...I want to focus on one bad argument that Cochrane uses. Most of the so-called growth policies Cochrane and other conservatives propose don't really target growth at all, just short-term efficiency. By pretending that one-shot efficiency boosts will increase long-term sustainable growth, Cochrane effectively executes a bait-and-switch.As it turns out, the difference between "growth" and "level" effects in growth theory and facts is not so strong. Many economists remember vaguely something from grad school about permanent "growth" effects being different and much larger than "level" effects. It turns out that the distinction is no longer so clear cut; "growth" is smaller and less permanent than you may have thought, and levels are bigger and longer lasting than you may have thought.
Along the way, I offer one quantitative exercise to help think just how much additional growth the US could get from the sort of free-market policies I outlined in the essay.
Part I Growth and Levels
A quick reply: China.
China removed exactly the sort of "level" or "inefficiency" economic distortions that free-market economists like myself (and Adam Smith) recommend. What happened? Here is a plot of China's per capita GDP, relative to the US (From World Bank). In case you've been sleeping under a rock somewhere, China took off.
Now, in the "growth" vs "level," or "frontier" vs. "development" dichotomy, China experienced a pure "level" effect. Its GDP increased by removing barriers to "short-term" efficiency, not by any of the "long-term" growth changes (more R&D, say) of growth theory.
But "temporary" "short-run" or "catch-up" growth can last for decades. And it can be highly significant for people's well-being. From 2000 to 2014, China's GDP per capita grew by a factor of 7, from $955 per person to $7,594 per person, 696%, 14.8% annual compound growth rate (my, compounding does a lot). And they're still at 15% of the US level of GDP per person. There is a lot of "growth" left in this "level" effect!
Lots and lots of people, even "liberals" in Noah's other false dichotomy, use the word "growth" to describe what happened to China, and would not belittle policies that could make the same thing happen here.
Part II. How much better can the US do?
But can liberalization policies have the same effect for us? Yes, you may say, China had scope for a big "catchup" growth effect. But the US is a "frontier" country. China can copy what we're doing. There is nobody for us to copy. Big increases in levels, which look like growth for a while, are over for us.
But are they? We know how much better China's economy can be, because we see the US. We see how much better North Korea's could be, because we see South Korea. (Literally, in this case.) How much better could the US be, really, if we removed all the distortions as in my growth essay?
To think about this issue, I made the following graph of GDP per capita versus the World Bank's
"Distance to Frontier" overall measure of government interference:
The distance to frontier score...shows the distance of each economy to the “frontier,” which represents the best performance observed on each of the indicators across all economies in the Doing Business sample since 2005.The individual measures are things like
Starting a Business, Dealing with Construction Permits, Getting Electricity, Registering Property, Getting Credit, Protecting Minority Investors, Paying Taxes, Trading Across Borders, Enforcing Contracts, Resolving Insolvency(I used GDP data for 2013, and distance for 2014. That gave the largest number of countries.)
The US is $52,000 per year and a distance score of 82. China is $7,000 and a score of 63. The diagonal line is an OLS regression fit.
The distance to frontier measure is highly correlated with GDP per capita. It tracks enormous variation in performance, from the abject poverty of $1,000 per year through the US and beyond.
The correlation would be stronger if not for the outliers. In red, Libya and Venezuela are arguably countries with temporarily higher GDP than the quality of their institutions will allow for long. In green, Rwanda and Georgia may have reasons for temporarily low GDP among improving institutions. Cuba and North Korea are missing. Luxembourg, Kuwait, have obvious stories. And I did not weight by population; large countries seem to be closer to the line.
Update: An attempt at nicer graph art. The countries are weighted by population. The dashed line is a weighted least squares fit, weighted by population. China is red, US is blue. Better?
Too much growth commentary, I think, confounds "frontier" with "perfect." The US has good institutions, but not perfect ones. It takes forever to get a building permit in Lybia. It takes 2 years or more to get one in Palo Alto. It could take 10 minutes. We are not completely uncorrupt. Our tax code is not perfect. Property rights in the US are not ironclad. A lawsuit might take 10 years in Egypt. But it still could take 3 years here. (Disclaimer, all made-up numbers.) And so forth.
So, the big question is, just how much greater "level" -- and how much China-like "growth" on the way -- could the US achieve by improving our good but imperfect institutions?
The Distance to Frontier measure is relative to the best country on each dimension in the World Bank sample. So a score of 100 is certainly possible. I labeled that by a hypothetical country, "Frontierland" (FRO) in the graph.
Perhaps we can do better. Even the best countries in the world are not perfect. Let's call the best possible institutions Libertarian Nirvana (LRN). How good could it be? If the US is currently 82, and the union of best current practices 100, let's consider the implications of a 110 guesstimate.
| Country | Code | Distance | GDP/N | % > US | 20 year growth |
|---|---|---|---|---|---|
| China | CHN | 61 | $7,000 | ||
| United States | USA | 82 | $53,000 | ||
| Frontierland | FRO | 100 | $163,000 | 209 | 5.6 |
| Libertarian Nirvana | LRN | 110 | $398,000 | 651 | 14.8 |
The table shows China and the US along with my hypothetical new countries. Frontierland generates $163,000 of GDP per capita, 209% better than the US. If it takes 20 years to adjust, that means 5.6% per year compound growth. Libertarian Nirvana generates $398,000 of GDP per capita, 651 percent better than the US, a level effect which if achieved in 20 years generates 14.8% compound annual growth along the way.
