economic growth

Income Inequality and Economic Growth

Standard & Poor’s adds fuel the the already raging fire of economic illiteracy with its research report entitled, “How Increasing Income Inequality Is Dampening U.S. Economic Growth, and Possible Ways to Change the Tide.” The S&P paper mines the Marxian-Pikettian vein of “underconsumption,” which (in the Marxian-Pikettian view) leads to economic collapse. (That Marx was wrong has been amply demonstrated by the superior performance of quasi-free economies, which have lifted the poor as well as the rich. Many writers have found grave errors in Piketty‘s reasoning– and data — these among them.)

The remedy for economic collapse (in the Marxian-Pikettian view) is socialism (perhaps smuggled in as “democratic” redistributionism). It is, of course, the kind of imaginary, painless socialism favored by affluent professors and pundits — favored as long as it doesn’t affect their own affluence. It bears no resemblance to the actual kind of socialism experienced by the billions who have been oppressed by it and the tens of millions who have been killed for its sake.

I have read two thorough take-downs of S&P’s screed. One is by Scott Winship (“S&P’s Fundamentally Flawed Inequality Report,” Economic Policies for the 21st Century at the Manhattan Institute, August 6, 2014). A second is by John Cochrane (“S&P Economists and Inequality,” The Grumpy Economist, August 8, 2014). Cochrane summarizes (and demolishes) the central theme of the S&P report, which I will address here:

[I]nequality is bad [because] it is bad for growth, and if the reason it is bad for growth is that it leads to insufficient consumption and lack of demand….

That bit of hogwash serves the redistributionist agenda. As Cochrane puts it, “redistributive taxation is a perennial answer in search of a question.” Indeed.

There’s more:

Inequality – growth is supposed to be about long run trends, not boom and slow recovery.

Professor of Public Policy at U.S. Berkeley Robert Reich argues that increased inequality has reduced overall aggregate demand. He observes that high-income households have a lower marginal propensity to consume (MPC) out of income than other households.

Let us begin at the beginning, that is, with some self-evident postulates that even a redistributionist will grant — until he grasps their anti-redistributionist implications:

  • All economic output is of two distinct types: consumption and investment (i.e., the replacement of or increase in the stock of capital that is used to produce goods for consumption).
  • The output of consumption goods must decline, ceteris paribus, if the stock of capital declines.
  • The stock of capital is sustained (and increased) by forgoing consumption.
  • The stock of capital is therefore sustained (and increased) by saving.
  • Saving rises with income because persons in high-income brackets usually consume a smaller fraction of their incomes than do persons in middle- and low-income brackets.
  • The redistribution of income from high-income earners to middle- and low-income earners therefore leads to a reduction in saving.
  • A reduction in saving means less investment and, thus, a reduction in the effective stock of capital, as it wears out.
  • With less capital, workers become less productive.
  • Output therefore declines, to the detriment of workers as well as “capitalists.”

In sum, efforts to make incomes more equal through redistribution have the opposite effect of the one claimed for it by ignorant bloviators like Robert Reich.

So much for the claim that a higher rate of consumption is a good policy for the long run.

What about in the short run; that is, what about Keynesian “stimulus” to “prime the pump”? I won’t repeat what I say in “The Keynesian Multiplier: Phony Math.” Go there, and see for yourself.

For an estimate of the destructive, long-run effect of government see “The True Multiplier.”

Every Silver Lining Has a Cloud

Today’s big economic news is the decline in real GDP reported by the Department of Commerce’s Bureau of Economic Analysis (BEA): an annualized rate of minus 2.9 percent from the fourth quarter of 2013 to the first quarter of 2014. Except for times when the economy was in or near recession, that’s the largest decline recorded since the advent of quarterly GDP estimates:

Quarterly vs annual changes in real GDP - 1948-2014
Derived from the “Current dollar and real GDP series” issued by BEA. See this post for my definition of a recession.

What’s the silver lining? Quarter-to-quarter changes in real GDP are more volatile than year-over-year and long-run changes. Some will take solace in the fact that real GDP rose by (a measly) 1.5 percent between the first quarter or 2013 and the first quarter of 2014. (Though they will conveniently ignore the long-run trend, marked by the dashed line in the graph.)

What’s the cloud? Well, as I pointed out above, the quarter-to-quarter decline in the first quarter of 2014 is unprecedented in the post-World War II era. Unless the sharp drop in the first quarter of 2014 is a one-off phenomenon (as suggested by some cheerleaders for Obamanomics), it points two possibilities:

  • The economy is in recession, as will become evident when the BEA reports on GDP for the second quarter of 2014.
  • The economy isn’t in recession — strictly speaking — but the dismal performance in the first quarter presages an acceleration of the downward trend marked by the dashed line in the graph. (For those of you who care about such things, the chance that the trend line reflects random “noise” in GDP statistics is less than 1 in 1 million.)

Even if there’s a rebound in the second quarter of 2014, the big picture is clear: The economy is in long-term decline, for reasons that I’ve discussed in the following posts:

The Laffer Curve, “Fiscal Responsibility,” and Economic Growth
The Causes of Economic Growth
In the Long Run We Are All Poorer
A Short Course in Economics
Addendum to a Short Course in Economics
The Price of Government
The Price of Government Redux
The Mega-Depression
As Goes Greece
Ricardian Equivalence Reconsidered
The Real Burden of Government
The Illusion of Prosperity and Stability
Taxing the Rich
More about Taxing the Rich
A Keynesian Fantasy Land
The Keynesian Fallacy and Regime Uncertainty
Why the “Stimulus” Failed to Stimulate
The “Jobs Speech” That Obama Should Have Given
Say’s Law, Government, and Unemployment
Unemployment and Economic Growth
Regime Uncertainty and the Great Recession
Regulation as Wishful Thinking
The Real Multiplier
The Commandeered Economy
We Owe It to Ourselves
In Defense of the 1%
Lay My (Regulatory) Burden Down
The Burden of Government
Economic Growth Since World War II
The Economy Slogs Along
Government in Macroeconomic Perspective
Keynesianism: Upside-Down Economics in the Collectivist Cause
The Price of Government, Once More
Economic Horror Stories: The Great “Demancipation” and Economic Stagnation
Economics: A Survey (also here)
Why Are Interest Rates So Low?
Vulgar Keynesianism and Capitalism
Estimating the Rahn Curve: Or, How Government Spending Inhibits Economic Growth
America’s Financial Crisis Is Now
The Keynesian Multiplier: Phony Math
The True Multiplier
The Obama Effect: Disguised Unemployment
Obamanomics: A Report Card

See especially “Regime Uncertainty and the Great Recession,” “Estimating the Rahn Curve: Or, How Government Spending Inhibits Economic Growth,” and “The True Multiplier.”

Obamanomics: A Report Card (Updated)

Here.

The good news? There is none.

The bad news? Sluggish growth persists, despite the hype about an unexpected “jump” in third-quarter GDP. The U.S. remains in the midst of the worst post-World War II “post-recession recovery,” which is neither post-recession nor a recovery.

The liberals want the U.S. to be European? Their dreams have come true, politically as well as economically.

Estimating the Rahn Curve: Or, How Government Inhibits Economic Growth

UPDATED 12/28/11 — This update incorporates GDP and government spending statistics for 2010 and corrects a minor discrepancy in the estimation of government spending. Also, there are new, easier-to-read graphs. The bottom line is the same as before: Government spending and everything that goes with it (including regulation) is destructive of economic growth.

UPDATED 09/19/13 — This version incorporates two later posts “Estimating the Rahn Curve: A Sequel” (01/24/12) and “More Evidence for the Rahn Curve” (05/27/12).

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The theory behind the Rahn Curve is simple — but not simplistic. A relatively small government with powers limited mainly to the protection of citizens and their property is worth more than its cost to taxpayers because it fosters productive economic activity (not to mention liberty). But additional government spending hinders productive activity in many ways, which are discussed in Daniel Mitchell’s paper, “The Impact of Government Spending on Economic Growth.” (I would add to Mitchell’s list the burden of regulatory activity, which accumulates with the size of government.)

