T he many economists who criticized Bob Dole's campaign pledge to cut taxes by 15 percent this fall cited the record of the 1980s as a convincing example that such a deep tax cut would not generate enough economic growth to pay for itself. As federal deficits grew through the 1980s, what we got instead, of course, was a quintupling of the national debt, high real interest rates, an overvalued dollar, and, to the ongoing consternation of Reagan revolution boosters, a low rate of savings. What's more, when measured over the business cycle, gross domestic product (GDP) continued to grow as slowly as it had in the 1970s, and there was no improvement in labor productivity growth.
Defenders of President Reagan's record would have none of this. They mounted a predictably swift response. But, as hard as they tried, they could come up with no new weapons to fight the battle. Rather, they fell back on what has become an old standby, which is to ignore distortions in the record caused by the ups and downs of the business cycle. Books like The Seven Fat Years, by the Wall Street Journal editorial chief Robert L. Bartley, were widely criticized for painting the Reagan record in a glorious light by only counting the good years and excluding the severe 1982 recession. A book called The Eight Fat Years would have had significantly different results. But chastisement has not deterred the supporters of the Reagan record-including some eminent scholars from the nation's great universities-from doing it all over again.
Alan Reynolds, a charter supply-sider and now the director of economic research for the Hudson Institute, presented probably the classic example of this rebuttal technique in the October 14, 1996, issue of the National Review. The irony is that Reynolds, perhaps humbled a bit, went out of his way in this piece to make the claim that he would adjust for the business cycle. In fact, he did nothing of the sort. "
To avoid being misled by the business cycle, growth should be measured from one business-cycle peak to the next," Reynolds quoted one of the vociferous critics of supply-side economics, the Concord Coalition. So far, so good. He then went on to complain that the Concord Coalition is distorting the record when it compares the annual rate of real GDP growth between 1969 and 1980, which was about 3.4 percent, to the slow growth rate of the 1980s. He has a point. The rate of economic growth during the business cycle be tween 1973 and 1980 was markedly slower than between 1969 and 1973. He delightedly reported that real GDP grew from the cycle peak in the fourth quarter of 1973 to the next peak in the first quarter of 1980 by only 16.2 percent. By contrast, real GDP grew by 32.8 percent between 1980 and 1990. On this he rested his case. To avoid being misled by the business cycle, growth should be measured from one business-cycle peak to the next," Reynolds quoted one of the vociferous critics of supply-side economics, the Concord Coalition. So far, so good. He then went on to complain that the Concord Coalition is distorting the record when it compares the annual rate of real GDP growth between 1969 and 1980, which was about 3.4 percent, to the slow growth rate of the 1980s. He has a point. The rate of economic growth during the business cycle be tween 1973 and 1980 was markedly slower than between 1969 and 1973. He delightedly reported that real GDP grew from the cycle peak in the fourth quarter of 1973 to the next peak in the first quarter of 1980 by only 16.2 percent. By contrast, real GDP grew by 32.8 percent between 1980 and 1990. On this he rested his case.
But something is fundamentally amiss here: Reynolds was comparing growth over a six-year period to growth over a ten-year period. In the 11 years between 1969 and 1980, GDP grew by well more than 40 percent, for example. In order to adjust for the business cycle, all one needs to do is compute the annual rate of growth over each period. Did the Reagan revolution improve the annual rate of growth compared to the record of the latter two-thirds of the 1970s? Reynolds didn't bother to run the numbers, even though he gave himself a decided ad vantage by citing the wrong real GDP data for the first quarter of 1980-he reported it as $4,574 trillion when in fact it was $4,674 trillion. Whether this was a simple mistake or wishful thinking, it certainly helped his cause. Real GDP rose by 19 percent between 1973 and 1980 rather than by the 16 percent he reports.
And the annual rates of growth? Real GDP grew by 2.9 percent a year between the quarterly peak in 1973 and the peak in 1980. It grew by only 2.8 percent a year between the quarterly peak in 1980 and the peak in 1990. So much for the corrective power of the Reagan tax cuts. No wonder Reynolds failed to do the computation for us.
TAYLORING THE NUMBERS
One might expect such slick and sloppy analysis from editorialists and Washington policy lobbyists. But well-respected scholars from the nation's best universities have also felt free to neglect the effects of the business cycle when it comes to justifying their political points of view. Robert Barro, a professor of economics at Harvard, presented one of the more memorable examples of this kind of oversimplification in September of 1992. In an op-ed for the Wall Street Journal, Barro graded presidential administrations for economic performance based on a version of the so-called misery index, which combines the unemployment rate and the inflation rate. Because reductions in inflation and unemployment are given equal weight in this computation, the sharply falling inflation during Reagan's years helped rank his terms first and second, according to Barro, out of the eleven presidential terms of the post-World War II period. No matter that the Federal Reserve deserved most of the credit.
