The Agenda

Krugman’s Counterfactuals

I love counterfactuals. One of my favorite books in Robert Fogel’s Railroads and American Economic Growth, a brilliant and subtle treatment of a number of very complex and difficult issues. Naturally, I’m delighted to see Paul Krugman wrestle with a counterfactual question regarding the post-1980 growth trajectory of the United States. 

 

Scott Sumner says that I’m wrong about taxes, regulation, and growth, because although American growth has slowed since deregulation and all that, the growth has been better than we might have expected.

We can try to parse whether that’s true — but in any case it’s not a response to my original point. That was about the claim, quite common on the right, that the US economy was stagnant until Reagan did away with those nasty New Deal policies — a claim that is simply, flatly, false. The era of strong unions, high minimum wages, high top marginal tax rates, etc. was also a period of rapid growth and rising living standards. That doesn’t prove causation; it does disprove the widespread dogma that these things are always economically devastating. And it’s telling that so many on the right have airbrushed the whole postwar generation out of history.

Please read Scott Sumner’s post. I guess one useful question is what exactly one means by “economically devastating.” This is pretty subjective, and so it’s hard to know what to make of Krugman’s argument. Sumner tried to contrast U.S. growth performance relative to other societies. But I actually think Sumner could have gone further than he did. The logic of conditional convergence suggests, as I’ve argued earlier, that Europe and Japan should have grown faster than the U.S., as ideas and capital flowed relatively freely across the OECD throughout this period and there was a great deal of room for the non-U.S. OECD to embrace productivity-enhancing managerial innovations. Krugman disputes this:

Part of the answer is that our relative decline for 30 years after WWII largely reflected technological catchup by others; by the 80s that catchup was largely over, with all advanced nations at roughly the same technological level, so there was no reason to expect faster growth in Europe and Japan.

I’m not sure this is true. Krugman is very familiar with the failures of the Japanese retail sector. And of course the U.S. saw considerable productivity gains in this sector throughout the 1990s. “Roughly at the same technological level” might be right, but the fact that the U.S. still had a higher level of GDP per worker hour than all but a handful of high-unemployment OECD economies suggests that there was still room for technological catchup, if we use the term technology broadly. 

Krugman goes on to discuss, very rightly, the labor-leisure tradeoff.

France, in particular, is a country with about the same level of technology and productivity as America, but with roughly 25 percent lower GDP per capita; this mainly reflects longer vacations and earlier retirement, which may or may not be bad things, but are not a straightforward case of inferior performance.

I find it very peculiar that Krugman is using France as his example, given that France went through a series of transformative neoliberal reforms during the 1980s as well. I strongly recommend reading Perry Anderson’s brilliant 2004 essay on postwar France in the London Review of Books.

Over twenty years, liberalisation has changed the face of France. What it liberated was, first and foremost, financial markets. The capital value of the stock market tripled as a proportion of GNP. The number of shareholders in the population increased four times over. Two-thirds of the largest French companies are now wholly or partially privatised concerns. Foreign ownership of equity in French enterprises has risen from 10 per cent in the mid-1980s to nearly 44 per cent today – a higher figure than in the UK itself. The rolling impact of these transformations will be felt for years to come. If they have not yet been accompanied by a significant rundown of the French systems of social provision, that has been due to caution more than conviction on the part of the country’s rulers, aware of the dangers of provoking electoral anger, and willing to trade sops like the 35-hour week for priorities like privatisation. By Anglo-American standards, France remains an over-regulated and cosseted country, as the Economist and Financial Times never fail to remind their readers. But by French standards, it has made impressive strides towards more acceptable international norms.

And how about those strong French labor unions?

Under the Fifth Republic, the French have increasingly resisted collective organisation. Today fewer than 2 per cent of the electorate are members of any political party, far the lowest figure in the EU. More striking still is the extraordinarily low rate of unionisation. Only 7 per cent of the workforce are members of trade unions, well below even the United States, where the comparable figure (still falling) is 11 per cent; let alone Austria or Sweden, where trade unions still account for between two-thirds and fourth-fifths of the employed population. The tiny size of industrial and political organisations speaks, undoubtedly, of deep-rooted individualist traits in French culture and society, widely remarked on by natives and foreigners alike: sturdier in many ways than their more celebrated American counterparts, because less subject to the pressures of moral conformity.

Granted, I’m being unfair here: I am analyzing France as though it were an actual country rather than an abstraction conjured up by “so many on the right” or “so many on the left,” some of my favorite interlocutors.

Let’s return to one of Krugman’s observations.