What does the Rahn Curve look like? Daniel Mitchell estimates this relationship between government spending and economic growth:

Rahn curve (2)

The curve is dashed rather than solid at low values of government spending because it has been decades since the governments of developed nations have spent as little as 20 percent of GDP. But as Mitchell and others note, the combined spending of governments in the U.S. was 10 percent (and less) until the eve of the Great Depression. And it was in the low-spending, laissez-faire era from the end of the Civil War to the early 1900s that the U.S. enjoyed its highest sustained rate of economic growth.

Here is a graphic look at the historical relationship between government spending and GDP growth:

(Source notes for this graph and those that follow are at the bottom of this post.)

The regression lines are there simply to emphasize the long-term trends. The relationship between government spending as a percentage of GDP (G/GDP) and real GDP growth will emerge from the following graphs. There are chronological gaps because the Civil War, WWI, the Great Depression, and WWII distorted the relationship between G/GDP and economic growth. Large wars inflate government spending and GDP. The Great Depression saw a large rise in G/GDP, by pre-Depression standards, even as the economy shrank and then sputtered to a less-than-full recovery before the onset of WWII.

Est Rahn curve 1792 1861

Est Rahn curve 1866 1917

Est Rahn curve 1792 1917

Est Rahn curve 1946-2010

The graphs paint a consistent picture: Higher G/GDP means lower growth. There is one inconsistency, however, and that is the persistence of growth in the range of 2 to 4 percent during the post-WWII era, despite G/GDP in the range of 25-45 percent. That is not the kind of growth one would expect, given the relationships that obtain in the earlier eras. (The extrapolated trend line for 1946-2009 comes into use below.)

There are at least five plausible — and not mutually exclusive — explanations for the discrepancy. First, there is the difficulty of estimating GDP for years long past. Second, it is almost impossible to generate a consistent estimate of real GDP spanning two centuries; current economic output is vastly greater in volume and variety than it was in the early days of the Republic. Third, productivity gains (advances in technology, management techniques, and workers’ skills) may offset the growth-inhibiting effects of government spending, to some extent. Fourth, government regulations and active interventions (e.g., antitrust activity, the income tax) have a cumulative effect that operates independently of G/GDP. Regulations and interventions may have had an especially strong effect in the early 1900s (see the second graph in this post). The effects of regulations and interventions may diminish with time because of  adaptive behavior (e.g., “capture” of regulatory bodies).

Finally, and perhaps most importantly, there is the shifting composition of government spending. At relatively low levels of G/GDP, G consists largely of government programs that usurp and interfere with private-sector functions by diverting resources from productive uses to uses favored by politicians, bureaucrats, and their patrons. Higher levels of G/GDP — such as those we in the United States have known since the end of WWII — are reached by the expansion of the welfare state. Government spending (at all levels) on so-called social benefits accounted for only 7 percent of G and 0.8 percent of GDP in 1929; in 2009, it accounted for 36 percent of G and 15 percent of GDP. The provision of “social benefits” brings government into the business of redistributing income, which discourages work, saving, and capital formation to some extent, but doesn’t impinge directly on commerce. Therefore, I would expect G to be less damaging to GDP growth at higher levels of G/GDP — which is the message to be found in the contrast between the experience of 1946-2009 and the experience of earlier periods.

With those thoughts in mind, I present this empirical picture of the relationship between G/GDP and GDP growth in the United States:

Est Rahn curve 1792-2010

The intermediate points, unfortunately, are missing because of the chronological gaps mentioned above. But, as indicated by the five earlier graphs, it is entirely reasonable to infer from the preceding graph a strong relationship between GDP growth and changes in G/GDP throughout the history of the Republic.

It is possible to obtain a rough estimate of the downward sloping portion of the Rahn curve by focusing on two eras: the post-Civil War years 1866-1890 — before the onset of “progressivism,” with its immediate and strong negative effects — and the post-WWII years 1946-2009. Thus:

Est Rahn curve rough sketch

My rough estimate is appropriately “fuzzy” and somewhat more generous than Daniel Mitchell’s, which is indicated by the heavy black line. In light of my discussion of the shifting composition of G as G/GDP becomes relatively large, I  have followed the slope of the trend line for 1792-2010; that is, every 1 percentage-point increase in G/GDP yields a decrease in the growth rate of about 0.07 percent. That seemingly small effect becomes a huge one when G/GDP rises over a long period of time (as has been the case for more than a century, with no end in sight).

For the record, the best fit through the “fuzzy” area is:

Annual rate of growth = -0.066(G/GDP) + 0.054.

Maximum GDP growth seems to occur when G/GDP is 2-4  percent. That is somewhat less than the 7-percent share of GDP that was spent on national defense, public order, and safety in 2010. The excess represents additional “insurance” against predators, foreign and domestic. (The effectiveness of the additional “insurance” is a separate question, though I am inclined to err on the side of caution when it comes to defense and law enforcement. Those functions are not responsible for the economic woes facing America’s taxpayers.)

If G/GDP reaches 55 percent — which it will if present entitlement “commitments” are not curtailed — the “baseline” rate of growth will shrink further: probably to less than 2 percent. And thus America will remain mired in its Mega-Depression.

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Source notes:

Estimates of real and nominal GDP, back to 1790, come from the feature “What Was the U.S GDP Then?” at MeasuringWorth.com.

Estimates of government spending (federal, State, and local) come from USgovernmentspending.com; Statistical Abstracts of the United States, Colonial Times to 1970: Part 2. Series Y 533-566. Federal, State, and Local Government Expenditures, by Function; and the Bureau of Economic Analysis (BEA), Table 3.1. Government Current Receipts and Expenditures (lines 34, 35).

I found the amount spent by governments (federal, State, and local) on national defense and public order and safety by consulting BEA Table 3.17. Selected Government Current and Capital Expenditures by Function.

The BEA tables cited above are available here.

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ADDENDUM: THE RAHN CURVE: A SEQUEL

In the original post (above) I note that maximum GDP growth occurs when government spends two to four percent of GDP. The two-to-four percent range represents the share of GDP claimed by American governments (federal, State, and local) throughout most of the 19th century, when government spending exceeded five percent of GDP only during the Civil War.

Of course, until the early part of the 20th century, when Progressivism began to make itself felt in Americans’ tax bills, governments restricted themselves (in the main) to the functions of national defense, public order, and safety — the terms used in national-income accounting. It is those functions — hereinafter called defense and justice — that foster liberty and economic growth because they protect peaceful, voluntary activity. Effective protection probably would cost more than four percent of GDP in these parlous times. But an adequate figure, except in the rare event of a major war, is probably no more than seven percent of GDP — the value for 2010, which includes the cost of fighting in Iraq and Afghanistan.

In any event, government spending — even on defense and justice — is impossible without private economic activity. It is that activity which yields the wherewithal for the provision of defense and justice. Once those things have been provided, the further diversion of resources by government is economically destructive. Specifically, from “Estimating the Rahn Curve” (above):

It is possible to obtain a rough estimate of the downward sloping portion of the Rahn curve by focusing on two eras: the post-Civil War years 1866-1890 — before the onset of “progressivism,” with its immediate and strong negative effects — and the post-WWII years 1946-2009. Thus:

Est Rahn curve rough sketch

My rough estimate is appropriately “fuzzy” and somewhat more generous than Daniel Mitchell’s [in “The Impact of Government Spending on Economic Growth”], which is indicated by the heavy black line. In light of my discussion of the shifting composition of G as G/GDP becomes relatively large, I  have followed the slope of the trend line for 1792-2010; that is, every 1 percentage-point increase in G/GDP yields a decrease in the growth rate of about 0.06 percent. That seemingly small effect becomes a huge one when G/GDP rises over a long period of time (as has been the case for more than a century, with no end in sight).