Barro went on to supplement the traditional index with a bonus for lowering interest rates as well-even though interest rates and inflation are closely correlated, so when one falls so usually does the other. Try to get that one by a Ph.D. dissertation committee. But this bit of double counting nudged the Bush record a little higher, and Barro awarded him a "gentleman's B," even though Barro admitted that under Bush the economy grew more slowly than under any other administration. The more important point was that Barro didn't take the business cycle into account at all. Instead, he simply measured performance over the four years of each administration compared to the years that preceded it. President Carter ranked worst on Barro's list. But his performance would have been significantly better had it been adjusted for the business cycle, because the Carter years did not include the first year of the economic recovery, in which growth is usually the fastest and the unemployment rate falls the most.
B arro may have had his tongue slightly in cheek. But John Taylor, the Stanford University economist and advisor to presidential candidate Bob Dole, recently committed to paper one of the more egregious examples of this sort of analysis, and one that significantly damages our understanding of recent economic history. In the final weeks of the presidential election campaign last October, Taylor wrote an unusually disturbing piece for the editorial page of the Wall Street Journal (Octo ber 18, 1996). His objective was to make a case for lowering taxes and reducing regulations. The evidence he chose to cite was the record of labor productivity growth in the Reagan-Bush years, which was indeed higher than it was in the Carter and Clinton years.
Let's remember that Taylor was on Bush's Council of Economic Advisers, so a little bias is understandable. But to ignore completely the influence of the business cycle over productivity growth rates, as Taylor did, goes well beyond acceptable bounds. If we were to choose a single measure for rating the nation's economic performance, I would agree that productivity should be the one. Labor productivity is simply the output of goods and services per hour of work, and it has been the source of the growing standard of living ever since the industrial revolution began.
But labor productivity is tied to the business cycle. In the first year of a business recovery, for example, labor productivity almost invariably rises the fastest as GDP bounces off the bottom of the cycle and as companies remain cautious about adding workers (keeping output per worker high) until they are certain business has truly recovered. As the expansion lengthens, productivity gains begin to peter out and sometimes productivity even shrinks before the next recession begins. Finally, during recessionary years, productivity does indeed usually fall (negative growth) as GDP falls. Thus, to find the trend rate of productivity growth, you should measure it over the course of an entire cycle. If a president's four-year term does not include a full cycle, you can't measure the true course of productivity without making adjustments. And few four-year terms have included such a complete cycle.
But Taylor computed the annual labor productivity growth rates for each administration by calendar years, without business cycle adjustments. My own computations of these non-business-cycle-adjusted productivity rates under the last four administrations differ only slightly from Taylor's (see "
The Real Deal
"). Over Reagan's two administrations, labor productivity grew by a rate of 1.3 percent a year. In President Bush's administration it grew by 1.2 percent a year.
In the Carter and Clinton years (up to mid-1996), labor productivity grew at only 0.4 percent a year. Taylor compared the Clinton performance to the bad old days before the Industrial Revolution. This is "close to the zero growth of pre-Industrial Revolution days," he wrote. "At that rate it would take 10 generations to double a person's income." And he, of course, attributed the better performance of the Reagan-Bush years to lower taxes and less regulation. (Incientally, under Barro's report card system, which ignores productivity, I am pretty certain that Clinton would have earned an A.) In the Carter and Clinton years (up to mid-1996), labor productivity grew at only 0.4 percent a year. Taylor compared the Clinton performance to the bad old days before the Industrial Revolution. This is "close to the zero growth of pre-Industrial Revolution days," he wrote. "At that rate it would take 10 generations to double a person's income." And he, of course, attributed the better performance of the Reagan-Bush years to lower taxes and less regulation. (Incientally, under Barro's report card system, which ignores productivity, I am pretty certain that Clinton would have earned an A.)
When we properly adjust for the business cycle, however, the results are nothing like what Taylor purported they are. First, let's consider the two Reagan administrations. Reagan left office in 1988, two years before the cycle ended-years during which productivity growth flagged. Between when Reagan took office in 1981 (a cycle peak) and 1990, labor productivity grew at a rate of only 1.1 percent a year.
Oddly enough, the four Bush years do indeed represent a fairly complete business cycle, though an inverted one of sorts. Bush's term began with the modest growth of the tail end of the long Reagan expansion, then dropped into a moderate recession, followed by recovery in 1992. In that last year, labor productivity grew rapidly, as it typically does in the first year of expansion. Over the four Bush years, labor productivity grew by 1.2 percent a year, as noted.
