America’s amazing success since 1980: Why Krugman is wrong
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. Indeed around that time most of the top British economists signed a petition asserting that Thatcher’s policies would fail. For those of you not old enough to remember 1980, let me explain why. Labour rule of Britain had reduced their economy to a shambles. The government ran the big manufacturing corporations and labor unions were running wild. They had 83% MTRs, 98% on capital. There was garbage piling up in the streets of London. Britain had been the sick man of Europe for decades, growing far more slowly than Germany, France and Italy. The US wasn’t doing as badly, but certainly wasn’t doing that well either. We had also been growing much more slowly than Europe and Japan. Unlike Britain, we were still richer than most other developed countries, so this convergence was viewed as partly inevitable (the catch-up from WWII), and partly reflecting the superior economic model of the Germans and Japanese.
Now let’s look at what actually happened over the next 28 years. All GDP per capita data are from the World Bank, and are normalized as a fraction of US GDP/person:
Country 1980 1994 2008
USA 1.000 1.000 1.000
Australia .841 .770 .837
Canada .905 .818 .843
Britain .688 .705 .765
France .780 .730 .713
Germany .803 .812 .763
Italy .756 .754 .675
Sweden .868 .777 .794
Switz. 1.146 .987 .915
Asia
HK .547 .845 .948
Japan .732 .815 .736
Singapore .577 .899 1.064
Latin America
Argentina .395 .300 .309
Chile .210 .251 .311
Note that four countries gained significantly on the US, two were roughly stable (Australia, Japan) and the rest regressed. The four that gained were Chile, Britain, Hong Kong and Singapore. Of course lots of poor countries gained on the US, but that’s to be expected. But I will show that the performance of every single country on the list is consistent with my view that the neoliberal reforms after 1980 helped growth, and inconsistent with Krugman’s view that they did not.
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.)
Australia: A traditionally rich country whose commodity export model started to sputter in the 1970s. They did major free market reforms (under a left wing government). Reforms continued when the conservatives took power. After 1994 they reversed their relative decline.
Japan: Just the opposite of Australia. Their free market export model did very well in the post war years, and didn’t hit a wall until about 1990. After that their economy was unable to find domestic growth sectors, as their dysfunctional government refused to reform their statist domestic economy.
HK and Singapore: Both are in the process of becoming much richer than the US. Some of that is due to their status as city-states. But in modern developed economies the rural populations are small and not that poor, so I think in time people will recognize that Singapore’s success is more than just demographics.
Chile and Argentina: Chile is the most famous Latin American example of neoliberal reforms. Note how in 1980 they were barely half as rich as their neighbor Argentina, and are now a bit richer. Almost every serious development economist attributes their relative success to their neoliberal reforms. BTW, there was a severe recession in Chile in 1974-75, but rapid growth from 1975-80. In addition, they were much poorer than Argentina in 1970 as well, so the starting date doesn’t explain much.
Canada: Similar to Australia, except that they were not as statist as Australia in the earlier period, and their reforms occurred in the 1990s when they began dramatically shrinking the size of government as a share of GDP. The 1990s reforms worked as their relative decline to the US was reversed, and they started catching up after 1994.
France and Germany: Did some reforms, but much less than Britain. They suffered a decline relative to both Britain and the US. I think the 1980 German numbers include the East, but can’t be certain. I do know that Germany’s relative decline increased after 1994, by which time the East German incomes had definitely been incorporated in the data.
Italy: Did even less reforms than Germany and France, and has a more statist model. Fell far behind Britain.
Sweden: Had a bad recession in the early 1990s and had suffered decades of relative decline. Did major cuts in MTRs, privatization and deregulation during the 1990s, and its relative performance improved after those reforms.
Switzerland: Is the glass half full or half empty? Switzerland has always been regarded as one of the most capitalist countries in Western Europe, but has also been among the least aggressive countries in terms of neoliberal reforms. That pattern would predict high levels of GDP/person, but relative decline vis-a-vis the US. And that is exactly what has occurred. They rested on their laurels and slipped quite a few notches down the Heritage and Fraser rankings. I suppose the highly democratic system allowed them to avoid the worst socialist excesses of the 20th century, but also prevented them from reforming as fast as more dictatorial forms of democracy, such as the UK.
So there you are, all these countries support my hypothesis that neoliberal reforms lead to faster growth in real income, relative to the unreformed alternative.