The following graphs offer another view of the devastation wrought by the growth of government spending — and regulation. (Sources are given in “Estimating the Rahn Curve.”) I begin with the share of GDP which is not spent by government:

Est Rahn curve sequel_priv GDP as pct total GDP

A note about my measure of government spending is in order. National-income accounting purists would insist that transfer payments (mainly Social Security, Medicare, and Medicaid) should not count as spending, even though I count them as such. But what does it matter whether money is taken from taxpayers and given to retired persons (as Social Security) or to government employees (as salary and benefits) or contractors (as reimbursement for products and services delivered to government)? All government spending represents the transfer of claims on resources from persons who earned those claims to other persons, who either did something of questionable value for the money (government employees and contractors) or nothing (e.g., retirees).

In any event, it is obvious that Americans enjoyed minimal government until the early 1900s, and have since “enjoyed” a vast expansion of government. Here is a closer look at the trend from 1900 onward:

Est Rahn curve sequel_private GDP pct total GDP since 1900

This is a good point at which to note that the expansion of government is understated by the growth of government spending, which only imperfectly captures the effects of the rapidly growing regulatory burden on America’s economy. The combined effects of government spending and regulation can be seen in this “before” and “after” depiction of growth rates:

Est Rahn curve sequel_growth rate of private GDP

(I omitted the major wars and the Great Depression because their inclusion would give an exaggerated view of economic growth in the aftermath of abnormally suppressed private economic activity.)

The marked diminution of growth  after 1900 has led to what I call America’s Mega-Depression. Note the similarity between the downward path of private sector GDP (two graphs earlier) and the downward path of the Mega-Depression in the following graph:

Est Rahn curve sequel_mega-depression

What is the Mega-Depression? It is a measure of the degree to which real GDP has fallen below what it would have been had economic growth continued at its post-Civil War pace. As I explain here, the Mega-Depression began in the early 1900s, when the economy began to sag under the weight of Progressivism (e.g., trust-busting, regulation, the income tax, the Fed). Then came the New Deal, whose interventions provoked and prolonged the Great Depression (see, for example, this, and this). From the New Deal and the Great Society arose the massive anti-market/initiative-draining/dependency-promoting schemes known as Social Security, Medicare, and Medicaid. The extension and expansion of those and other intrusive government programs has continued unto the present day (e.g., Obamacare), with the result that our lives and livelihoods are hemmed in by mountains of regulatory restrictions.

Regulation aside, government spending — except for defense and justice — is counterproductive. Not only does it fail to stimulate the economy in the short run, but it also robs the economy of the investments that are needed for long-run growth.

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ADDENDUM: MORE EVIDENCE FOR THE RAHN CURVE

Here:

[W]e have some new research from the United Kingdom. The Centre for Policy Studies has released a new study, authored by Ryan Bourne and Thomas Oechsle, examining the relationship between economic growth and the size of the public sector.

The chart above compares growth rates for nations with big governments and small governments over the past two decades. The difference is significant, but that’s just the tip of the iceberg. The most important findings of the report are the estimates showing how more spending and more taxes are associated with weaker performance.

Here are some key passages from the study.

Using tax to GDP and spending to GDP ratios as a proxy for size of government, regression analysis can be used to estimate the effect of government size on GDP growth in a set of countries defined as advanced by the IMF between 1965 and 2010. …As supply-side economists would expect, the coefficients on the tax revenue to GDP and government spending to GDP ratios are negative and statistically significant. This suggests that, ceteris paribus, a larger tax burden results in a slower annual growth of real GDP per capita. Though it is unlikely that this effect would be linear (we might expect the effect to be larger for countries with huge tax burdens), the regressions suggest that an increase in the tax revenue to GDP ratio by 10 percentage points will, if the other variables do not change, lead to a decrease in the rate of economic growth per capita by 1.2 percentage points. The result is very similar for government outlays to GDP, where an increase by 10 percentage points is associated with a fall in the economic growth rate of 1.1 percentage points. This is in line with other findings in the academic literature. …The two small government economies with the lowest marginal tax rates, Singapore and Hong Kong, were also those which experienced the fastest average real GDP growth.

My own estimate (see above) for the United States, is that

every 1 percentage-point increase in G/GDP yields a decrease in the growth rate of about 0.07 percent. That seemingly small effect becomes a huge one when G/GDP rises over a long period of time (as has been the case for more than a century, with no end in sight).

In other words, every 10 percentage-point increase in the ratio of government spending to GDP causes a not-insignificant drop of 0.7 percentage points in the rate of growth. That is somewhat below the estimate quoted above (1.1 percentage points), but surely it is within the range of uncertainty that surrounds the estimate.

Why Are Interest Rates So Low?

A REISSUE (WITHOUT UPDATES) OF THE ORIGINAL POST DATED DECEMBER 7, 2011

Interest rates reflect the supply of and demand for funds. Money is tighter now than it was in the years immediately before the onset of the Great Recession. Tim Congdon explains:

In the three years to October 2008, the quantity of money soared from $10,032 billion to $14,186 billion, with a compound annual growth rate of just over 12 per cent. The money growth rate in this period was the highest since the early 1970s. Indeed, 1972 and 1973 had many similarities to 2006 and 2007, with bubbling asset markets, buoyant consumer spending and incipient inflationary pressures. On the other hand, in the three years from October 2008 the quantity of money was virtually unchanged. (It stood at $14,340 billion in October 2011.) In other words, in the three years of the Great Recession the quantity of money did not increase at all.

But if money is relatively tight, why are interest rates so low? For example, as of October 2011, year-over-year inflation stood at 3.53 percent (derived from CPI-U estimates, available here). In October, Aaa bond yields averaged 3.98 percent, for a real rate of about 0.4 percent; Baa bond yields averaged 5.37 percent, for a real rate of about 1.8 percent; and conventional mortgages averaged 4.07 percent, for a real rate of about 0.5 percent. By contrast, in 1990-2000, when the CPI-U rose at an annual rate of 3.4 percent, real Aaa, Baa, and conventional mortgage rates hovered in the 4-6 percent range. (Real rates are derived from interest rate statistics available here.)

The reason for these (and other) low rates is that borrowers have become less keen about borrowing; that is, they lack confidence about future prospects for income (in the case of households) and returns on investment (in the case of businesses). Why should that be?

If the post-World War II trend is any indication — and I believe that it is — the American economy is sinking into stagnation. Here is the long view:

  • 1790-1861 — annual growth of 4.1 percent — a booming young economy, probably at its freest
  • 1866-1907 — annual growth of 4.3 percent — a robust economy, fueled by (mostly) laissez-faire policies and the concomitant rise of technological innovation and entrepreneurship
  • 1970-2010 — annual growth of 2.8 percent – sagging under the cumulative weight of “progressivism,” New Deal legislation, LBJ’s “Great Society” (with its legacy of the ever-expanding and oppressive welfare/transfer-payment schemes: Medicare, Medicaid, a more generous package of Social Security benefits), and an ever-growing mountain of regulatory restrictions.

(From this post, as updated in this one.)

And here is the post-World War II view:

Annual change in real GDP 1948-2011

This trend cannot be reversed by infusions of “stimulus spending” or “quantitative easing.” It reflects an underlying problem that cannot be cured by those simplistic macroeconomic “fixes.”

The underlying problem is not “tight money,” it is that American businesses are rightly pessimistic about an economic future that is dominated by a mountain of debt (in the form of promised “entitlements”) and by an ever-growing regulatory burden. Thus business investment has been a decline fraction of private-sector GDP:

Non-household GPDI fraction GDP - G
Derived from Bureau of Economic Analysis, Table 1.1.5. Gross Domestic Product (available here). The numerator is gross private domestic investment (GPDI, line 7) less the residential portion (line 12). The denominator is GDP (line 1) less government consumption expenditures and gross investment (line 21).

