Was Friedman right? The debate on American post-1980 reforms

Interesting debate in the US blogosphere on the pro-market reforms implemented in the US (and other countries including Britain & Ireland) since 1980. Paul Krugman defends the large rise in American living standards pre 1980 liberalisation and contrasts it with more moribund growth there after while Scott Summer highlights the reversal of the American economies (and that of other reformers) relative decline.

Krugman

Read almost any conservative commentator on economic history, and you’ll find that the era of postwar prosperity — the gigantic rise in living standards after World War II — has been expunged from the record.

You can see why: the facts are embarrassing. Here’s a rough-cut version. The blue line, left scale, shows median family income in 2008 dollars; the red line, right scale, shows the top marginal tax rate, a rough indicator of the overall stance of policy. Basically, US postwar economic history falls into two parts: an era of high taxes on the rich and extensive regulation, during which living standards experienced extraordinary growth; and an era of low taxes on the rich and deregulation, during which living standards for most Americans rose fitfully at best.

Scott Summer

Suppose you had gotten a room full of economists together in 1980, and made the following predictions:

1. Over the next 28 years the US would grow as fast as Japan, and faster than Europe (in GDP per capita, PPP.)

2. Over the next 28 years Britain would overtake Germany and France in GDP per capita.

And you said you were making these predictions because you thought Thatcher and Reagan’s policies would be a success. Your predictions (and the rationale) would have been met with laughter

and again

Krugman makes the basic mistake of just looking at time series evidence, and only two data points: US growth before and after 1980. Growth has been slower, but that’s true almost everywhere. What is important is that the neoliberal reforms in America have helped arrest our relative decline. The few countries that continued to gain on us were either more aggressive reformers (Chile and Britain), or were developing countries that adopted the world’s most capitalist model. (According to every survey I have seen HK and Singapore are the top two in economic freedom.)

They are comparing different metrics , Krugman is looking at real median household wages – which increased only very slowly (although per family member, rather more quickly) and Summers relative GDP per capita. One comment caught my eye on Summers blog –

I wonder if opening up markets is like increasing competition in a particular market, where the price (ideally) quickly falls to the marginal cost of producing the good — thus profits head towards (almost) zero. In this case, we open up trade and globalization means that our GDP per capita falls because other countries have lower GDP per capita. Another way, being a manufacturing country isn’t as profitable as it used to be, so we switch to more information technology which still maintains some education barriers to entry (and the US has a pretty good post-secondary system.)

I actually thought this was part of the (unacknowledged) liberal goal in our support of free markets. It is a giant transfer of wealth from the US to other countries, bringing up their living standards at the cost of reducing our own. Sort of like foreign aid, but at levels that would not be politically feasible. I mean 1% of GDP growth??! No way!

Krugman responded to Scott Summer’s argument

Given all that, what do we learn from the fact that since 1980 the United States has more or less maintained its relative GDP per capita, after substantial decline previously? Well, that’s not a simple story. Part of the answer is that our relative decline for 30 years after WWII largely reflected technological catchup by others; by the 80s that catchup was largely over, with all advanced nations at roughly the same technological level, so there was no reason to expect faster growth in Europe and Japan.

This may be true of the USA, but it doesn’t seem like a good explanation for the turn around in Britain’s fortunes. He also argues that since 1980 the trend in European countries has been to use their productivity increases to take more leisure (rather than increase GDP), in the case of the UK this may account for part of the difference (note they didn’t just stop falling behind, but actually increased their relative GDP too).

So since 1980 the UK and the USA have had faster relative GDP growth rates, but, in the USA at least, disappointing growth rates in real median incomes. Ireland, by way of contrast, took a path between the pre & post 1980 approachs. It began liberalising in the late 1980’s, but at the same time formed Social Partnership between business, government and the unions. Ireland then managed to achieve both stellar GDP growth rates and large increases in real wages.

No bio, some books worth reading – The Rational Optimist: How Prosperity Evolves – Matt Ridley .

Crisis Economics: A Crash Course in the Future of Finance -Nouriel Roubini, Stephen Mihm

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