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Saturday, October 08, 2005

Faith Based Economics

I'm known to advocate economic policies that not everybody agrees with from time to time. I've been queried as to whether the available economic data demonstrates the effectiveness of the policies I advocate. Unfortunately, there are too many degrees of freedom (6 billion and then some) in our economic system for the available data to unequivocally demonstrate the effectiveness of any policy.

I recently had someone retort the following regarding the lack of overwhelming data:
"In the absence of data, isn't this just faith-based economics, then? Why should we lend credence to the idea?"
The inevitable follow-on mocking comment came as well:
"Why not intelligent design economics?"
In some sense, they're right. We can think about how economic interactions might work, we can create models of those interactions, and we can consider and hypothesize the effects of various policies on those models, but without actual, statistically significant data, which will probably never exist, a leap of faith is required to actually pull the trigger and implement any economic policy.

The faith based, Intelligent Design approach to economics actually has a long and interesting history. I'll jump into the story with Marx, the ultimate Intelligent Designer. Since Marxism hadn't, by definition, been tried before Marx invented it, there was absolutely no data available to support it. Nonetheless, dozens of countries embraced Marxist forms of government, leading to tens of millions dead, hundreds of million in poverty (at least using the levels defined by the U.S. Census Bureau), and billions oppressed over a span of decades, before mostly collapsing over the last couple of decades. Even here, with fairly consistent data, it's still impossible to prove that the Central Planning required by Marxist forms of government lead to poorly performing economic systems. After all, maybe all those instantiations of the Marxist approach were all poorly done, and if they had been done right, utopia would have been achieved as promised. Many people still believe that - they're keeping the Marxist faith.

As the economy started heading into a recession after the 1929 stock market crash, tax receipts dropped. Then,
Obsessed about deficits, Hoover had raised individual tax rates at all income levels -- the top rate rose from 25 percent to 63 percent. Following Hoover, Roosevelt signed into law a series of tax increases. At the bottom end, personal exemptions were reduced and an earned income credit was eliminated. At the top end, the highest marginal rate was increased to 79 percent in 1936.
The depression deepened and went on and on. Did any historical data support the idea that raising taxes as the country slid into a recession and then depression was a good idea? No, none whatsoever. But Hoover and FDR had faith that it was critically important to try and balance the budget. Of course, we can't prove with certainty that raising taxes made the depression worse. Perhaps people were so tired of roaring away through the 1920s that they simply needed to be depressed for an entire decade. And then after the 1930s was over, maybe it wasn't the largest deficits (as a percentage of GDP) that this country has ever experienced (Reagan and Bush deficits are tiny by comparison) that stimulated the economy out of the depression, rather people were just finally ready to be over being depressed. Certainly, there are many people who believe Hoover's and FDR's tax increases didn't increase the depth or length of the depression and/or the deficits incurred for WWII didn't help the economy recover - they're keeping the pro-taxation and anti-deficit faith.

President Lyndon Johnson declared a war on poverty. He pushed many "Great Society" programs through congress that were Intelligently Designed to eradicate poverty. Many of these programs still exist today. While there aren't a lot of poverty statistics prior to Johnson's declaration of war, when he left office in 1969, the poverty rate (as defined by the measurements his administration developed) was 12.1 percent. The poverty rate fluctuated within a fairly narrow band throughout the 1970s. When President Carter left office 12 years later in 1981, the poverty rate was 14.0 percent. At the end of 2004, it's 12.7 percent. This data hardly demonstrates that the War on Poverty was a resounding success. However, there's no doubt that other factors could have overwhelmed the possible benefits of the War on Poverty. And indeed, a large number people remain convinced that such programs are extremely beneficial - they're keeping the help-the-poor-thru-federal-government-programs faith.

President Nixon decided that the Keynesian economic approach was just what the country needed to really rev up the economy. The data didn't provide a lot of support for the concept, but he got the Fed to loosen the money supply while allowing tax bracket creep to increase effective tax rates in the hope that inflation would be kept in check. As usual, there's not enough data to prove that Nixon's policies led to the stagflation that enveloped the rest of the 1970s and brought down two presidents (Ford and Carter). And no doubt Nixon did not intend for that to happen - but he no lack of faith in his policies.

And then talk about faith - how about Reagan, Laffer, and those supply-siders? When I first heard the supply-side concept, I thought it was, by far, the stupidest economic policy I'd ever heard. I likened it to friends of mine who were convinced that if you left work later allowing rush hour traffic to subside, you'd get home earlier. But the economic data wasn't so bad after Reagan's policies were instituted. The economy improved and business cycles have been pretty mild ever since. Of course, there are too many other factors that could explain the economic turn around. It could be that Reagan's charisma just got everybody fired up. Maybe demographic trends were the main undergirding of the economic turn around. The personal computer was just invented, so maybe the economic improvement was mostly due to technology. Or maybe after 1970s, everybody was just ready to be productive again. Lots of people maintain that it was other factors like these that revived the economy and not the supply-side policies - they're keeping the anti-supply-side faith.

An awful lot of credence has been assigned to awful lot of economic policies throughout the ages with not a lot of supporting data. It seems the best anyone can hope for is to specify policies for which there is no contradicting data. Perhaps, with a lot of luck, policies for which the data is at least somewhat aligned can be tried.

That's the best anyone can do and I have no interest in being held to a higher standard. I write about economic policy not because I expect to convince anyone else, but to point out that there are other ways of looking at economic policy.

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