As long as business remains (rightly) pessimistic about the twin burdens of debt and regulation, the economy will sink deeper into stagnation. The only way to overcome that pessimism is to scale back “entitlements” and regulations, and to do so promptly and drastically.

In sum, the present focus on — and debate about — conventional macroeconomic “fixes” (fiscal vs. monetary policy) is entirely misguided. Today’s economists and policy-makers should consult Hayek, not Keynes or Friedman or their intellectual descendants. If economists and policy-makers would would read and heed Hayek — the Hayek of 1944 onward, in particular — they would understand that our present and future economic morass is entirely political in origin: Failed government policies have led to more failed government policies, which have shackled both the economy and the people.

Economic and political freedoms are indivisible. It will take the repeal of the regulatory-welfare state to restore prosperity and liberty to the land.

The Price of Government, Once More

I was pleased to read a recent post by Mark Perry, “Federal regulations have lowered real GDP growth by 2% per year since 1949 and made America 72% poorer.” It wasn’t the message that pleased me; it was the corroboration of what I have been saying for several years.

Regulation is one of the many counterproductive activities that is financed by government spending. The main economic effect of government spending, aside from regulation, is the deadweight loss it imposes on the economy; that is, it moves resources from productive uses to less productive, unproductive, and counterproductive ones. And then there is taxation (progressive and otherwise), which penalizes success and deters growth-producing investment.

All in all, the price of government is extremely high. But most voters are unaware of the price, and so they continue to elect and support the very “free lunch” politicians who are, in fact, robbing them blind.

Consider, for example, these posts by James Pethokoukis:
Is the Era of Fast U.S. Economic Growth Coming to an End?AEIdeas, July 13, 2013
My Counter: Why U.S. Economic Growth Doesn’t Have to Come to an End,” AEIdeas, August 23, 2012

Pethokoukis’s thesis, with which I agree, is that government — not lack of opportunity — is the main obstacle to the resumption of a high rate of growth.

For much more, see:
The Price of Government
The Price of Government Redux
The Mega-Depression
Ricardian Equivalence Reconsidered
The Real Burden of Government
The Rahn Curve at Work
The “Forthcoming Financial Collapse”
Estimating the Rahn Curve: Or, How Government Inhibits Economic Growth
The Deficit Commission’s Deficit of Understanding
The Bowles-Simpson Report
The Bowles-Simpson Band-Aid
The Stagnation Thesis
America’s Financial Crisis Is Now
Estimating the Rahn Curve: A Sequel
Lay My (Regulatory) Burden Down
More Evidence for the Rahn Curve

 

Taxes Matter

A recent story in The Telegraph (UK) leads with this:

Almost two-thirds of the country’s million-pound earners disappeared from Britain after the introduction of the 50 [percent] top rate of tax, figures have disclosed.

Surprise, surprise!

It happens here, too. For example, the net flow of persons among States (i.e., pattern of inter-State migration) is strongly determined by the relative tax burdens of the States (including taxes imposed by local governments).

The table below gives a hint of the strong relationship between tax burdens and inter-State migration. “In/Out represents the number of residents who moved into a State from another State, divided by the number of residents who moved out of the State to another State. The tax burden represents total State and local taxes levied on residents of a State, divided by income earned by residents of the State. (Sources and methods are discussed in the footnote to this post.)

In-out ratios and tax burdens of States

Green shading indicates States in the top (best) one-third of each distribution; gray shading indicates States in the bottom (worst) one-third. Alaska and the District of Columbia are omitted for reasons discussed in the footnote.  As it turns out, statistical analysis yields two significant determinants of a State’s In/Out ratio:

  • whether it is situated in the “Blue,” heavily unionized, North Central region of the United States, with its relatively high unemployment rate; and
  • the State’s tax burden.

Take California (please). In 2010 alone, the Golden State’s heavy tax burden — 11.2 percent vs. the national average of 9.5 percent — cost it 54,000 residents. And California is not the most repulsive of States (“tax-wise”). That “honor” goes to New York, with a burden of 12.8 percent in 2010 — a burden that cost the Empire State 66,000 residents in that year. Then there is Wisconsin — with only 1/6 the population of California — which lost 33,000 current and prospective residents because it is in the North Central region and has a tax burden of 11.1 percent.

When low In/Out ratios persist for years — as they have in California, New York, and most of the North Central States — the result is a massive reduction in the number of taxpaying citizens and businesses. Persistently low In/Out ratios lead to fiscal death-spirals:

  • Current and prospective residents and businesses are driven away by high taxes and other unfavorable conditions (e.g. unionization).
  • Instead of paring government and taking other steps to make the State more attractive (e.g., playing tough with public-sector unions), taxes are raised on remaining residents and businesses.
  • More residents and business are driven away.
  • Some amount of paring may eventually occur, but taxes remain disproportionately high (and other unfavorable conditions usually persist), so more residents and businesses are driven away.
  • And so on.

Detroit — which lost more than 60 percent of its population between 1950 and 2010 — is a prime example of a jurisdiction in a death-spiral, but it is far from the only one.

But voting with one’s feet, which works on the municipal and State levels, does not work on the national level. And the proponents of Big Government understand that. It is a sad fact that, for most citizens, the cost of fleeing the country for a better place (if one can be found) would far outweigh the additional burden of higher marginal tax rates, higher rates on capital gains, the perpetuation and expansion of “entitlements,” and the ever-growing volume of regulations (which are taxes in a different guise).

What the proponents of Big Government do not understand — or do not care about — is that they are killing the goose that lays the golden eggs. When people cannot reap the hard-won rewards of their labors and their investments, they labor and invest less. The result is slower and slower economic growth, and the imminent Europeannirvana” so devoutly wished by proponents of Big Government.

Related posts:
The Laffer Curve, “Fiscal Responsibility,” and Economic Growth
The Causes of Economic Growth
In the Long Run We Are All Poorer
A Short Course in Economics
Addendum to a Short Course in Economics
The Price of Government
The Price of Government Redux
The Mega-Depression
As Goes Greece
Ricardian Equivalence Reconsidered
The Real Burden of Government
The Illusion of Prosperity and Stability
Estimating the Rahn Curve: Or, How Government Inhibits Economic Growth
Taxing the Rich
More about Taxing the Rich
America’s Financial Crisis Is Now
A Keynesian Fantasy Land
The Keynesian Fallacy and Regime Uncertainty
Why the “Stimulus” Failed to Stimulate
The “Jobs Speech” That Obama Should Have Given
Say’s Law, Government, and Unemployment
Unemployment and Economic Growth
Regime Uncertainty and the Great Recession
Regulation as Wishful Thinking
The Real Multiplier
Vulgar Keynesianism and Capitalism
Why Are Interest Rates So Low?
The Commandeered Economy
Stocks for the Long Run?
We Owe It to Ourselves
Stocks for the Long Run? (Part II)
Estimating the Rahn Curve: A Sequel
In Defense of the 1%
Bonds for the Long Run?
The Real Multiplier (II)
Lay My (Regulatory) Burden Down
The Burden of Government
Economic Growth Since World War II
More Evidence for the Rahn Curve
The Economy Slogs Along
The Obama Effect: Disguised Unemployment
The Stock Market as a Leading Indicator of GDP
Government in Macroeconomic Perspective
Where We Are, Economically
Keynesianism: Upside-Down Economics in the Collectivist Cause
The Economic Outlook in Brief
Is Taxation Slavery? (yes)

__________
EXPLANATORY NOTE AND REFERENCES:

I began with Census Bureau estimates of State-to-State migrations in 2010. I derived estimates of in- and out-migration for each State and the District of Columbia. The “turnover” rates for Alaska and the District of Columbia proved to be much higher than the rates for the other 49 States. Preliminary analyses of the relationship between In/Out ratio and key variables (e.g., tax burden) confirmed that the inclusion of Alaska and D.C. in the analysis would bias the results, so I dropped those two entities from the analysis.

