The Fundamental Fallacy of Pop Economics

The Fundamental Fallacy of Pop Economics (which I get to name, because this is my blog and I can do whatever I want, mwahahaha) is the idea that the President controls economic outcomes.

The Fundamental Fallacy is in operation every time you hear a phrase like "the Bush boom" or "the Obama recovery". It's in effect every time someone asks "how many jobs Obama has created". It's present every time you see charts of economic activity divided up by presidential administration. For example, here's a chart from Salon writer Sean McElwee, using data from a paper by Alan Blinder and Mark Watson:

Blinder and Watson attribute the difference to "shocks to oil prices, total factor productivity, European growth, and consumer expectations of future economic conditions", but McElwee attributes it to progressive economic policy.

Larry Bartels has made headlines with similar analyses about inequality:

But the worst perpetrators of this fallacy tend to be conservative econ/finance commentators. And of these, the worst I've seen is Larry Kudlow. Kudlow is being mooted for chairman of the Council of Economic Advisers -- basically, the president's chief economist. Here's an excerpt from a Kudlow post in December 2007 (!) denying that the economy was in danger: 

The recession debate is over. It’s not gonna happen. Time to move on. At a bare minimum, we are looking at Goldilocks 2.0. (And that’s a minimum). The Bush boom is alive and well. It’s finishing up its sixth splendid year with many more years to come.

Notice how this is actually wrong (there was a mild recession in 2001), but Kudlow explicitly associates economic good fortune with the President's term in office. Here's another, from around the same time:

The GOP...has a positive supply-side message of limited government, lower spending, and lower tax rates....I believe the economic pendulum will soon swing in favor of the GOP. There’s no recession coming. The pessimistas were wrong. It’s not going to happen. At a bare minimum, we are looking at Goldilocks 2.0. (And that’s a minimum)...The Bush boom is alive and well.

Or here's Kudlow on Obama:

You've had so much war on business in the last eight or 10 years…I think that has really damaged the economy and has held businesses back from investing and creating jobs. It will take a while to turn that ship around," Kudlow said of Obama's economic policies.

You see the same kind of President-based magical thinking here. In fact, go back and read Kudlow's commentary over the years, and his whole body of work is shot through with this simple thesis - Republican presidents are great for the economy, Democratic presidents are terrible, etc. Kudlow has ridden the Fundamental Fallacy about as far as it's possible to ride it. 

In a recent post, James Kwak declares that Kudlow is a victim of what he calls "economism" (and which I call "101ism"). He thinks Kudlow is wedded to a vision of an economy where free markets always work best. But I respectfully disagree with James. Kudlow doesn't seem to think about supply and demand, or deadweight loss, or any of that - nothing that would be taught in an econ class. Kudlow's thinking is more instinctive and tribal - it's "Republican President = good economy". It's the idea that if the man in charge comes from Our Team, things must go well, and if it's someone from the Other Team, things are bound to be a disaster. The Fundamental Fallacy doesn't come from Econ 101 - it's far more primal than that, an upwelling of our deepest pack instincts.

So, you may ask, why is the Fundamental Fallacy a fallacy? Three basic reasons:

1. Reason 1: Policy isn't all-powerful. 

Macroeconomic models are not reliable, so it's very hard to get believable numbers for the effects of policies like the Bush tax cuts or Obama's stimulus bill. But most estimates show that the effect of both was very modest - the Bush tax cuts might have increased overall GDP by 0.5-1.5% in the short term, and probably had close to no effect in the long term. Meanwhile, the ARRA's effect on unemployment and growth was probably quite modest. Optimistic estimates have Obama's policy package reducing unemployment by about 0.5-1.5% from 2009 through 2013 - not nothing, but not nearly enough to make the Great Recession go away. And those are the most optimistic, favorable estimates.

Only in (some) econ models does policy have complete control over things like GDP and unemployment. But those models are almost certainly highly misspecified. In reality, policy has institutional constraints - nominal interest rates can't go much below zero, there's a federal debt ceiling, etc. And even more importantly, if policy becomes extreme enough, the models themselves start to lose validity - if you have the government go deeply enough into debt, the fiscal stimulus effect will no longer be the only way in which more government borrowing affects the economy. 

In reality, things like growth and unemployment are often determined by natural forces rather than government decisions. For example, I suspect that the pattern of higher growth during Democratic administrations cited by Blinder & Watson is at least partly endogenous - recessions cause white working-class voters to ignore social/identity issues and vote for Democrats like Clinton in 1992 and Obama in 2008, allowing those Democrats to take credit for the natural as well as the policy-induced parts of the recovery.

2. Reason 2: The President doesn't control policy.

Charts like those of Bartels and Blinder & Watson, as well as buzzwords like Kudlow's "Bush boom" look only at the party of the President. But Congress is often controlled by a different party. Obama and Clinton faced Republican Congresses for much of their term in office, and Reagan faced a Democratic Congress. Even when the President has a Congress of the same party, it's often difficult for him to push through his desired policies - witness Bush's failure to privatize Social Security, or Clinton's failure to enact fiscal stimulus.

Additionally, a lot of power is held by the states. Much of Obama's stimulus bill actually just went to shore up decreases in state spending. Meanwhile, the Fed controls interest rates, and though the President appoints the Fed chair, he has very little control over what that Fed chair subsequently decides to do. 

3. Policy often acts with a lag.

Cutting taxes does relatively little if spending isn't also cut. That's because if tax cuts aren't eventually matched by spending cuts, then the government has to either hike taxes, or default on its debt. Therefore, if tax cuts don't "starve the beast", their only effect will be through short-run fiscal stimulus. And tax cuts aren't a very efficient form of stimulus.

So, guess what? Tax cuts don't ever seem to lead to spending cuts. "Starve the beast" doesn't work. 

This is just one example of how policy often acts with "long and variable lags". Deregulation is another. Many people believe that Reagan's deregulations led to the boom of the late 1980s, but Carter actually slashed a lot more regulation than Reagan did. It could have taken years for those deregulations to lead to higher growth. 

Any structural policy you want to name - welfare reform, tax cuts, infrastructure spending, research spending, trade treaties - should only have its full effect after a number of years. It takes years for businesses to invest and grow, for trade patterns to shift, and (probably) for worker and consumer behavior to permanently change. Presidential terms only last 8 years at most. So even if presidents controlled policy, and even if policy was very effective, we'd still see many presidents getting credit for their predecessors' deeds.

Obviously there are some big exceptions to this. The President can start a war, and wars can make the economy boom (as in WW2 for America) or wreck it utterly (as in WW2 for everyone else). Given enough power, a President could in theory wreak havoc on the economy, as Hugo Chavez did in Venezuela. In poor countries, a strong President like Deng Xiaoping can push through reforms that change a country's entire economic destiny. 

But when a country is already rich, where the President is restrained by checks and balances, and where policy changes are not sweeping or huge - i.e., as in the United States over the past half century - we would be well-advised not to exaggerate the economic impact of the chief executive.