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Saturday, May 24, 2008

Libertarians vs. Macroeconomics: Long-Term Economic Growth

                                 PREFATORY REMARKS

Libertarians vs. Macroeconomics as a Discipline: Prof Bug Takes Up the Challenge

A good two days ago, at a stimulating libertarian web-site run by Arnold Kling, prof bug took up the challenge that Kling made to me for criticizing a list of his ideal course-curriculum for an ideal econ undergrad major. That list set out a number of strictly limited libertarian or free-market courses, all microeconomic in nature. Yes, that's right: nothing in macroeconomics.

Is that surprising?  Not really.  A Chicago University-trained economist, Kling --- like his professors at Chicago --- regards macroeconomics as largely a creation of a misguided Keynesian revolution of the 1930s and then elaborated on, wrongly, for the next three to four decades . . . with more and more efforts by US and European policymakers, seen as especially futile and harmful to properly working free-markets, to fine-tune their national economies with a mix of fiscal and monetary policies. 

Why Libertarians Dislike Macroeconomics, Born in the Keynesian Revolution of the 1930s and 1940s

In libertarian thought, to put it tersely, there's no proper role for economic policymaking beyond keeping the money supply growing in line with potential GDP growth, holding taxes to a minimum, and protecting property.  Otherwise . . . stand out of the way, guys!  You will invariably muck up things!

Is such stringent faultfinding justified by the record?  The key question here, right?  And the answer: no, not according to the record.

What it does show, that record, is that the earlier Keynesian efforts --- which downplayed monetary policy, pursued over-ambitious fiscal fine-tuning of the national economy, and supplemented these macro-level policies with an array of excessive, ill-founded regulations --- were the culprit, not macroeconomics itself.  And for that matter, however over-reaching those efforts were, they did keep the US and West Europe from sliding again into the nightmare of Great Depression days . . . which, bad enough in the US and UK, were the precipitating factors (not the underlying structural causes) that torpedoed one democratic country after another in West and Central Europe and brought Nazis and fascists to power. 

And however overly ambitious the misguided fine-tuning of the national economy's short-termed fluctuations might have been, both the US and West Europe did manage to experience 25 years or so of rapid rises in GDP and per capita income.

Since the Mid-1970s

Since roughly the mid-1970s, which marked the end of that post-WWII growth surge everywhere in the industrial world --- yes, even in Japan --- the uneven thrust in West Europe and especially the English-speaking countries has been to deregulate much of the economy (especially labor and product-markets), reduce taxes, and try to limit government spending.  The record here across industrial countries has been uneven.  Obviously.  It has been most successful in the English-speaking countries --- especially in the US, Britain, Ireland, Australia, and New Zealand; one and all, they have thoroughly reformed their welfare-systems, deregulated formerly over-regulated industries, freed-up product and labor markets, and --- with Britain and Canada something of an exception --- reduced taxes and governmental spending, all the while opening up to far more international competition thanks to globalizing forces and changes in governmental policies.  (In the US, it's worth adding, federal government spending has remained more or less steady since the late 1970s --- at about 33% of GDP.

More recently, many of the West European countries on the Continent --- all big-spending welfare-states, with highly regulated product- and labor-markets (until recently) ---have followed certain of these free-market reforms. 

In Particular . . .

They have sought to reduce their much higher-levels of structural unemployment by freeing up their labor markets --- which means in effect two changes: 1) requiring the unemployed to take a job within a year or lose most of their unemployment or welfare benefits, and 2) making it easier for firms to lay off excess or unproductive employees.  Similarly, but with less success so far, many of the same countries have tried to make their product markets more flexible and competitive as well. The outcome? Germany, Scandinavia, Holland, Austria, and Spain have improved their growth rates of GDP and job-creation, at any rate compared to the previous decade or two. By contrast, Italy still lags badly on these scores, as do Greece, Belgium, and Portugal. 