For the other 49 States, I considered the relationship between In/Out ratio and several variables:

  • population (from the same source as migration statistics);
  • regional effects, represented by dummy variables for Northeast & Mid-Atlantic (CT, DE, ME, MA, NH, NJ, NY, PA, RI, VT); North Central (IL, IN, MI, MN, OH, WI); South & Southeast (AL, AR, FL, GA, KY, LA, MD, MS, MO, NC, OK, SC, TN, TX, VA, WV); Plains & Mountain States (AZ, CO, IA, ID, KS, MT, NE, NV, NM, ND, SD, UT, WY); and West (CA, HI, OR, WA). (The statistical results are unaffected by reasonable variations in assignments — MD and VA to Northeast & Mid-Atlantic, TX to Plains & Mountain States, for example.)

Regressions on various combinations of explanatory variables yielded one statistically significant equation:

In/Out = 1.60 – 0.21NC – 5.58TB

where NC is 1 if a State is in the North Central region (otherwise it is 0), and TB is the State’s tax burden (expressed as a decimal fraction). Each State’s tax burden includes local taxes and taxes imposed on the State’s residents by other States. (A person who lives in New Jersey and works in New York knows that one price of living in New Jersey is the payment of New York’s income taxes.)

The equation and its constant and coefficients are significant at the 1-percent level, and better. The standard error of the estimate is 0.15, against a mean for In/Out of 1.048. The residuals are randomly distributed with respect to the estimated values.)

According to the equation, a North Central State with a tax burden of 10.2 percent (the average for North Central States) would have an In/Out ratio of 0.82; the average for North Central States is 0.83. A State in another region with a tax burden of 9.4 percent (the average for all other States) would have an In/Out ratio of 1.08; the  average for States not in the North Central region is 1.08.

Here is a plot of estimated vs. actual In/Out ratios:

In-out ratios_estimated vs actual

The outliers — States with residuals greater than 1 standard error — are indicated by the green shading (good) and gray shading (bad):

Residuals for estimate of In-out ratio vs Ncent and tax burden

The top 6 States have something extra going for them; the bottom 9 States have something extra going against them. The extras could be an especially hospitable or inhospitable business climate, climatic and/or geographical allure (or lack thereof), cost of living, unemployment well above or below the national average, the political climate (“Blue” to “Red” shifts prevail), or something else. Whatever the case, I am easily persuaded that New York (where I have lived and run a business), Michigan (my home State), California (a well-known basket case), Nevada (ditto), New Jersey (ditto), and West Virginia (with which I am all too familiar) have a lot going against them, even when it is not an excessive tax burden.

The Economic Outlook in Brief

I have elsewhere quantified the connection between government spending and economic growth (e.g., here and here).* I have also shown that stock prices indicate the direction of economic growth. It should not surprise you if I say that

  • the re-election of Obama portends further growth of government spending — specifically, the uncontrolled growth of entitlement spending, as accelerated by Obamacare;
  • the rate of economic growth will continue to decline for as long as entitlements grow as a percentage of GDP; and
  • in anticipation of slower economic growth, stock prices will continue to decline, in real terms.

You can follow the links in the first paragraph if you wish to learn more. Here is a bit of additional evidence for my gloomy outlook. The real value of the S&P Composite Index has fluctuated in trough-to peak-to trough cycles, four of which have been completed since the 1870s:


Derived from Robert Shiller’s data set at http://www.econ.yale.edu/~shiller/data/ie_data.xls.

We are now on the downside of the fifth cycle, which began in July 1982 and peaked in August 2000. If the present cycle follows the pattern of the other two long cycles, it may not bottom out until sometime after 2020  (though it may never end if economic growth continues to decline). And if it does bottom out then, the real value of the S&P composite will have risen only about two-fold from where its value at the start of the cycle in July 1982. In nominal terms, the S&P Composite will have dropped to about half its current level by 2020.

But, as I say, the stock market merely anticipates underlying economic conditions. Those conditions seem destined to worsen because the entitlements mess will not be dealt with for as long as there is gridlock in Washington.

__________
* See also the second graph in this post by James Pethokoukis of the American Enterprise Institute. The graph highlights the inverse relationship between entitlement spending and growth-producing innovation. Entitlement spending diminishes investments in innovation by (a) diverting resources from productive to unproductive uses and (b) penalizing (taxing) productive activities that fund innovation and its implementation.

Related posts:
The Laffer Curve, “Fiscal Responsibility,” and Economic Growth
The Causes of Economic Growth
In the Long Run We Are All Poorer
A Short Course in Economics
Addendum to a Short Course in Economics
The Price of Government
The Price of Government Redux
The Mega-Depression
As Goes Greece
Ricardian Equivalence Reconsidered
The Real Burden of Government
The Illusion of Prosperity and Stability
Estimating the Rahn Curve: Or, How Government Inhibits Economic Growth
Taxing the Rich
More about Taxing the Rich
America’s Financial Crisis Is Now
A Keynesian Fantasy Land
The Keynesian Fallacy and Regime Uncertainty
Why the “Stimulus” Failed to Stimulate
The “Jobs Speech” That Obama Should Have Given
Say’s Law, Government, and Unemployment
Unemployment and Economic Growth
Regime Uncertainty and the Great Recession
Regulation as Wishful Thinking
The Real Multiplier
Vulgar Keynesianism and Capitalism
Why Are Interest Rates So Low?
The Commandeered Economy
Stocks for the Long Run?
We Owe It to Ourselves
Stocks for the Long Run? (Part II)
Estimating the Rahn Curve: A Sequel
In Defense of the 1%
Bonds for the Long Run?
The Real Multiplier (II)
Lay My (Regulatory) Burden Down
The Burden of Government
Economic Growth Since World War II
More Evidence for the Rahn Curve
The Economy Slogs Along
The Obama Effect: Disguised Unemployment
The Stock Market as a Leading Indicator of GDP
Government in Macroeconomic Perspective
Where We Are, Economically
Keynesianism: Upside-Down Economics in the Collectivist Cause

Where We Are, Economically

UPDATED (10/26/12)

The advance estimate of GDP for the third quarter of 2012 has been released. Real growth continues to slog along at about 2 percent. I have updated the graph, but the text needs no revision.

*  *   *

It occurred to me that the trend line in the second graph of “The Economy Slogs Along” is misleading. It is linear, when it should be curvilinear. Here is a better version:


Derived from the October 26, 2012 release of GDP estimates by the Bureau of Economic Analysis. (Contrary to the position of the National Bureau of Economic Research, there was no recession in 2000-2001. For my definition of a recession, see “Economic Growth Since World War II.”)

The more descriptive regression line underscores the moral of “Obama’s Economic Record in Perspective,” which is this:

The claims by Obama and his retinue about O’s supposed “rescue” of the economy from the abyss of depression are ludicrous. (See, for example, “A Keynesian Fantasy Land,” “The Keynesian Fallacy and Regime Uncertainty,” “Why the “Stimulus” Failed to Stimulate,” “Regime Uncertainty and the Great Recession,” The Real Multiplier,” “The Real Multiplier (II),”The Economy Slogs Along,” and “The Obama Effect: Disguised Unemployment.”) Nevertheless our flannel-mouthed president his sycophants insist that he has done great things for the country, though the only great thing that he could do is to leave it alone.

Obama is not to blame for the Great Recession, but the sluggish recovery is due to his anti-business rhetoric and policies (including Obamacare, among others). All that Obama can rightly take “credit” for is an acceleration of the downward trend of economic growth.

