic needs.

Some people-- including teenagers and other non-primary earners-- work even though what they earn is less than what they need to live on.  Unless the government, in the spirit of paternalistic benevolence, tells them they can't.  That's where long-term unemployment comes from.

UPDATE: I forgot to mention the biggest single point in favor of the Bush economy: the world economy was booming in 2004-07, growing at maybe the fastest pace in history.  Now, that may or may not have much to do with President Bush.  I can think of a couple of reasons why it might.  (1) The Bush administration's deficit spending served as a Keynesian stimulus for the world economy as a whole.  (2) The Iraq War may have served as a good stiff shock to dictators and nasty rulers that they'd better govern well or they might get overthrown.  Both of these possibilities are just speculation.  Also, the current financial crisis is making it look like this worldwide boom might have been an unsustainable bubble (which, if so, may or may not have been, to some greater or lesser degree, the Bush administration's fault).  But it will take a steep drop and a period of slow growth or stagnation to erase the world economy's gains in 2004-07.

Historical Analogies Run Amok

"From Plan A to Plan F" (Brad DeLong, The Guardian, 10/16/2008)

The Bush administration, having entered office as social conservatives, leaves office as conservative socialists, proprietors of the most sudden large expansion of the state's role in the US economy since mobilisation for the second world war. Why did they decide to partially and quasi-nationalise America's banks - to invest $250bn in preferred stock plus warrants and tell the banks that it wanted them to use the capital to expand their loan base rather than contract it via deleveraging? It is certainly not what Henry Paulson signed up as Treasury secretary to do.

I am an economic historian. An occupational disease of being an economic historian is to insist that the answers to all questions lie in the Great Depression that started in 1929. When the financial crisis hit in a sudden squall in August 2007, in the back of the Federal Reserve's mind was that it should not repeat any of the mistakes that led to the Depression. Hence Ben Bernanke and his Fed loaned extraordinarily freely to banks and near-banks and non-banks in order to avoid what Milton Friedman said was the key mistake that made the Depression Great: that the Fed had triggered or allowed a liquidity squeeze that made cash hard to get. Call this Plan A.

In a couple of months it became clear that Plan A was not working. The economy was weakening. And the Fed remembered the theory - put forward by, among others, Lawrence Summers and myself - that what made the Depression Great was that businesses began to expect deflation. The expectation of falling prices made every business postpone its investment spending - better to wait a year and build your plant and equipment then when prices were cheaper - and so private investment collapsed. So Bernanke and his Fed lowered interest rates to what they thought were levels that might trigger inflation, as a way of making sure that no business anywhere would even begin to suspect that a deflationary spiral was in the making. That was Plan B.

But the economy fell toward (if not into) recession, and interest rates had already been pushed down so low that the Fed's monetary policy had lost its virtue and vigour. So it was time for Plan C: mail out a bunch of extra tax-rebate cheques, hoping that they would stimulate consumer spending and that once consumers began spending more the economy would recover with at worst a small recession.

Meanwhile, the investment bank Bear Stearns collapsed. The Federal Reserve and the Treasury concluded that they could not stand by and wait to see if Plan C was working. They had to move to Plan D: case-by-case forced mergers, liquidations and nationalisations of banks and other financial institutions in order to prevent the course of events that the third theory of the Depression said had made it Great.

This theory was Bernanke's: that the downfall of 1929-1933 was largely the result of bank failures that collapsed businesses' ability to borrow to expand or even fund ongoing operations. So we had the forced merger of Bear Stearns into JPMorgan Chase; a lull to see if Plan C would work (it didn't); the renationalisation or deprivatisation of the mortgage lenders Fannie Mae and Freddie Mac; that strange weekend when the Fed bought the insurance company AIG; and the bankruptcy of Lehman Brothers, as Bernanke and Paulson decided that they could not rescue the creditors of every firm on Wall Street.

They were wrong. The failure of Lehman Brothers triggered or uncovered or brought on financial catastrophe - not just in America but in Europe too, where hitherto policymakers had been watching with concern and some alarm. It was time for Plan E: the Paulson plan, a $700bn programme by which the Treasury would buy up troubled mortgages, mortgage-backed securities and derivatives thereof with an eye toward making sure that the banking system recovered so that it could do its job of transferring the savings of Americans to businesses that wanted to hire workers, and so keep the recession a small one and avoid the mistakes that the Bernanke theory said had made the Depression Great.

The hope behind the Paulson plan was supply and demand. Banks and investors want yield, and so are willing to buy risky assets. If the Treasury were to buy $700bn of risky financial assets and put them on the shelf, this would diminish the supply. When supply falls, prices rise. As the prices of financial assets rose, banks would profit immensely - and people would no longer fear that the bank they were dealing with might dry up and blow away in the next week.

