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.
Great post...thank you!ReplyDelete
Suppose that Trump stacks the Fed with cronies who don't care about the proverbial long run, just about making Trump look good now. Can't they do it? And if so, shouldn't Trump get credit for the boom?ReplyDelete
It may be more effect than cause. Fearing loss of their jobs voters elect a Democrat, fearing loss of their money (taxes) voters elect a Republican which leads to Democratic administrations during recoveries and Republican administrations ending in recessions. Even passively, this still indicates Democrats don't derail recoveries while Republicans don't prevent recessions. That doesn't mean we will see one soon, but we likely will see one in the not distant future.ReplyDelete
Refreshing advice. (The Orange One should read this; but of course he doesn't have to, he's so smart.)ReplyDelete
According to http://www.factcheck.org/2015/10/clinton-economy-better-under-democrats/, who interviewed Blinder and Watson, it may be that it is not directly economic policy that explains the difference (and there is no doubt it is significant) between the outcomes, but that policy in general probably explains most of it: for instance, rises in oil prices happened under Republican administrations as a result of their war policies; or better productivity growth under Democrats may be due to incidental, non-economic, policies. So even if one can't persuasively make an economic argument for better performance under Democrats, it's statistically a better bet to side with Democrats in predicting future growth.ReplyDelete
I think this is some fine liberalbrag.ReplyDelete
While flattering yourself to bee far too objective to fall for the Fundamental Fallacy, you just happen to document in passing that under Democrats: the GDP grows more quickly, recessions are rarer, the unemployment rate is lower, the stock market does better, wages grow more quickly, and part of the horrendous worsening of income inequality under Republicans is reversed. Then you very effectively / fairly skewer Kudlow for being partisan.
That is some good work right there. No snark intended. Thank you for your service to America.
But I wrote this:Delete
"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."
Noah, you might want to introduce some asymmetry here. Presidents, like governors, have only limited abilities to improve the economy; however, there are plenty of ways that Presidents and governors can trash economic growth. Their abilities to achieve good or bad results are not symmetric. Kansas is a good case in point. Gov. Brownback's ability to turn a pig's ear into a silk purse is limited and the Kansas economy was probably going to be weak no matter who was in office. But I don't think there can be much doubt that Brownback's policies have made things a lot worse than they had to be. I suspect we'll see the same dynamic play out with Trump. There's probably not a lot of difference between what a President Hillary Clinton could have accomplished compared to your standard issue establishment Republican. But Donald Trump's ability to do damage is worrisome to say the least. It's a tough life for politicians. Not much they can do to make things better, but a hell of a lot of things they can do to make things worse.ReplyDelete
This is a really important point. But it's also subject to caveats. Often, bad shocks come and it's not the President's fault.Delete
"I suspect we'll see the same dynamic play out with Trump.."Delete
Kansas, being monetarily non-sovereign, is broke. Any monetarily NON-sovereign government — be it city, county, state (Kansas) or nation (Greece) — that runs an ongoing trade deficit, eventually will run out of money.
The United States, being Monetarily Sovereign, never can be “broke.” It has the unlimited ability to pay its bills. (Debt ceiling ruse aside.)
But there are policies that play out in the short run. Tax cuts quickly increase deficits and inequality. Unfunded wars have short term effects. America quickly regeared for war in WWII.Delete
And the president's policies play out fairly widely: the president controls who runs a variety of government agencies. Compare and contrast the FEMA response to Katrina and Sandy.
To what extent did Republican foreign relations with the Saudis help bring about the oil shocks of the 70s?
"Kudlow has ridden the Fundamental Fallacy about as far as it's possible to ride it."ReplyDelete
I think we are going to see him try to ride it a lot farther - moving from commenting on past policy from the outside to influencing future policy from the insider.
You say: "wars can make the economy boom (as in WW2 for America) or wreck it utterly (as in WW2 for everyone else)"ReplyDelete
But actually the Australian economy boomed after WW2 and for a couple of decades afterwards as well. And the world's 12th or 13th largest economy (depending on who you believe this quarter) - in the world's 53rd largest nation by total population - is about to enter its 26th year without a recession; which includes, of course, not experiencing a recession during the GFC.
But that's all right, nobody thinks about Australia - it doesn't even have a President.
Perfect post. I agree 100%, and have been defending this idea for a long time. But psychological biases prevent many economists from acknowledging this.ReplyDelete
Congratulations and greetings from Argentina.
Noah: "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."ReplyDelete
Krugman has had many columns on this topic. The short version is that the cost of borrowing for the US federal government is very, very close to zero, and certainly lower than for almost all private parties.