Related posts:
Are We Mortgaging Our Children’s Future?
In the Long Run We Are All Poorer
Mr. Greenspan Doth Protest Too Much
The Price of Government
Fascism and the Future of America
The Indivisibility of Economic and Social Liberty
Rationing and Health Care
The Fed and Business Cycles
The Commandeered Economy
The Perils of Nannyism: The Case of Obamacare
The Price of Government Redux
As Goes Greece
The State of the Union: 2010
The Shape of Things to Come
Ricardian Equivalence Reconsidered
The Real Burden of Government
Toward a Risk-Free Economy
The Rahn Curve at Work
The Illusion of Prosperity and Stability
More about the Perils of Obamacare
Health Care “Reform”: The Short of It
The Mega-Depression
I Want My Country Back
The “Forthcoming Financial Collapse”
Estimating the Rahn Curve: Or, How Government Inhibits Economic Growth
The Deficit Commission’s Deficit of Understanding
The Bowles-Simpson Report
The Bowles-Simpson Band-Aid
The Stagnation Thesis
America’s Financial Crisis Is Now
Understanding Hayek
Money, Credit, and Economic Fluctuations
A Keynesian Fantasy Land
The Keynesian Fallacy and Regime Uncertainty
Why the “Stimulus” Failed to Stimulate
The “Jobs Speech” That Obama Should Have Given
Say’s Law, Government, and Unemployment
Regime Uncertainty and the Great Recession
Regulation as Wishful Thinking
Vulgar Keynesianism and Capitalism
Why Are Interest Rates So Low?
Don’t Just Stand There, “Do Something”
The Commandeered Economy
Stocks for the Long Run?
We Owe It to Ourselves
Stocks for the Long Run? (Part II)
Bonds for the Long Run?
The Real Multiplier (II)
The Burden of Government
Economic Growth Since World War II
More Evidence for the Rahn Curve
The Economy Slogs Along
The Obama Effect: Disguised Unemployment
Obama’s Economic Record in Perspective

The Capitalist Paradox Meets the Interest-Group Paradox

An insightful post at Imlac’s Journal includes this quotation:

Schumpeter argued the economic systems that encourage entrepreneurship and development will eventually produce enough wealth to support large classes of individuals who have no involvement in the wealth-creation process. This generates apathy or even disgust for market institutions, which leads to the gradual takeover of business by bureaucracy, and eventually to full-blown socialism. [Matt McCaffrey, "Entrepreneurs and Investment: Past, Present, ... Future?," International Business Times, December 9, 2011]

This, of course, is the capitalist paradox, of which the author of Imlac’s Journal writes. He concludes with these observations:

[U]nder statist regimes, people’s choices are limited or predetermined. This may, in theory, obviate certain evils. But as McCaffrey points out, “the regime uncertainty” of onerous and ever changing regulations imposed on entrepreneurs is, ironically, much worse than the uncertainties of the normal market, to which individuals can respond more rapidly and flexibly when unhampered by unnecessary governmental intervention.

The capitalist paradox is made possible by the “comfort factor” invoked by Schumpeter. (See this, for example.) It is of a kind with the foolishness of extreme libertarians who decry defense spending and America’s “too high” rate of incarceration, when it is such things that keep them free to utter their foolishness.

The capitalist paradox also arises from the inability and unwillingness of politicians and voters to see beyond the superficial aspects of legislation and regulation. In Bastiat‘s words,

a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

The unseen effects — the theft of Americans’ liberty and prosperity — had been foreseen by some (e.g., Tocqueville and Hayek). But their wise words have been overwhelmed by ignorance and power-lust. The masses and their masters are willfully blind and deaf to the dire consequences of the capitalist paradox because of what I have called the interest-group paradox:

The interest-group paradox is a paradox of mass action….

Pork-barrel legislation exemplifies the interest-group paradox in action, though the paradox encompasses much more than pork-barrel legislation. There are myriad government programs that — like pork-barrel projects — are intended to favor particular classes of individuals. Here is a minute sample:

  • Social Security, Medicare, and Medicaid, for the benefit of the elderly (including the indigent elderly)
  • Tax credits and deductions, for the benefit of low-income families, charitable and other non-profit institutions, and home buyers (with mortgages)
  • Progressive income-tax rates, for the benefit of persons in the mid-to-low income brackets
  • Subsidies for various kinds of “essential” or “distressed” industries, such as agriculture and automobile manufacturing
  • Import quotas, tariffs, and other restrictions on trade, for the benefit of particular industries and/or labor unions
  • Pro-union laws (in many States), for the benefit of unions and unionized workers
  • Non-smoking ordinances, for the benefit of bar and restaurant employees and non-smoking patrons.

What do each of these examples have in common? Answer: Each comes with costs. There are direct costs (e.g., higher taxes for some persons, higher prices for imported goods), which the intended beneficiaries and their proponents hope to impose on non-beneficiaries. Just as importantly, there are indirect costs of various kinds (e.g., disincentives to work and save, disincentives to make investments that spur economic growth). (Exercise for the reader: Describe the indirect costs of each of the examples listed above.)

You may believe that a particular program is worth what it costs — given that you probably have little idea of its direct costs and no idea of its indirect costs. The problem is millions of your fellow Americans believe the same thing about each of their favorite programs. Because there are thousands of government programs (federal, State, and local), each intended to help a particular class of citizens at the expense of others, the net result is that almost no one in this fair land enjoys a “free lunch.” Even the relatively few persons who might seem to have obtained a “free lunch” — homeless persons taking advantage of a government-provided shelter — often are victims of the “free lunch” syndrome. Some homeless persons may be homeless because they have lost their jobs and can’t afford to own or rent housing. But they may have lost their jobs because of pro-union laws, minimum-wage laws, or progressive tax rates (which caused “the rich” to create fewer jobs through business start-ups and expansions).

The paradox that arises from the “free lunch” syndrome is…. like the paradox of panic, in that there is a  crowd of interest groups rushing toward a goal — a “pot of gold” — and (figuratively) crushing each other in the attempt to snatch the pot of gold before another group is able to grasp it. The gold that any group happens to snatch is a kind of fool’s gold: It passes from one fool to another in a game of beggar-thy-neighbor, and as it passes much of it falls into the maw of bureaucracy.

[The interest-group paradox] has dominated American politics since the advent of “progressivism” in the late 1800s. Today, most Americans are either “progressives” (whatever they may call themselves) or victims of “progressivism.” All too often they are both.

Related posts:
Democracy and Liberty
The Interest-Group Paradox
Is Statism Inevitable?
Inventing “Liberalism”
The Price of Government
Fascism and the Future of America
The Indivisibility of Economic and Social Liberty
Law and Liberty
The Devolution of American Politics from Wisdom to Opportunism
The Price of Government Redux
The Near-Victory of Communism
The Mega-Depression
Tocqueville’s Prescience
Accountants of the Soul
Ricardian Equivalence Reconsidered
The Real Burden of Government
Rawls Meets Bentham
Is Liberty Possible?
The Left
The Divine Right of the Majority
The “Forthcoming Financial Collapse”
Estimating the Rahn Curve: Or, How Government Inhibits Economic Growth
The Deficit Commission’s Deficit of Understanding
Our Enemy, the State
Understanding Hayek
The Bowles-Simpson Report
The Bowles-Simpson Band-Aid
The Stagnation Thesis
America’s Financial Crisis Is Now
Utilitarianism and Psychopathy
Estimating the Rahn Curve: A Sequel
Lay My (Regulatory) Burden Down
The Burden of Government
Economic Growth Since World War II
More Evidence for the Rahn Curve
Obamacare, Slopes, Ratchets, and the Death-Spiral of Liberty

Economic Growth Since World War II

As we await (probably in vain) the resumption of robust economic growth, let us see what we can learn from the record since World War II (from 1947, to be precise). The  Bureau of Economic Analysis (BEA) provides  in spreadsheet form (here) quarterly and annual estimates of current- and constant-dollar (year 2005) GDP from 1947 to the present. BEA’s numbers yield several insights about the course of economic growth in the U.S.

I begin with this graph:

The exponential trend line indicates a constant-dollar (real) growth rate for the entire period of 0.81 percent quarterly, or 3.3 percent annually. The actual beginning-to-end annual growth rate is 3.2 percent.