There are two kinds of economists. Those who read the Economist (or FT) every week, and have a pretty good sense of what is going on in the world, and who know why some countries are doing better than others. And those who are lost in their ivory tower doing arcane research. The latter group is often much more highly skilled than I am, and come up with more important new ideas than I ever will. But when talking to this group I often find they are totally oblivious to the neoliberal revolution of the past 30 years. (BTW, this isn’t a jab at the left, most of the guys I am thinking of are right-wingers.)
You can’t just take a single data point to evaluate a complex phenomenon. “Eh, you say there’s a neoliberal revolution? OK, let me check to see whether most countries grew faster or slower after 1980. That should settle the argument.” Actually it doesn’t. The neoliberal revolution occurred precisely because growth was slowing almost everywhere in the 1970s and 1980s, and after 1980 growth slowed the most in those countries that reformed the least.
PS. I don’t mean to suggest the left doesn’t have any counterarguments. Reasonable progressives would admit than some of the reforms were sensible (cutting MTRs below 90%, privatizing British steel and autos, abolishing the CAB, etc.) And they’d also point to the fact that leisure has increased faster in Europe and thus the hourly real wage numbers look somewhat better vis-a-vis the US. And then I’d respond that the French productivity numbers are inflated by the fact that their labor market keeps many of the least productive people unemployed (teens and immigrants.) And they’d respond by pointing to our large prison population. The debate never ends. But Krugman was using simple real income numbers in his recent post. And by that criterion the results are clear—neoliberal reforms produce higher levels of GDP per capita.
HT: James, Marcus
Update: Several commenters mentioned median income rather than GDP/person. The median income data does show slower growth than GDP/capita, partly because of increasing inequality, but partly because of statistical problems with the data (health benefits are excluded, etc.) I believe consumption data is far superior to median real income, and that shows Americans doing much better. Will Wilkinson has posted on this. The consumption data also show a much smaller increase in inequality. But I was primarily interested in international comparisons, for which all I had was GDP data in PPP terms. The point was that countries that did more reforms did better than those that did fewer reforms. I am not denying that growth in US living standards slowed after 1973, rather I am arguing that it would have slowed more had we not reformed our economy.
themoneyillusion.com
23. May 2010 at 07:26
Good, timely topic! Arguably India belongs on the list, no? It still has a “mixed model,” to be sure, but, judged by it’s own historical standards, the liberalization of the early 90’s was dramatic, and the results across a range of measures have been impressive.
themoneyillusion.com
scott sumner
23. May 2010 at 09:07
Rob, Yes, Both India and China have done much better after the reforms. I focused on developed countries as they are more similar to the US.
themoneyillusion.com
What does Krugman think of the neoliberal policy revolution?
Paul Krugman replied to my critique of his comments on neoliberal reforms after 1980. First a couple quick points:
1. Krugman’s right that I didn’t really refute his specific point—that these reforms were associated with a slowdown in real income growth. Indeed I agree with that observation. I thought it would be more interesting to explore an implication that I believe 99.9% of his readers drew from the post—which is that the reforms did not boost growth in real incomes relative to the alternative of maintaining the 1945-80 economic model. I strongly disagree with that view. It would be interesting for Krugman to indicate whether or not that is his view.
2. It seems to me that he also changed the subject a bit with his discussion of hourly wages. His initial post looked at annual incomes, which is how I responded. In addition, I did concede at the end of my post that increasing leisure time in Europe explains part of the differences. I would point out, however, that part of that “leisure” is a much higher natural rate of unemployment among the young and immigrants than in America. And I seem to recall that liberals don’t like it when conservatives call unemployment “leisure.” In addition, if the leisure is triggered by tax distortions, it may simply encourage more inefficient home production, and less efficient market production. But yes, the extra leisure does have some bearing on the comparisons, as I conceded. And to be fair, Krugman refers to the working hours and retirement age differences, not the unemployment gap.