The era of strong unions, high minimum wages, high top marginal tax rates, etc. was also a period of rapid growth and rising living standards.

Krugman helpfully notes that the international context was important, though of course his interpretation of that international context is somehwhat idiosyncratic — i.e., there was little room for catchup growth in Europe and Japan post-1980, a pretty remarkable statement. My sense that Europe and Japan are ahead of us in some technological domains (broadband penetration comes to mind) while we’re ahead in many other domains, many of which fit under the rubric of managerial innovations that enhance capital productivity.  

Let’s think about the international context in a stylized way. Scott Winship wrote something very smart about this in his subject (check out his brilliant Ph.D. dissertation) in a blog post for Progressive Fix:

 

It is certainly true that wage growth has been slower since 1973 than in the two previous decades. But that isn’t a realistic bar to use. The U.S. was the only major economy left standing after World War II, and there was little foreign competition putting downward pressure on manufacturing wages and jobs. The period between WWII and 1973 was anomalous—it could not have been expected to have lasted.

The other way to judge middle-class living standards in the U.S. is to compare them to those in other countries. The Luxembourg Income Study shows that at most points in the income distribution (the 25th percentile, the median, the 75th percentile), income in the U.S. exceeds that in nearly all European countries, including Sweden, the model for many on the left. (The most accessible evidence on this is in a 2002 article in the journal Daedalus by Christopher Jencks.) Determining how to incorporate publicly provided benefits such as education and health care is very complicated, but the evidence we have indicates that American middle-class living standards are at worst comparable to those in European nations.

So yes, Krugman is right to say that the postwar economic model delivered high growth. And he references the same postwar story that Winship invokes, only Krugman uses it in a very different, and quite slippery, way. As Winship explains, the economic model of that era delivered high wages in a very different context. Essentially, Krugman is suggesting that there is no reason to believe that the postwar economic model would have performed any less well than the post-stagflation model in a world defined by more open OECD economies. That is a very different, very strong claim, than simply observing that the U.S. enjoyed high GDP and wage growth in the postwar era..

And the country he offers as a counterexample — France — has very weak labor unions, and weaker labor market regulations than is commonly believed on the U.S. right and left. Indeed, the 35-hour workweek legislation was coupled with a number of liberalizing reforms, as Anderson observes. Moreover, as Monica Prasad explains, France and West Germany were in many respects more economically liberal (in the European sense) than Britain and the U.S. in the postwar era due to a pro-modernization consensus among elites. The key move was heavy reliance on consumption taxes rather than income taxes, and an collaborative rather than confrontational posture on the part of labor. 

To be sure, the fact that Europe is poorer than the U.S. can be attributed in part to the labor-leisure trade-off. But as Edward Prescott has argued, the labor-leisure trade-off appears to be highly susceptible to marginal tax rates.

Americans now work 50 percent more than do the Germans, French, and Italians.This was not the case in the early 1970s, when the Western Europeansworked more than Americans. This article examines the role of taxes in accountingfor the differences in labor supply across time and across countries;in particular, the effective marginal tax rate on labor income. The population of countries considered is the G-7 countries, which are major advanced industrialcountries. The surprising fi nding is that this marginal tax rate accounts for thepredominance of differences at points in time and the large change in relativelabor supply over time.

Prescott could be wrong about this, and he’s only looking at the G-7. But surely this is useful information to keep in mind. 

Let’s say leisure preferences really are the driving force. Can we attribute the income gap between the top and bottom fifths of the U.S. population to leisure preferences as well? Working hours vary fairly sharply across quintiles in the U.S., with higher earners generally working longer hours. Many would object that less affluent Americans are in fact shut out of the labor market — many are relegated to the informal sector, etc. Of course, these pathologies are common in European economies as well. Indeed, some would suggest that it is dysfunctional labor markets and high marginal tax rates that shape the different patterns of work and leisure.

Krugman ends his post with the following:

But back to the original point: where this all started was with the common assertion that the US economy was a failure until Reagan came along. This should be true, according to doctrine — so that’s what people believe happened, even though it didn’t.

Do you know any conservatives who believe that the U.S. economy was a failure until Reagan came along? Given that the United States was the world’s richest large economy at the time, that’s a bit of a head-scratcher. I believe, and my hunch is that many conservatives believe, that the 1970s were not an era covered in glory when it comes to economic policy. (And of course the U.S. economy was under Republican stewardship for most of the decade.) But my sense is that this is a pretty different claim from that which Krugman is attributing to doctrinaire conservatives.

Reihan Salam — Reihan Salam is executive editor of National Review and a National Review Institute policy fellow.

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