The red bands parallel to the trend line delineate the 99.7% (3-sigma) confidence interval around the trend. GDP has been running at the lower edge of the confidence interval since the first quarter of 2009, that is, since the ascendancy of Barack Obama.

The vertical gray bars represent recessions, which do not correspond precisely to the periods defined as such by the National Bureau of Economic Research (NBER). I define a recession as:

  • two or more consecutive quarters in which real GDP (annualized) is below real GDP (annualized) for an earlier quarter, during which
  • the annual (year-over-year) change in real GDP is negative, in at least one quarter.

For example:

Annualized real GDP in the second quarter of 1953 was $2,366.2 billion (i.e., about $2.4 trillion in year 2005 dollars). Annualized GDP for the next  five quarters: $2,358.1, $2,314.6, $2,303.5, $2,306.4, and $2,332.4 billion, respectively. The U.S. was still in recession (by my definition) even as GDP began to rise from $2,303.5 billion because GDP remained below $2,366.2 billion. The recession (i.e., drop in output) did not end until the fourth quarter of 1954, when annualized GDP reached $2,379.1 billion, thus surpassing the value for the second quarter of 1953. Moreover, the year-over-year change in GDP was negative in the first three quarters of the recession.

Unlike the NBER, I do not locate a recession in 2001. Real GDP, measured quarterly, dropped in the first and third quarters of 2001, but each decline lasted only a quarter. But, whereas the NBER places the Great Recession from December 2007 to June 2009, I date it from the first quarter of 2008 through the third quarter of 2011 (at least).

My method of identifying a recession is more objective and consistent than the NBER’s method, which one economist describes as “The NBER will know it when it sees it.” Moreover, unlike the NBER, I would not presume to pinpoint the first and last months of a recession, given the volatility of GDP estimates:

This graph suggests three things: (1) the uncertainty of quarterly estimates, (2) a declining rate of growth since 1947, and (3) some degree of periodicity in economic growth.

The periodicity, though irregular, can be seen more clearly in the following graph, where the vertical gray bars indicate quarters in which growth is below the declining trend line shown in the preceding graph.

The two preceding graphs lead to two observations:

The following statistics underscore the first point:

Inter-recessionary period Annual  growth rate
1947q4 – 1948q4 4.6%
1950q1 – 1953q2 7.5%
1954q4 – 1957q3 3.9%
1958q4 – 1960q1 3.7%
1961q2 – 1969q3 5.1%
1970q3 – 1973q4 4.4%
1975q4 – 1980q1 4.2%
1981q1 – 1981q3 3.3%
1983q2 – 1990q3 4.2%
1991q4 – 2007q4 3.1%

To put a point on it, here are the rates of growth during the three longest periods of above-trend growth since World War II:

  • 1963q1 – 1966q1 — 6.6%
  • 1983q1 – 1986q1 — 5.1%
  • 1995q3 – 1999q4 — 4.5%

It is hard to deny the almost-constant deceleration of growth in the post-war era — especially the sharper deceleration after 1970 — a deceleration that is embedded in the longer downward trend that began in the early 1900s.

In this connection, I note that the “Clinton boom“ — 3.4 percent real growth from 1993 to 2001 — was nothing to write home about, being mainly the product of Clinton’s self-promotion and the average citizen’s ahistorical (if not anti-historical) perspective. The boomlet of the 1990s, whatever its causes, was less impressive than several earlier post-war expansions. In fact, the overall rate of growth from the first quarter of 1947 to the first quarter of 1993 — recessions and all — was 3.4 percent.

What about the lingering Great Recession? It lingers mainly because it has been used — first by Bush, then by Obama — as an excuse for eve more disastrous expansions of the cost and reach of government.

Related posts:
Are We Mortgaging Our Children’s Future?
In the Long Run We Are All Poorer
Mr. Greenspan Doth Protest Too Much
The Price of Government
Fascism and the Future of America
The Indivisibility of Economic and Social Liberty
Rationing and Health Care
The Fed and Business Cycles
The Commandeered Economy
The Perils of Nannyism: The Case of Obamacare
The Price of Government Redux
As Goes Greece
The State of the Union: 2010
The Shape of Things to Come
Ricardian Equivalence Reconsidered
The Real Burden of Government
Toward a Risk-Free Economy
The Rahn Curve at Work
The Illusion of Prosperity and Stability
More about the Perils of Obamacare
Health Care “Reform”: The Short of It
The Mega-Depression
I Want My Country Back
The “Forthcoming Financial Collapse”
Estimating the Rahn Curve: Or, How Government Inhibits Economic Growth
The Deficit Commission’s Deficit of Understanding
The Bowles-Simpson Report
The Bowles-Simpson Band-Aid
The Stagnation Thesis
America’s Financial Crisis Is Now
Understanding Hayek
Money, Credit, and Economic Fluctuations
A Keynesian Fantasy Land
The Keynesian Fallacy and Regime Uncertainty
Why the “Stimulus” Failed to Stimulate
The “Jobs Speech” That Obama Should Have Given
Say’s Law, Government, and Unemployment
Regime Uncertainty and the Great Recession
Regulation as Wishful Thinking
Vulgar Keynesianism and Capitalism
Why Are Interest Rates So Low?
Don’t Just Stand There, “Do Something”
The Commandeered Economy
Stocks for the Long Run?
We Owe It to Ourselves
Stocks for the Long Run? (Part II)
Bonds for the Long Run?
The Real Multiplier (II)
The Burden of Government

Higher Taxes, Higher Government Spending, Slower Economic Growth

J.D. Foster and Curtis Dubay, writing at The Foundry (“Of Course Higher Taxes Slow Growth — A Response to Diamond and Saez“), make mincemeat of Peter Diamond and Emmanuel Saez’s arguments for higher taxes on “the rich.” Implicit in Foster and Dubay’s takedown of Diamond and Saez is the demonstrably strong (and negative relationship) between government spending and economic growth.

Spending is funded by taxes, after all. And even when spending is funded by borrowing it amounts to a tax on the productive sectors of the economy. How is that? When government sell bonds to the public it redirects money from productive uses in the private sector to unproductive and counter-productive uses in the so-called public sector (i.e., government). The thievery is no less destructive — but more apparent — when the Fed creates money out of thin air to finance government spending.

So, the focus should be on spending, for which taxation is a proxy. The effect of government spending on economic growth is nothing less than disastrous. I have treated the subject at length in “Estimating the Rahn Curve: Or, How Government Inhibits Economic Growth.” Here is another version of the final graph in that post:

The bottom line is that for every 10 percentage points by which government spending rises, the rate of growth declines by 0.7 percentage points. If you think that 0.7 percent is negligible, try compounding it over a lifespan of 80 years. In that time, a sustained 10 percent rise in government spending will reduce the average person’s real income by more than 40 percent.

That, my friends, is soak-the-rich Obamanomics at work. Apologists for Obamanomics, like Diamond and Saez, should be ashamed of themselves for abetting economically destructive demagoguery.

Related posts:
The Causes of Economic Growth
A Short Course in Economics
Addendum to a Short Course in Economics
Enough of “Social Welfare”
The Case of the Purblind Economist
Economic Growth since WWII
The Price of Government
Does the Minimum Wage Increase Unemployment?
The Price of Government Redux
The Mega-Depression
The Real Burden of Government
Toward a Risk-Free Economy
The Rahn Curve at Work
The Illusion of Prosperity and Stability
Society and the State
The “Forthcoming Financial Collapse”
Estimating the Rahn Curve: Or, How Government Inhibits Economic Growth
The Deficit Commission’s Deficit of Understanding
Undermining the Free Society
The Bowles-Simpson Report
The Bowles-Simpson Band-Aid
Build It and They Will Pay
Government vs. Community
The Stagnation Thesis
Government Failure: An Example
Taxing the Rich
More about Taxing the Rich
Voluntary Taxation
Money, Credit, and Economic Fluctuations
A Keynesian Fantasy Land
“Tax Expenditures” Are Not Expenditures
The Keynesian Fallacy and Regime Uncertainty
Why the “Stimulus” Failed to Stimulate
The “Jobs Speech” That Obama Should Have Given
Regime Uncertainty and the Great Recession
The Real Multiplier
Vulgar Keynesianism and Capitalism
Why Are Interest Rates So Low?
Don’t Just Stand There, “Do Something”
Economic Growth Since World War II
The Commandeered Economy
We Owe It to Ourselves
In Defense of the 1%
The Real Multiplier (II)

Stocks for the Long Run? (Part II)

In “Stocks for the Long Run?” I say that

unless the course of the regulatory-welfare state is reversed, a prolonged downward shift in the real rate of GDP growth is in the works — probably to about 2 percent. At that rate, expect a continuation of the present trend [since 2000] — stock-price “growth” [adjusted for inflation] of about -4 percent a year.