These numbers seem big. But there are no black boxes here. You see the graph, I'm just fitting the line. And China just did achieve nearly 20 years of 14% growth, and a 700% improvement.
In a sense, the numbers are conservative. The US is above the regression line in the graph. By the regression line, our GDP per capita should only be $33,000 per capita. I extrapolated the regression line, not the current state of the US.
Summary: It is surprising that bad policies, bad institutions, bad ease of doing business, can do quite so much damage. Harberger triangles just don't seem to add up to the difference between $1,000 and $53,000 GDP per capita. But the evidence -- especially the basically controlled experiments of the Koreas and Germanys -- is pretty strong.
The converse must therefore also be true. If bad institutions and policies can do so much damage, better ones may also be able to do a lot of good.
This is admittedly simplistic. Growth theory does distinguish between "ideas" produced by the "frontier" country, that are harder to improve, and "misallocation", "development" of more efficiently using existing ideas. As traditional macroeconomics thinks about aggregate demand easily raising GDP until we run in to aggregate supply, there is a point of superb efficiency beyond which you can't go without more ideas. I don't know where that point is. But uniting the existing best practices around the world in Frontierland is surely a lower bound, and an extra 10 percent doesn't seem horribly implausible.
Lots of other new research suggests that level inefficiencies are sizeable. For example, Chang-Tai Hsieh and Pete Klenow measure misallocation -- the extent to which low productivity plants should contract and high productivity plans should expand, largely by just moving people around (yes, I'm simplifying). They report from this source "Full liberalization, by this calculation, would boost aggregate manufacturing TFP by 86%–115% in China, 100%–128% in India, and 30%–43% in the United States." And this is just from better matches. They're not even talking about policies that raise TFP at all plants, like removing regulatory barriers.
Likewise, Michael Clemens argues that opening borders -- again better matching skills and opportunities -- would roughly double world GDP. That too is (as far as I can tell) based only on "level" calculations, not the "scale" effects of better ideas that growth theory (below) would adduce. But you'd get a lot of "growth" on the way to doubling the level!
Part III. Smith, meet Jones; Growth effects are smaller than you thought
Conversely, it turns out that "growth" effects are vanishing from growth theory. Levels are all we have -- but big levels, that take decades of "transitory" growth to achieve.
The crucial references here are Chad Jones' 2005 "Growth and Ideas" and 1995 "R&D based models of economic growth" and 1999 "Sources of U.S. Economic Growth in a World of Ideas" My discussion will pretty freely plagiarize.
Suppose output is produced using labor \(L_Y\) and a stock of ideas \(A\) by \[ Y = A^\sigma L_Y \] New ideas are likewise produced from labor and old ideas, \[ \dot{A} = \delta L_A A^\phi \] where \(L_A\) is the number of people working on ideas, often (but too narrowly, in my view) called "researchers." To keep it simple, suppose a fraction \(s\) of the labor force works in research, \(L_A= s L\) and that population \(L\) grows at the rate \(n\). The classic Romer, Grossman and Helpman, and Aghion and Howitt models specify \(\phi = 1\). Then we have \[ \frac{\dot{A}}{A} = \delta s L \] and growth in output per capita is \[ g_Y \equiv \frac{\dot{Y}}{Y} -\frac{\dot{L}}{L} = \sigma \delta s L. \] Here you see the new growth theory promise: an increase in the fraction of the population doing research \(s\) can raise the permanent growth rate of output per capita! This is a "growth effect" as opposed to those boring old "level effects" of standard efficiency-improving microeconomics.
But here you also see the fatal flaw pointed out by Jones. The growth rate of output should increase with the level of population. As world population increased from 2 billion in 1927 to 7 billion today, growth should have increased from 2% to 7% per year, per capita. The growth rate of output per capita should itself be growing exponentially! Substituting, we should see \[ g_Y = \sigma \delta s L_0 e^{nt} \] The problem is deep. The model with \(\phi = 1\) gets all sorts of scale effects wrong. Not only has the population increased over the last century, the fraction engaged in R&D has increased dramatically. Integration, by which two economies merge and effectively double their populations, should double their growth rates. Yet frontier growth rates are quite steady, if anything declining since the 1970s.
Jones' solution is simple: How about \(\phi < 1\)? Let's think hard about returns to scale in idea-production
If \(\phi > 0\), then the number of new ideas a researcher invents over a given interval of time is an increasing function of the existing stock of knowledge. We might label this the standing on shoulders effect: the discovery of ideas in the past makes us more effective researchers today. Alternatively, though, one might consider the case where \(\phi < 0\), i.e. where the productivity of research declines as new ideas are discovered. A useful analogy in this case is a fishing pond. If the pond is stocked with only 100 fish, then it may be increasingly difficult to catch each new fish. Similarly, perhaps the most obvious new ideas are discovered first and it gets increasingly difficult to find the next new idea.Or, maybe \(\phi=0\) is a useful benchmark: each hour of work produces the same number of new ideas. But \(\phi=1\) is a strange case; each hour of effort produces the same increase in the growth rate of new ideas.