And France?  It remains a case stuck in between these two groups: announced reforms aplenty, with little by way of actual effective implementation . . . the country, it seems, deadlocked in a stalemate, each reform contested not just by left-wing parties but by every status-quo group using its market-power, political patronage, and street demonstrations to undermine any tought measures proposed by conservative governments since 2002.

Note though.

None of these market-oriented policies means that macro-economics --- which, in the short-run, studies the fluctuations in a national economy of prices, output, and employment . . . all associated with the business cycle --- is itself a dead discipline.

Only free-market libertarians think it should be dismissed, an ideological excuse for governmental fiscal and monetary policymakers.  to try smoothing out these fluctuations and reducing their severity. In fact that has been the case since 1945, compared to the previous 150 years of economic life in the US and Europe: no major depressions of the sort that badly dislocated the industrial countries in the last three decades of the 19th century and the Great Depression years of the 1930s, when one unstable democratic government after another on the European Continent fell under the control of fascist, Nazi, or authoritarian reactionary dictatorships.

Since 1980, the US economy has noticeably improved its ability to reduce the degree and severity of recessions too: where one occurred every 4 to 5 years between 1945 and 1982, we have had only two brief and shallow recessions --- 1990-1991 and the first three quarters of 2001. (No, we're not in a recession now, and though GDP growth has definitely slowed, unemployment seems table at around 5.0%, financial markets seem less roiled by the housing bubble's aftermath or (remarkably) severe oil price-shocks, and GDP growth looks like it will start picking up in the 3rd and 4th quarters, not to mention next year . . . at any rate, according to the best forecasts.

The Crux of the Issue At Stake 

Enter the theoretical question at stake between Kling and me (and in the posts at Econlog joined by others): is this better economic performance in sustaining high levels of GDP output, job-creation, impressively low levels of unemployment, and overall price stability a matter of simply freeing up to an extent previously over-regulated labor and product markets or, additionally, better and wiser policymaking by above all the Federal Reserve in monetary policy and, to an extent, fiscal stimulants in the early 1980s Reagan era and the early part of this decade in the Bush-Jr. period?


What follows is a literal re-posting of the buggy prof's comments left at the Kling site five days ago (May 24th, 2008)

                                             Introductory Comments

Arnold on Institutions

Arnold has written intelligent and informatively on the latter, following Douglass North, but tended only briefly (if I remember correctly) to link the wider concerns of a societal or national culture to institutions. National cultures in turn help explain --- help, not fully account for --- the range of political ideologies in each country: why, for instance, do the Continental EU countries in West Europe have a much larger state-role, sustained by socialist-influence political parties and right-wing versions of statist paternalism (Gaullism, say, in France or Christian Democracy in Germany), whereas these influences never or hardly existed in Britain, let alone the US. 

Oddly enough, though, to judge by his challenge today, he has forgotten that institutional analysis --- which should always be carried out comparatively across various countries --- is clearly a macroeconomic matter. Which leads to the next logical step, namely . . .

Macroeconomics Defined 

Always useful to begin with a clear definition of a controversy, which (I trust) isn't seen as tendentious. Macroeconomics is that branch of economics focused on the long-term growth of a national economy and, especially in the short-run, fluctuations in prices, output, and employment. Both lead to questions about the role of the government (state if you want) in both the long- and short-terms.

                                 Long-Term Economic Growth.

Nobody disputes that long-term economic growth is largely a matter of an efficient private sector: especially the inputs of capital investment (productively employed), technological change, and (more controversial but sound in my view), vigorous entrepreneurship. The reason for the latter's need? If we're talking about radical, structurally changing technological breakthroughs that come generally in clustered waves --- roughly every 50-60 years since the first big wave in the 1760s-1820 period or so (iron, steel, textiles, and new energy systems for the machines that produced these) or since 1975 or so in ICT and the Internet --- it takes new dynamic start-ups to generally bring them successfully to the market-place.