What I’d like to know is what Krugman thinks about the neoliberal revolution that swept the world after 1980. I define neoliberal reforms as:
1. Sharp cuts in the top MTRs
2. Deregulation of prices, trade and market access
3. Privatization of state-owned enterprises, services, and infrastructure
According to the various free marketing rankings, almost every country in the world became more neoliberal after 1980. Although neoliberalism is often associated with conservatives like Reagan and Thatcher, that is actually a misleading impression. I seem to recall finding only 4 countries out of 200 that hadn’t become more free market since 1980 according to the Heritage index, but my memory may be off. In any case, it is clear that even the Nordic countries, which Krugman seems to view as pretty good models, did a massive amount of deregulation, privatization and cuts in high MTRs after 1980. In my sample of 32 developed countries I found Denmark was second to New Zealand in the extent it moved toward freer markets after 1980.
In America the major neoliberal policy innovations were:
1. Deregulation of transport, communications, energy, and finance
2. Cuts in the top MTR from 90% to 28%
3. NAFTA and other tariff cuts
4. Welfare reform plus EITC
All of these had strong bi-partisan support, often from even liberal Democrats. Three occurred under Democratic presidents.
Obviously not every neoliberal reform was a success. Banking deregulation went poorly, and electricity deregulation in California went poorly. But even in the Nordic countries it seems the neoliberal reforms are accepted as being necessary. Indeed some of those countries have privatized many governmental services that are usually government run in the US, such as airports, air traffic control, postal services, passenger trains, water systems, public schools, highways, etc, etc. I seem to recall Krugman occasionally criticizing those on the right who see privatization as a panacea, but don’t recall him expressing an opinion on those trends in Northern Europe. The European countries have also continually slashed their corporate tax rates, to levels far below the US. How does Krugman feel about that? Some have no capital gains taxes, or inheritance taxes. What does Krugman think of moving to a progressive consumption tax regime? More than almost any other blogger I know, Krugman’s posts can be read two ways; as a sensible liberal, or as a knee-jerk leftist. Partly this may reflect his choice of topics–right now he may consider refuting conservative nonsense to be his most important duty—perhaps that makes him seem more left wing than he really is.
My point is that it isn’t obvious that a liberal like Krugman would oppose the general thrust of the neoliberal revolution. I doubt he wants to go back to an era where many western governments owned big manufacturing firms like steel and autos, set airfares, and had 90% tax rates. On the other hand his posts on the topic often suggest that the 1945-80 period was a sort of Golden Age, and we’d be better off trying to recapture that era.
Perhaps he’d respond “it’s complicated” and favor some reforms but not others. I imagine that he has a fairly sophisticated view of the issue, but it isn’t obvious what that view is from reading his posts. And his supporters often seem to view the entire neoliberal revolution as some sort of right wing plot, when if you look internationally it was adopted almost everywhere, and often by left-leaning governments. (Even where there was no hidden racial agenda, which Krugman suggests influenced Republican policy after 1980.) The evidence also shows that countries where the electorate have a more idealistic or civic-minded culture (Denmark) reformed much faster than cultures where the electorate had a less civic-minded culture (Greece.)
In my last post I argued that the growth of the 1950s and 60s resulted from a technological revolution that began in the 19th century and hit a wall around 1973. At that point growth slowed almost everywhere in the late 1970s and 1980s, even before neoliberal reforms were put into effect. Indeed that’s partly why they were put into effect. And the evidence shows that the faster reforming countries did better than the slower reforming countries. When economic growth was simply churning out more steel and more washing machines, everyone could do it. Even the flawed Soviet model. But we can’t go back to that world, it’s gone forever.
PS. I’m sure Krugman’s too busy to repeatedly respond to my posts. Perhaps his readers could point me to Krugman posts where he discusses neoliberal reforms in other countries. I recall one where he was skeptical of Chile’s success, and that’s why I pointed to the Chile/Argentina comparison. But how about Northern Europe?
PPS. I need to slow down. Here’s what I should have responded to:
We can try to parse whether that’s true — but in any case it’s not a response to my original point. That was about the claim, quite common on the right, that the US economy was stagnant until Reagan did away with those nasty New Deal policies — a claim that is simply, flatly, false. The era of strong unions, high minimum wages, high top marginal tax rates, etc. was also a period of rapid growth and rising living standards. That doesn’t prove causation; it does disprove the widespread dogma that these things are always economically devastating.
The Soviet regime produced very rapid growth in living standards between 1945-73. I claim that that record of success doesn’t disprove the assertion that by the 1980s that same system was “economically devastating.” The US system during that period was far better than the Soviet model, but also had features that undermined performance in the long run.
themoneyillusion.com
Responses to additional criticisms
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