The financial markets swallowed the passage of Plan E without a burp and continued on their downward spiral toward universal financial-sector bankruptcy.

It was time for Plan F. If the prospect of buying up mortgage-backed securities did not boost asset prices and bring banks enough investment profits to create confidence that they were not all going bankrupt next month, governments could invest public money in the banks whether they liked it or not, thus making them so well-capitalised that their failure would be inconceivable.

What I find most scary about this is that policymakers (and Brad DeLong, but that's not so important) seem to be thinking so much about the Great Depression.  The world economy today is dozens of times bigger, and far more integrated.  There have been tremendous technological changes, big changes in the socioeconomic structure of most societies, big changes in policy.  Both Wall Street and Washington-- or, more generally (or rather, less metonymously) both finance and government-- have been transformed.  Even without any specific story about how 2008 is different from 1929, is it plausible that making the right policy choices now consists of nothing but implementing our best guess about what would have been the right thing to do eighty years ago.

If you look in the rear-view mirror all the time, you crash.

Financial and Legal/Regulatory Co-Evolution

For economic commentary on the current financial crisis, I am not the equal of Dani Rodrik, or Tyler Cowen, but I might as well comment on the topic du jour, since I'm supposed to be an expert a specialist of sorts.  Latest news:

• With Goldman Sachs and Morgan Stanley turning into bank holding companies to escape the fates of Lehman Brothers, Merrill Lynch, Bear Stearns etc., the once-mighty investment bank is no more.  (I remember hearing Harvard undergrads chattering to one another with starry-eyed greed about "i-banking" jobs.  The recollection now has the flavor of one of those historical anecdotes with a built-in moral, like the Titanic.) 
• The Bush administration/Hank Paulson is pushing for fast action on what is being called a $700 billion bailout of Wall Street.

Lest I violate my personal taboo on political blogging, I'll leave the news and retreat into arcana. 

Suppose I promise to do A in return for your promise to do B.  We have a contract, maybe we even write it down with the help of fancy lawyers.  But am I willing/able to do A, and you to do B?  If not, will a court enforce the contract, and how?

As the economy gets bigger and more complex, the types of contracts that it is advantageous for people to sign keeps increasing, as a means to incentivize effort or innovation, or to spread risk.

Suppose that at time t, the economy is sufficiently developed that three types of contracts would be advantageous for private agents to sign; we'll call them Contracts X, Y, and Z.  Contract X is well-understood by regulators and courts.  Contract Y is not dealt with in any extant legislation or case law, but the private sector is aware of it.  Contract Z, no one has thought of yet.

Some agents will choose not to engage in contracts of type Y, but some will, hoping that either (a) counter-parties will keep their end of the bargain voluntarily, from honor or for repeat business or their reputations, or (b) courts and/or regulators will find out about, approve, and enforce Contract Y if forced to do so by a breakdown of some instance of it.  If Contract Y is more advantageous in some circumstances than Contract X, market forces will cause it to spread, and eventually some breakdown will force courts/regulators to catch up with the private-sector-driven evolution of contract law.  Once they do, the margins for Contract Y-type deals will be reduced by competition, and some clever entrepreneur may have an idea for Contract Z.

One interpretation of financial crises is that they reflect the painful learning curve as those to whom justice and property rights are entrusted learn to cope with the ever-growing sophistication of markets.

Russia's Suez Crisis Update

"Russia halts trading after 17% fall in share price" (FT, 9/16/2008):

Russian shares suffered their steepest one-day fall in more than a decade on Tuesday, losing up to 20 per cent, as a sharp slide in oil prices and difficult money market conditions triggered a rush to sell.

The heads of the Russian central bank, the finance ministry and the financial market regulator met on Tuesday night for an emergency discussion on ways to halt the crisis.

Earlier, trading had been suspended on both the Micex and RTS stock exchanges as investors ignored assurances by Russian officials and a cycle of distrust set in amid liquidity fears.

Margin calls forced domestic traders to liquidate positions and brokers pulled credit lines. At least one Moscow bank failed to meet payments.

The rouble-denominated Micex Index closed 17.75 per cent down, the sharpest one-day drop since the August 1998 financial crisis, while the dollar-denominated RTS index closed down 11.47 per cent, its lowest lvel since January 2006.

Interbank money market rates climbed to 11 per cent, their highest since a mini-banking crisis in summer 2004.

Chris Weafer, chief strategist at Uralsib investment bank: “We’re in completely uncharted territory where the prevailing emotion is of fear and numbnes. No one knows where this could stop”.

Alexei Kudrin, finance minister, insisted that the financial system was not in a systemic crisis but the central bank injected a record $14.16bn in one-day funds into the money market.