Be sure to note the minus sign in front of the 4.

Stocks are not bound to rise predictably over time, despite graphs like the next one, which I constructed from the data set cited in “Stocks for the Long Run?”. “Price” (the blue line) traces the real growth in the value of S&P Composite Index; “price + dividends” (the orange line) traces real growth in the value of the S&P Composite Index plus dividends paid on the stocks comprised in the index; “dividends reinvested” (the green line) traces the real value of the S&P Composite Index if dividends had been reinvested in shares of the stocks comprised in the index (green line):

From 1871 through 2010, the average annual increase in the value of the S&P Composite, with dividends reinvested, was 6.7 percent. This kind of hypothetical long-term “return” is cited often as a reason for buying and holding stocks. But a real return of 6.7 percent is not graven in stone, as the following chart indicates.

After a period of decline in the early 1900s, the cumulative rate of return on the S&P Composite, with dividends reinvested, dropped to 5.3 percent in 1920, jumped to 8.3 percent in 1929, plummeted to 5.4 percent in 1932, returned to 7.6 percent in 1966, dipped to 6.2 percent in 1982, climbed back to 7.4 percent in 2000, and (as noted above) dropped to 6.7 percent by the end of 2010. In other words, long-run averages can be moved considerably by short run bouts of what I call “irrational exuberance and rational pessimism.”

Moreover, as a practical matter, the buy-hold-reinvest strategy would not work if there were a massive influx of stock-buyers intent on buying, holding, and reinvesting dividends. They would be chasing illusory returns because massive purchases of stocks would not be rewarded (quickly, at least) by proportionate increases in corporate earnings, which is the main driver of stock prices in the long run. The more likely result would be a bubble — like those of the late 1920s and late 1990s — which would burst, leading to lower stock prices and a greater reluctance to invest in stocks.

More realistic measures of expected returns from buying and holding stocks are depicted by the “price” and “price + dividends” lines. At the end of 2010, the average annual real return on the S&P Composite Index since 1871 was 2 percent. With dividends, the average annual real return was 2.3 percent. But almost no one — not even an institutional investor — is likely to hold stocks in the S&P Composite Index for 140 years.

It makes sense, therefore, to consider shorter holding periods: 10, 20, and 30 years.

If history is any guide, consistently positive real returns on stocks are available only to the relatively rare investor who adheres doggedly to the buy-hold-reinvest strategy for 20 years or longer.

But history is not a reliable guide because — unless the course of the regulatory-welfare state is reversed — the rate of GDP growth will continue to fall, and stock prices are likely to fall in sympathy.

Related posts:
The Price of Government
The Price of Government Redux
The Mega-Depression
As Goes Greece
The Real Burden of Government
The Illusion of Prosperity and Stability
The “Forthcoming Financial Collapse”
Estimating the Rahn Curve: Or, How Government Inhibits Economic Growth
The Deficit Commission’s Deficit of Understanding
The Bowles-Simpson Report
The Bowles-Simpson Band-Aid
The Stagnation Thesis
America’s Financial Crisis Is Now
Why Are Interest Rates So Low?
Economic Growth Since World War II
The Commandeered Economy
Stocks for the Long Run?

Stocks for the Long Run?

This post examines the relationship between stock prices and GDP and considers the long-term outlook for stock prices. I begin with a question: Do swings in stock prices — as as measured by a broad index like the S&P Composite — portend swings in the rate and direction of economic growth?

Here is a chart of constant-dollar GDP, indexed to its value in 1871, which I derived from estimates of constant-dollar GDP that are available at What Was U.S. GDP Then?:

Drawing on the data set for Robert Shiller’s Irrational Exuberance — a data set that Shiller keeps up to date — I graphed the real value of the  S&P Composite Index and identified major turning points in the constant-dollar value of the S&P Composite:

A comparison of the two charts suggests that stock prices react strongly to transient events (e.g., shifts in the rate of inflation and consumer confidence), but that there is not a strong relationship between GDP and the daily, weekly, monthly, or quarterly gyrations of the stock market. There is a weak but statistically significant correlation between annual changes in stock prices and GDP, which is evident in the following comparison of stock prices and GDP, dating back to 1950, which I derived from historical prices of the S&P 500 (available here) and estimates of constant-dollar GDP (available here).

In words, the first three graphs suggest that stock prices, measured broadly, oscillate jaggedly around the GDP trend, in cycles of irrational exuberance and rational pessimism.

On closer inspection of the long-term trends depicted in the first two graphs, I found some evidence that major turns in stock prices mark major turns in the course of economic growth. I should emphasize that the points of coincidence between major turns in stock prices and economic growth are evident only with long hindsight; I advise against attempts to predict the near-term course of GDP by transitory changes in stock prices, and vice versa.

Specifically, I calculated the changes in stock prices and GDP that occurred between the turning points identified in the second graph above, with this result:

Market turning point (Year and month)

Duration of trend (years and months)

Real S&P change (annual rate)

Read GDP change (annual rate)

1877.06

28.07

5.2%

4.4%

1906.01

14.11

-7.7%

1.9%

1920.12

8.09

20.6%

4.0%

1929.09

2.09

-44.9%

-9.4%

1932.06

33.07

6.5%

5.0%

1966.01

16.07

-5.6%

2.7%

1982.08

18.00

12.0%

3.3%

2000.08

11.04

-3.8%

1.5%

2011.12

(December 2011 probably is not a turning point. I include the period from August 2000 to the present only to show that the trend in stock prices since August 2000 has mirrored the trend in GDP growth since that date.)

The relationship between rates of change in real GDP and stock prices seems to be robust:

A similar relationship holds even with the removal of the “outlier” (1929-1932):

Both correlations are statistically significant, despite the small sample sizes. And they are similar to the following (also significant) correlation, which is drawn from the data presented in the third chart above:

The bottom line is that stock prices can decline even as GDP rises. A long-term, downward shift in the real rate of GDP growth is likely to trigger a significant downward shift in the movement of stock prices.

In fact, unless the course of the regulatory-welfare state is reversed, a prolonged downward shift in the real rate of GDP growth is in the works — probably to about 2 percent. At that rate, expect a continuation of the present trend — stock-price “growth” of about -4 percent a year.

If you think that I am being unduly pessimistic, look at the trend for 1906-1920 (the aftermath of Progressivism’s rise) and the trend for 1966-1982 (the aftermath of the formation of the Great Society). What we have today is a vast regulatory-welfare state built on the foundations of Progressivism, the New Deal, the Great Society.

Happy New Year!

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Related posts:
The Price of Government
The Price of Government Redux
The Mega-Depression
As Goes Greece
The Real Burden of Government
The Illusion of Prosperity and Stability
The “Forthcoming Financial Collapse”
Estimating the Rahn Curve: Or, How Government Inhibits Economic Growth
The Deficit Commission’s Deficit of Understanding
The Bowles-Simpson Report
The Bowles-Simpson Band-Aid
The Stagnation Thesis
America’s Financial Crisis Is Now
Why Are Interest Rates So Low?
Economic Growth Since World War II
The Commandeered Economy