In response to a John Cochrane policy paper on growth policies, I wrote a post chiding Cochrane for selling efficiency policies as long-term growth policies. Cochrane now has a long and rather testy reply to Yours Truly. The basic message of the reply is: "If level effects are really, really big, they tend to look like long-term growth effects."
Yep. That's right.
Cochrane's original paper described the impact of growth policies by drawing an analogy with the period from 1950-2000:
If the US economy had grown at 2% rather than 3.5% since 1950, income per person by 2000 would have been $23,000 not $50,000. That’s a huge difference. Nowhere in economic policy are we even talking about events that will double, or halve, the average American’s living standards in the next generation.To get a policy change that had that effect, we'd need:
A) A doubling of the level of detrended steady-state GDP, and
B) Frictions in the economy and/or the policy-making process that smoothed that change over 50 years.
Cochrane, in his new post, asserts that (A) is possible (I'll get to that later). He doesn't mention (B). How much of the growth we enjoyed from 1950 to 2000 a result of policy improvement? Cochrane certainly believes strongly that Reagan's policies caused a lot of the growth in the 80s and 90s, but how about the equally impressive growth from 1950-1980?
When I look at U.S. history I see a pretty smooth growth trend (I'll use a David Andolfatto tweet instead of just grabbing FRED data, because it's funnier!):
See the big growth takeoffs from policy liberalization? Neither do I.
Of course, at any time we could have chosen to become North Korea, at which point the line would have crashed and burned, so in some sense the whole upward trend was due to policy. But I think that it's hard to look at this steady upward march and see anything other than the steady improvement of technology. If you look at other countries, you see that they did just about as well as us (or better) over this time period, and that our growth and theirs was highly correlated. To me, that says that it was technology (and trade), not policy changes, that drove most of the global growth trend.
But OK, OK, if we DID engineer policy changes that doubled our income, would it matter to us if it was abrupt or spread out over decades? No, it would not. So Cochrane is right - a "level effect" that huge really would be party time.
So maybe my Bloomberg piece didn't really manage to express what actually annoyed me about Cochrane's paper. I guess it wasn't just about "growth effects" vs. "level effects". It was about proof versus conjecture.
Cochrane, by citing the growth we enjoyed from 1950-2000, and then telling us that we can enjoy similar growth if we do his preferred policies, seems to imply that this is something we've done before and therefore something we can do again. To me, that doesn't seem to fit the facts, even if you give Reagan as much credit as Cochrane gives him. To me, it seems pretty obvious that liberalizing policy changes produced, in the past, at best small bumps in the trend of steady technological progress.
But OK, OK, John obviously really believes that his preferred policies would engineer a HUGE change - a doubling or tripling - of our potential GDP. I may disagree with that prediction, but I guess I shouldn't dismiss it out of hand. I definitely think that pointing to the growth from 1950-2000 as an example of what we could achieve with deregulation is misleading. But ultimately that springs from the fact that my priors about how the world works are just very different from John's.
Anyway, on to John's other points:
Cochrane Point 1: If China did it, why not us?
Because China started off very far away from the technological frontier. If you liberalize your economy in ways that allow you to start importing and applying foreign technology, you will be able to grow fast. Some of China's growth is simple Solow capital catch-up, but some of it is a sudden and dramatic influx of foreign technology.
The U.S. is at or near the technological frontier, so I assume it would be a lot harder for us to do what China did. I think this again illustrates a difference in the way John and I think about productivity - he seems to instinctively think of policy, I always instinctively think of technology.
Cochrane Point 2: We could triple or octuple our GDP by making it easier to do business!
I was pretty skeptical of this argument. Reverse causation is a much bigger problem than Cochrane seems to think; he dismisses it with some anecdotes, but I don't think it can be dismissed. Another problem is the poor fit of the regression line Cochrane shows - see Kevin Grier for more on this point.
A third problem is that the World Bank's "Ease of Doing Business" indicators are constructed from surveys, which have all kinds of huge methodological issues (which Cochrane himself has pointed out in other contexts). They are not objective measures of the ease of doing business.
What this means is that A) the hypothetical "frontier" that the World Bank and Cochrane construct may not exist, and B) attempts to reach that frontier might actually hurt rather than help growth/efficiency. Alternatively, engineering improvements in the rankings might help a lot for poor countries but not help much for rich countries.
If we look at real-world examples, only one single country - Singapore - has both A) substantially higher GDP than the U.S., and B) better performance on the World Bank rankings. Singapore's GDP is about 60% higher than ours in PPP terms, so if we could reach that level it would indeed be great. They are #1 in the World Bank's rankings. The U.S. is #7. Countries #2-#6 are actually all a bit poorer than the U.S.
But maybe we can emulate Singapore.
Cochrane Point 3: Permanent growth effects might not actually exist.
Yep, true. Cochrane points to a Chad Jones paper showing this, which I actually already knew. It's a good paper. In fact, if you just use a simple Solow-type exogenous growth model you get a similar conclusion - there's nothing you can do to boost growth in the very long run.
Whether or not this is true, it is orthogonal to my point. I was talking about the overselling of efficiency-based policies by appealing to the history of long-term growth. I did not intend to claim that there are other clearly identifiable policies we could take to boost the growth trend for 50 years.
Cochrane Point 4: I should not have used the word "conservative".
I think this word was appropriate. First of all, it's one that the public intuitively understands. Second of all, it accurately communicates Cochrane's apparent love for Republican politicians, especially Reagan. In an earlier post (also a rebuttal to Yours Truly), Cochrane wrote:
In 1980 Ronald Reagan announced some pretty radical growth-oriented policies, at least by the standards of the time. (Not much new since Adam Smith, of course.) The standard liberal commentators made the standard objections: voodoo economics, numbers don't add up, it will take generations of unemployment to lower inflation, the debt will explode, and so forth. (Plus, the Soviet Union will be there forever, we might as well get along.) Reagan offered optimism; won, malaise ended, we won the cold war, and there was an economic boom.I would note that:
A) John uses the word "liberal" to describe people who disagree with his desired policies, and most people use "conservative" to mean the opposite of "liberal".
B) Reagan's policies included more tax cuts, while the big deregulations came under Carter. Deregulation is the centerpiece of Cochrane's current growth proposals, so it's interesting that he credits Reagan 100% and Carter 0%. If the World Bank's Ease of Doing Business rankings had been around at the time, I think Carter's reforms would have resulted in a lot more improvement than Reagan's, but Cochrane gives Reagan all the credit. That sort of feels like a politically "conservative" view of things.
So I don't think that any harm was done by the use of "conservative".