"But the worst perpetrators of this fallacy tend to be conservative econ/finance commentators. "ReplyDelete
Define "worst." Every partisan does it, from Nancy Pelosi to writers at the Washington Post. Here is Paul Waldmann in the WaPo:
"If they were going to be honest, Republicans would have to admit one of two things. First, Barack Obama and Democrats in general have cracked the code on job creation, and we don’t have to debate how to go about it anymore. Or second, the president doesn’t have much effect on the economy one way or another."
Cracked the code of job creation!
Is Bill McBride, possibly the most read economist on the interwebs, encouraging this fallacy with his monthly post of jobs under various Presidents: http://www.calculatedriskblog.com/2016/12/public-and-private-sector-payroll-jobs.html"
I have seen Democrats foist this same (Democratic Presidents are good for the economy) story, so it's hard to tell who is the worst.
Problem for me now is that I cannot get past this simple statement that conservative economists are the worst. Really? This smacks of partisan confirmation bias.
Kudlow, by the way, is not my favorite economist. He has been wrong about a lot of stuff. But, the FOMC has also been over-forecasting GDP growth for years.
So, at least Kudlow is in good company. In fact, the entire economics profession has been so wrong, that they pretty much got fired Nov 9th. Economists are about as reputable as fortune tellers and used car salesman. In fact, economists might be worse off. At least for used cars I can get the Carfax.
So to a regular person, one economist calling another one a "the worst" is like one used car salesman calling another one dishonest. It's hard these days to distinguish the totally wrong from the merely wrong.
That is the real problem: Not Kudlow, but partisan rants thinly disguised as "analysis." Anything that even smells like a partisan rant people tune out.
Speaking of tuning out, I have no idea what the rest of your post says. I can't get past "the worst perpetrators of this fallacy tend to be conservative econ/finance commentators."
Since I know left-leaning economists sell me the same (Democratic Presidents are good for the economy) snake oil, I just have to assume it's a partisan rant about Kudlow.
Kudlow is not an economist.Delete
I am not sure whether "not an economist" is a feature or a bug these days. You did need to be an economist to be extra specially wrong over the last 9 years, but it sure did help.Delete
Dude, everybody knows that Democrats are great at timing cycles. That is why I proposed Republicans let the Democrats get Clinton in there. Instead, they will pay the price in 2020 and Democrats will come back in with gusto(again). Democrats are a crisis party, pure and simple. When the economy is down, who do you turn to?Delete
It is sorta like Noah's article on blooms with business investment. Business investment has recovered, pure and simple. We don't need nor should desire business growth above 3%. That is excess and you see the crash of excess in every recession. Yet, Noah can't accept that. I suspect business investment will grow to fast in 2017-18 and the price will be paid by the 2020 election.
Statements like "the price will be paid by the 2020 election" are so 2015. late. This is the Trump era, the era of go-big-or-go-home.Delete
Trump hired the freakin CEO of Exxon. We are going to burn so much coal and oil that the seas will rise faster than a Tsunami, drowning the coastal elites who voted for Clinton. That is the Trump re-election plan, summarized.
I would not worry about the Democrats in 2020. I'd buy a boat and learn to sail if I were you.
Economic policy effects economics.ReplyDelete
U.S. laborers in the manufacturing industry compete with foreign laborers in the manufacturing industry due to economic policy. Just as U.S. laborers in professional services (doctors, lawyers, dentists, etc) DON'T compete with foreign laborers in professional services due to economic policy.
Cutting taxes is a dreadful way of trying to achieve growth. Occasionally an economy may experience stagnation at a point where all other factors would indicate the economy is sound and that would justify either a tax break or tax holiday in order to prime the pump, but taxes overall are a good thing for regulating the economy and to pay for infrastructure and social programs which are and should be beyond the purview of the market generally and of corporations in particular. The American attitude towards corporations is a strange one which sets it at odds with common sense. Corporations are not people. Corporations are instruments of government.ReplyDelete
Like Kudlow, you are also not an economist.Delete
In the eyes of the public, an "economist" is someone who calls themselves an "economist".Delete
It's sort of the way women are always giving birth to babies. Men can do it to, it's just that we never see it happen due to endogenous factors. Maybe it's whoever is on the bottom during intercourse who gives birth. One day a male dervish will give birth and a Republican president will not correlate with a recession, slow growth and unemployment.ReplyDelete
For the amusement of the crowd, I'll cite the generally ignored book 'Presimetrics' which documents a lot of these peculiar blue-boom, red-bust coincidences. I'll also note the red-state, blue-state paradox in which anti-business government policies at the state level tend to produce better economic outcomes. That's another totally inexplicable coincidence.
Take this philosophy to its logical conclusion, or perhaps a bit beyond, and it isn't the local kleptocrats who have been keeping Africa underdeveloped, and it isn't an international capitalist conspiracy, it's just a coincidence. After all, how much impact could government policy have?