Entrepreneurship, Radical Technological Change, and Creative-Destruction 

Our best guide here is probably Joseph Schumpeter's work on bold risk-taking entrepreneurship, clustered waves of technology (long-term cycles), and the concept of creative-destruction:  you can't diffuse the spillover benefits of big radical technological changes if you can't free up capital and skilled labor (including maybe managerial know-how) by letting older, more standardized industries shrink or decline or disappear and direct that capital and skilled labor into the new, more productive sectors.

Standard growth-models of the Solow sort completely ignored these crucial elements, other than capital investments.

And they postulated, wrongly, an end-state as capital accumulation occurred by means of diminishing returns, with somehow --- full external to growth modeling (exogenous to it) --- technological change intervened. New growth theory at least tried to endogenize technological change, but neglected the clustered-wave ideas of Schumpeter, the crucial role of bold entrepreneurship, and above all the key idea of creative-destruction. Only in the late 90's did Schumpeter's work enjoy the revival that it deserves

    Social Norms and Cultures: Missing in Standard Institutional Work

But the main problem even with Schumpeter's work is that the institutional background was ignored until recently (except for North and his followers in economics) or taken for granted. So let's define institutions --- yes, a macro-level matter, and not just confined to the national economy.

Institutions are systems of general rules embodied in various organizations --- say, legal courts and the police, legislatures, executives, civil and military bureaucracies, corporate businesses, educational systems, and professional associations--- that enforce them formally by means sanctions or rewards and can often alter them in rule-based or prescribed manner.

Formally viewed, those rules divide into constitutional matters of any country, its formal legal system, and various regulatory measures.  What matters no less, though --- and probably even more (especially in highly corrupt, predatory governmental systems rife throughout the developing world where the formal legal system means little) ---are the informal ways in which these organizations operate, and that means grasping the social norms --- a cultural matter --- that prevail within each and between them. 

Some of these social norms are specific to individual organizations: say, the ways in which cops on -the-street are honest or corrupt (or worse). Most of these social norms, though, derive from other, much wider sources.  They reflect a particular kind of national culture that evolves historically and profoundly shaped the workings of institutions and the attitudes and behavior of their organizational members. 

And as long as national cultures differ so much, then virtually all of the Arab world, tropical Africa, central Asia, and much of Latin America will remain economically backward . . . unable to develop an effective 20th-century industrial economy, let alone a post-industrial, knowledge-based economy of the 21st century sort that has been pioneered above all by the US. 

                               National Cultures and Their Huge Diversity

A national culture means what?

A network of beliefs, values, and operational (social) norms about the world and human nature and the wider society around individuals within a particular nation (or local) society: such as whether you can trust others or not, whether the basis of your community is your family or wider family clan, or tribal-clan, or social class (the aristocracy, say, vs. the peasants vs. the urban workers), or maybe , if a country is lucky, in some meaningful way a national community based on shared citizenship. If a fairly widespread sense of trust exists, then in turn large numbers of people can be counted on to cooperate spontaneously for common ends --- within specific organizations and between them and the community in question. If trust doesn't exist --- or if mistrust and cynicism do on a large scale --- then pervasive corruption and predatory behavior are likely to prevail among power-holders, and social and political conflicts cannot be easily resolves except by ever greater formal sanctions . . . at the extreme, in say virtually every Arab country, only by despots and their favored tribal-clan and wider crony patron-follower networks.

Another example: assumptions about how to get ahead in life . . . a key cultural matter, with specific behavioral outcomes. Do people rise in income, wealth, and status by means of hard-work, education, and professional accomplishments (including starting a new business) or by means of gaining access to a crony patron-follower network, mutual back-scratching, and the orgy of money-grabbing and power-aggrandizement that ensues?

                                            Socialization Processes

How do cultures get transmitted from one generation to another?