The Carter years between 1977 and 1980 include a recession but exclude 1976, the first full year of recovery, in which labor productivity grew by 3.6 percent. If we include that year in the Carter record, which would complete the cycle, we would find that labor productivity grew by 1.1 percent a year. Similarly, the first Clinton term does not include 1992, the first full year of recovery, in which productivity rose by 3.2 percent. If 1992 were included, productivity in the Clinton years would have risen by 1.1 percent a year. (Although the Clinton record, it should be noted, is as yet recession-free.)
N on-economists may well ask why Carter and Clinton should be credited for recoveries that did not begin on their watch. (There is, of course, a serious question about whether any president should be credited for igniting a business recovery even when it occurs in his administration.) But the goal is not to give Carter or Clinton credit for economic expansion that had nothing to do with their policies. The point is that if we are to compare records on productivity growth, it must be done over the same part of the business cycle, and preferably it should be over an entire business cycle if we are to determine the long-term trend. Others may also insist that we should give Reagan credit for the length of his business expansion. But let's keep in mind that the durability of the 1980s expansion, unlike the one in the 1960s, came at the expense of building a mountain of debt. And, again, the question is whether the long-term course of productivity growth was altered under Reagan's administration. The answer is that it was not. The 1.6 percent productivity growth from the 1982 bottom of the cycle, so frequently cited by the Reagan boosters, takes into account neither the drop in productivity during the Reagan recession nor the flagging rate of growth in the final two years of the Reagan expansion presided over by George Bush. In fact, the final GDP data for 1990, which showed that productivity had grown at only an annual rate of 0.4 percent over the four years between 1986 and 1990, ought to have caused John Taylor many sleepless nights. But somehow I doubt that he rushed to phone Bush's Council of Economic Advisers to warn his colleagues that their policies were responsible for a rate of productivity growth no higher than the pre-Industrial Revolution era.
ANEMIC PRODUCTIVITY GROWTH
What is so damaging about Taylor's analysis is that it ignores what, in my view, is the most important fact about the economy over the past quarter century. Under Democratic and Republican administrations alike, labor productivity has continued to grow at a rate of about 1 percent a year. This is less than half the average rate of productivity growth since 1870, which economic historians place at 2.25 percent a year. It is well below the rapid rate of productivity growth of nearly 3 percent a year reached in the 25 years after World War II. The Reagan revolution could not raise the peak-to-peak rate of productivity growth above 1 percent a year between 1979 and 1990. Since the cyclical peak in 1990, it is still growing at about 1 percent a year.
I n sum, this historically slow rate of productivity growth has held through periods of inflation and disinflation, high and low real interest rates, soaring and falling oil prices, an overvalued and an undervalued dollar, tax cuts and tax hikes, union strength and union weakness, deregulation and even a bit of reregulation. This is the central fact of our current economic circumstances. Such a history over a quarter of a century suggests that we may well have to adjust to slow labor productivity growth indefinitely. But it also suggests that we should search imaginatively for ideas that have not yet been tested.
Economists sometimes seem to be infinitely flexible; they can find support for their theories whatever the historical facts. Some will claim that productivity did not rise more rapidly because we did not cut taxes enough in the 1980s. Others will say the Federal Reserve has yet to create an environment of low real interest rates without high inflation. My own preference is to think about what we have not had. We have badly neglected long-term, high-risk private investment as well as basic research. We have also underinvested in key public goods, from daycare to infrastructure, urban centers, education for the less well off, and federal research and development. What we should not pretend is that there is evidence from the past 25 years that demonstrates which policies have worked to sustain and enhance productivity. Certainly, there is no evidence to support Taylor's contention that a combination of income tax cuts, capital gains tax cuts, and fewer regulations has improved America's economic prospects.
The expansion of the 1990s may yet hold more bad news. The next recession could push the trend rate of productivity growth lower than 1 percent a year. Some observers still plead that the productivity of services is being underestimated and that inflation is overstated. But even if this were true, there is no reason to think that these mismeasurements are significantly greater in the 1990s than they were in the 1980s or throughout the post war period. Pro duct and services quality rose rapidly then too-is MRI technology a more significant advance than the polio vaccine? Had John Taylor devoted himself to demonstrating how little progress we have made in the 1990s toward improving labor productivity, despite the Clinton expansion, he would have done a service. Instead, he has distorted the record. The respected economist adds his name to a lengthening list of those who are willing to ignore the most basic conventions of economic analysis to make their case.