The finance ministry also placed an additional R150bn ($5.8bn) in one-month deposits into the banking system. Konstantin Korishchenko, central bank deputy, told Russian news agencies that the bank and the finance ministry could provide a total of $117.6bn in liquidity to the banking sector.

But market players said banks were ceasing to lend to second and third-tier companies and brokers were pulling credit lines. KIT Finance, big Moscow investment house confirmed rumours that it had been unable to make payment on a series of short-term loans.

It said: “In connection with the fact that a series of our clients did not meet their obligations to our bank, we have not met our obligations to our counterparties.

“We recognise our responsibility to our counter-parties and to the market and we are working intensively to resolve the situation.”

Andrei Sharonov, managing director of Troika Dialog, a Moscow investment bank, and a former deputy economic minister, said: “This is a vicious circle,” said , .

“It is a situation of total mistrust. The liquidity crisis is being caused by a crisis of confidence in which people are frightened to borrow and frightened to lend.”

Shares in Russia’s biggest state-controlled banks led the slide with Sberbank, the state-controlled savings bank, closing 21.72 per cent down and VTB losing 29.26 per cent. The bank was suffered on investor fears about its securities portfolio, which makes up about 10 per cent of its assets.

It's been ten years since Russia's last financial crisis, in 1998.  The war in Georgia is probably not the main cause of this-- turmoil on Wall Street, and falling oil prices, were surely the trigger-- but it undoubtedly made matters worse.

It's up to Putin, as prime minister, to do something about it.  For Russia's sake, I hope he gets them through it all right.  But if he doesn't, he ought to be vulnerable, and maybe he really is.

Meanwhile, let's hope Russians learn the lesson: Aggression doesn't pay.  Thanks to Tyler for the pointer.

"The Greatest Financial Crisis in America Since the Great Depression"

The title of this post is probably an accurate description of what's happened on Wall Street in the last year or so and especially the last 72 hours.  And yet, the funny thing is that it's far from certain the US economy-- "Main Street"-- will be hurt, or hurt much.

What is the difference between a financial crisis and a crisis for the economy?  In 1929 there was a financial crisis that led to an economic depression.  In 1987 there was a financial crisis that basically had no effect on the economy.  In 2001 a stockmarket bubble popped, without it ever being quite a crisis, and the economy slowed down a bit: it's generally regarded as a recession though I'm not sure it's clear that it meets the technical definition of two quarters of consecutive decline.  So far, the US seems to have weathered financial crisis for a year without anything that can be legitimately called a recession, although Phil Gramm's accurate characterization of it as a "mental recession" has proven unpopular.  What's the pattern?  Is there a pattern?

Look at it another way: Why care about the financial sector more than other sectors?  Suppose there were a crisis in the toilet-paper sector.  Cheap toilet paper from Mexico, or a standards war, or mismanagement in toilet-paper giants lead to a collapse in domestic production, bankruptcies, lay-offs.  No one would think the US economy as a whole was endangered by this development.  Why is finance more important than toilet paper?  It's bigger, but there seems to be a widespread impression that finance is important out of all proportion to most measures of its industry size.

There are good theoretical reasons to think finance is especially important.  But it's difficult to establish how much the theory fits the reality.  Or, if finance is important generally, what parts of finance matter, and how much, and why.

As an "economist"-- still in training, second-year PhD student with an earlier Masters involving PhD-level economics, and four years' work experience in econ-related positions-- I feel like I'm supposed to care about dramatic developments in Wall Street and have special insights about their significance.  I'm not sure I do.  Except maybe one thing.  The biggest cause of the turmoil seems to be the decline in housing prices.  The decline in housing prices is especially damaging because of the way it affects the functionality of the standard mortgage contract: when the price of a house falls, it no longer serves as effective collateral for the associated loans, giving people an incentive to walk away from their houses.  For even a little bit of that to occur can have devastating ramifications.  It seems to me that as long as America's unusual homeownership-cum-mortgage model is in place-- and although it's a bad model artificially created by distorting subsidies, don't expect it to go away soon (not that homeownership is bad, but America has way way way over-promoted it)-- the Fed cannot allow house prices to fall without crippling the financial system.  And if it can't allow house prices to fall, it shouldn't allow them to rise, either, otherwise policy has an inflationary bias.  So we need to re-define inflation to include home prices-- not rental prices, which are already included in the relevant indices, but home purchase prices-- and maybe other asset prices as well.  It should be part of the Fed's mandate to prevent home prices from rising too fast.  That means we should have had tighter money over the past decade or so, back to the Greenspan years.

Right now, I think we should tolerate just a bit more inflation temporarily so that housing prices can recover a bit, or anyway stop sliding, in order to shore up the financial system.  At the same time, we should probably also explicitly think about the dollar's attractiveness as a world currency, since that's also been called into question somewhat over the past year and a half.  But those goals conflict a bit.  Hmm.