Simply said, by a socialization process that begins in infancy and early childhood, thanks to the formal and informal (ostensive) learning by the young child in its interactions with its parents, in learning a language, in interacting with siblings and teachers and others . . . reinforced through dynamic stages of personality development that can and are studied in a variety of ways. The same holds for why, say, a sub-group of a society may be socialized into highly dysfunctional beliefs, values, and norms of behavior . . . the case of far too many African-American infants and children being born these days into single-parent mother-headed families who live in bad crime-ridden neighborhoods and with no father-figure around to identify and idealize as an internalized "self-object" for guidance in life.

Observe quickly:socialization is never perfect.  Even in the same family, siblings will grow up with different personality structures and, to an extent, different internalized beliefs, norms, and expectations. Here biology is at work, as well as different birth-years.  On a wider scale, the more complex, ethnically diverse, and populous a national society, the more likely there will be certain sub-cultures.

Hence, to take one example --- a disheartening one --- the virtual disappearance of the black two-parent family (which in 1950 was indistinguishable from the white two-parent family, about 88-89% of the totals) means that 70% of all births these days are illegitimate . . . with the children growing up in a single-parent mother-headed family.

Boys who grow up in such families will tend, more and more, to rebel against feminine authority, hate women --- all 'hos, nothing else --- and express their assertions of masculinity in violent and self-destructive ways.

The Institutional and Cultural Preconditions of Rich Industrial Countries

Against this background, what do all the rich industrialized countries of the world have in common --- rich defined, say, as $20-25,000 minimum in per capita income translated into PPP (purchasing power parity): all of West Europe, North America, Australia and New Zealand, Japan, South Korea, Taiwan, and Singapore?

With the exception of Singapore, all are functioning democratic states; all are capitalist, but with considerable variations in the role of the state in economic life; all have independent judiciaries, police subject to professional rules and legal norms, militarize under constitutional authority, a considerable amount of free speech, free assembly, and competitive elections; and all have generally well-educated populations, able to work with the most advanced technologies --- even if most countries acquire the cutting-edge technologies by means of imports from a half-dozen of the richest and usually most scientifically renown: the US, Germany, Japan, France, and Britain, with the others showing ability not just to acquire technologies by means of licensing or multinational implants, but able to diffuse them within and across industries fairly quickly. And generally, all protect private property through the legal system; restrict corruption (with fairly big variations, say, between Scandinavia and Italy or Greece); and operate with a sense of shared national citizenship.

Singapore stands out as an exception in democracy and fully free expression and association. On the other hand, it is small and homogeneously Chinese and does very well in importing and diffusing technologies near the technological frontier.

                                               And China?

No country in the world that fails to meet these criteria --- certainly not China (a per capita income of under $6,000 vs. the US's $46,000 in 2007, adjusted for PPP) --- is ever likely to close the gap noticeably without major changes.

In the Chinese case ---- where its real GDP growth rate has always been exaggerated (owing to a combination of dubious inflation-deflators and locally gathered statistics that even the Prime Minister openly questioned in the late 1990s) --- the advance of its economy is in line with standard convergence catch-up growth theory, at any rate as pioneered early in the 20th century and after WWII by Japan and then since the 1960s by the smaller Asian dynamos and possibly India since 1990 or so. Roughly 66-70% of its technologically advanced exports --- including consumer electronics and pharmaceuticals --- are provided by foreign multinationals working in that country, which use disciplined and fairly cheap Chinese labor as an export assembly line.

Then, too, whenever Chinese per capita income looks like soaring , the World Bank discovers --- as it did in 1993 and again two years ago --- 200-300 million very poor Chinese that didn't appear in the statistics earlier.


A query prompts itself here: Can a country ruled by a cumbersome state, topped by a corrupt and venal CP monopoly --- whose banking system is still overwhelmingly used by the state to funnel the massive savings of the Chinese people into preferred investments (mainly propping up the remaining and ineffectual state-owned industries) --- move within two or three decades into the charmed circle of rich and technologically advanced countries without major political and cultural changes? Meaning? Clear reforms that move the country toward far greater decentralization of economic decision-making to firms and individuals; a rule of law (not least for intellectual property); free expression and the right to discuss, innovate, and move freely in and out of the country; and the self-immolation of the CP monopoly --- when has this ever occurred (not just Communist monopolies, but any power-wielding monopoly in history)?

