Money Illusion

TheMoneyIllusion A slightly off-center perspective on monetary problems.
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.
http://www.themoneyillusion.com/?p=5164