Solving the model for \(\phi \lt 1 \) the idea accumulation equation is \[ \frac{\dot{A}}{A} = \delta s L_0 e^{nt} A^{\phi-1} \] Let's look for a constant growth rate solution \(A_t = A_0e^{g_At}\), \[ g_A= \delta s L_0 e^{nt} A_0^{\phi-1} e^{(\phi-1){g_At}} \] This will only work if the exponents cancel, \[n+(\phi-1)g_A = 0 \] \[g_A = \frac{n}{1-\phi} \] The steady state output per capita growth is then \[ g_Y = \sigma g_A = \frac{\sigma n}{1-\phi}\] This change solves the problem: It's still an endogenous growth model, in which growth is driven by the accumulation of non-rivalrous ideas. There are still externalities, and doing more idea-creation might be a good idea itself. But now the model predicts a sensible steady growth in per-capita income.
The model no longer has "growth effects." Jones:
Changes in research intensity no longer affect the long-run growth rate but, rather, affect the long-run level of income along the balanced-growth path (through transitory effects on growth). Similarly, changes in the size of the population affect the level of income but not its long-run growth rate. Finally, the long-run growth rateOn reflection, this distinction isn't really a big deal. The model behaves smoothly, for any finitely long period of time or data, as \(\phi\) approaches one. The "level" effects get larger, and the period of temporary "growth" in transition dynamics to a new level gets longer. Even a century's worth of steady growth can't easily distinguish between values of \(\phi\) a bit below one, and the limit \(\phi=1\) of permanent growth effects.
This should remind you of the great unit root debate. A model \(y_t = \phi y_{t-1} + \varepsilon_t\) with \( \phi=1\) has a unit root, and shocks have permanent effects. A model with \( \phi < 1\) is stationary, with only transitory responses to shocks. But \(\phi=0.99\) behaves for a century's worth of data almost exactly like \(\phi=1\). So the difference between "permanent" and "transitory", like the difference between "growth" and "level" really is not stark.
So where are we? There is no magic difference between permanent growth effects and one-time level increases. All we have are distortions that change the level of GDP per capita.
The big question remains: how bad are the distortions? Which ones have large effects and which are tolerable small effects? Endogenous growth theory still suggests that distortions which interfere with idea production, including embodiment of new ideas in productivity-raising businesses, will have much larger effects than, say, higher sales taxes on tacos. Just why is the correlation between bad government and bad economies so strong? My essay just suggested getting rid of all the distortions we could find.
Part IV. Needless politicization
As I hope this extensive post shows, these questions are not political, and the subject of much deep current research.
Noah chooses to make this political. The quote again,
...I want to focus on one bad argument that Cochrane uses. Most of the so-called growth policies Cochrane and other conservatives propose don't really target growth at all, just short-term efficiency. By pretending that one-shot efficiency boosts will increase long-term sustainable growth, Cochrane effectively executes a bait-and-switch."Bad argument" may just mean that Noah is unaware of Jones' and related work. "Cochrane and other conservatives" is telling. Look at my profile. You don't find that word. Open borders, drug legalization, and so forth are not well described as "conservative." I emailed Noah last time he used the word, so his inaccuracy is intentional.
"Pretending" "bait-and-switch" are unsubstantiated charges of intentional deception. And to call permanent increases in efficiency "short-term" is itself a bit of a stretch.
Even the New York Times, and many respectable "liberal" economists use the words "growth" to describe what has happened in China and to describe what "short-term" level effects could do for the US. From the Hilary Clinton Campaign website,
Hillary understands that in order to raise incomes, we need strong growth, fair growth, and long-term growth. And she has a plan to get us there.No, that's not my essay, nor the Bush 4% growth website. There is the word "growth," all over the place, but only the scientific research might count as raising growth in the Noah Smith classificiation. Yet he does not include her among "conservative" economists displaying "bad arguments," "pretending," or "bait and switching."
Strong growth
Provide tax relief for families. Hillary will cut taxes for hard-working families to increase their take-home pay...
Unleash small business growth. ..She’s put forward a small-business agenda to expand access to capital, provide tax relief, cut red tape, and help small businesses bring their goods to new markets.
...Hillary’s New College Compact will invest $350 billion so that students do not have to borrow to pay tuition at a public college in their state. ..
Boost public investment in infrastructure and scientific research. ... Hillary has called for a national infrastructure bank... She will call for reform that closes corporate tax loopholes and drives investment here, in the U.S. And she would increase funding for scientific research at agencies like the National Institutes of Health and the National Science Foundation.
Lift up participation in the workforce—especially for women...
Enough. Shoehorning interesting economics into partisan political "conservative" vs. "liberal" categories is not a useful way to understand the issues here.
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