                                 One Clear Conclusion

And so, what can we conclude about long-term growth, a macro-economic matter?

Without explicit studying of these matters --- technological invention and innovation (especially of the radical economy-changing sort), entrepreneurship, waves of creative destruction, and key institutional-cultural matters --- economists who hope to understand why some countries are rich and advanced and others aren't (and others likely won't ever become rich and advanced) need to be carefully trained in these matters: both historically and in the present, with constant exposure to not just theory but evidence of all sorts . . . only some of which can be modeled formally and run statistically.

                                   Another Conclusion

And within the circle of rich industrial democratic countries, which do better and why?

For my part, I add that at my web-site ---The Buggy Professor --- I posted 7 or 8 very long articles in 2004-2005 on why the less statist economies of the English-speaking world have generally done better in GDP and per capita income growth than their more statist equivalents in Japan or on the Continent of Europe. Britain, Ireland, New Zealand, and Australia all reduced state-spending and especially on welfare while freeing-up more than labor markets, with a noticeable boost in their rates of growth in GDP and per capita income.

Note quickly.

None of that buggy work denied that the Continental EU countries couldn't make their labor-markets more flexible. In fact, since then, the Scandinavians and Germany and France (the latter to an extent) --- have, moving in a commendable increase in the labor-participation ratios of their populations between the ages of 16 and 64. Similarly, they are all trying --- with various degrees of success --- to deal with an ever larger number of retirees in the future (as the potential native labor force shrinks) by expanding the age-limit of full pensioned-retirement . . . almost all of which, on the Continent, is in the form of state-funded pensions.

What they haven't done, so far --- nor Japan noticeably either --- is expand their rate of productivity. In fact, the most recent study of the increased ratio of labor-force participation in West Europe shows that it has come so far at a reduced rate of productivity. Or (as I posted yesterday at Carpe Diem --- Mark Perry's laudable web site) in a debate with a vocal big-government advocate of the EU Continental sort:

                                         A Revealing Study 

One of the best recent studies of this is by Robert Gordon (an outstanding macro-economist at Northwestern) and Ian Dew-Becker (probably a British economist):

"Europe's employment growth revived after 1995 while productivity growth slowed: Is it a coincidence?" April 15, 2008 Click here: http://www.voxeu.org/index.php?q=node/1058

Their findings, though, might not make you happy. They note that the improved labor-force participation ratio (and reduced EU unemployment) has come at the expense of productivity growth. It's as though, the note, the EU countries have not experienced yet the "Internet Revolution" that drove up the US rate of productivity markedly starting in the early- and mid-1990s and that has continued ever since:


".... The third and most novel - and also most controversial - finding is that there may have been a substantial trade-off between labour productivity and employment growth over the past two decades. Before 1995, European policy made labour more expensive through higher taxes, tighter regulations, and strong unions. This reduced labour demand, lowering employment but raising the real wage and the average product of labour. Slow employment growth and relatively high productivity growth were negatively correlated. After 1995, this process was reversed, with lower taxes and looser regulations reducing the cost of labour, which helps explain the simultaneous increase of growth in employment per capita and slower growth in labour productivity."

"We find that the revival of European employment growth can help explain why European productivity slowed. But we do not explain why European productivity growth did not accelerate as occurred in the US. US productivity took off after 1995, growing at 0.7 percent faster per year, but in Europe a literal reading of the productivity growth data leads to doubt that the internet revolution ever occurred in Europe. Some of Europe's poor recent performance can be explained by reforms that will enhance growth in the long run, but not all of it. Our findings should lead EU policymakers to think about the two-edged effects of policy reforms on employment and productivity, but they should also worry about how to encourage innovation and the adoption of new technologies.1"