The Corner

Economy & Business

Obama’s Non-Recovery Isn’t Due to the Size of the Recession

Harvard University’s Robert Barro has a great piece ​over at the Wall Street Journal debunking the claim the Obama non-recovery was the result of the 2008 recession’s severity and the accompanying financial crisis. He writes that the administration’s explanation for the weak recovery conflicts with the evidence, which shows that a large decline predicts a stronger recovery:

Yet in a recent study of economic downturns in the U.S. and elsewhere since 1870, economist Tao Jin and I found that historically the opposite has been true. Empirically, the growth rate during a recovery relates positively to the magnitude of decline during the downturn.

In our paper, “Rare Events and Long-Run Risks,” we examined macroeconomic disasters in 42 countries, featuring 185 contractions in GDP per capita of 10% or more. These contractions are dominated by wartime devastation such as World War I (1914-18) and World War II (1939-45) and financial crises such as the Great Depression of the 1930s. Many are global events, some are for individual or a few countries.

On average, during a recovery, an economy recoups about half the GDP lost during the downturn. The recovery is typically quick, with an average duration around two years. For example, a 4% decline in per capita GDP during a contraction predicts subsequent recovery of 2%, implying 1% per year higher growth than normal during the recovery. Hence, the growth rate of U.S. per capita GDP from 2009 to 2011 should have been around 3% per year, rather than the 1.5% that materialized. . . . 

Moreover, many of the biggest downturns featured financial crises. For example, the U.S. per capita GDP growth rate from 1933-40 was 6.5% per year, the highest of any peacetime interval of several years, despite the 1937 recession. This strong recovery followed the cumulative decline in the level of per capita GDP by around 29% from 1929-33 during the Great Depression.

Instead of counterproductive stimulus spending, new regulations of the labor and financial markets, and a large Federal Reserve expansion, Barro suggests that we should have enhanced economic freedom:

Variables that encourage economic growth include strong rule of law and property rights, free trade, rolling back inefficient regulations and other constraints on market activity, public infrastructure such as highways and airports, strong institutions for education and health, fiscal discipline (including a moderate ratio of public debt to GDP), efficient taxation, and sound monetary policy as reflected in low and stable inflation.

The data show that nations that take to heart Adam Smith’s prescription of “peace, easy taxes, and a tolerable administration of justice ”enjoy higher growth rates, higher levels of entrepreneurship and innovation, and, most importantly, lower poverty rates than do countries with less economic freedom. An academic review of 45 studies examining the freedom–growth relationship found that “regardless of the sample of countries, the measure of economic freedom and the level of aggregation, there is a solid finding of a direct positive association between economic freedom and economic growth.” Economic freedom also leads to a reduction in violent ethnic conflict, rates of homicides, is positively related to the female empowerment index and female literacy, reduces infant mortality and maternal mortality, and promotes tolerance. To be sure, in a free society, people are still not angels but they are better off than in a less free society.

Barro has a final word of advice about the policies of Donald Trump and Hillary Clinton:

Given the need for productivity-enhancing policies, it is sad that recent policy suggestions from Donald Trump and Hillary Clinton have emphasized restrictions on trade and immigration and higher minimum wages. The former policies are equivalent to constraining technological progress. Expanded trade in goods and people is like better technology — both raise the total real value of goods and services that can be produced for given inputs. Mandating a higher minimum wage amounts to inefficient regulation of the labor market by pricing young and less-productive workers out of the job market.

That’s right, these policies will make the problem even worse and we can expect economic growth to slow even further.

Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

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