Thursday, April 26, 2012

Ideology and Facts in the Economic Policy Debate

The fact that ideology matters in the economic policy debate should not be a surprise to anyone. But the influence that ideology has has in some of the economic analysis we have seen since the beginning of the financial crisis has led to completely contradictory statements about the facts behind the causes and potential remedies to the crisis.

Via Greg Mankiw's blog I read a strong criticism of the Obama administration written by James Capretta. Quoting from his article:
When he (Obama) came into office, he favored a massive injection of new government spending into the economy in the name of “stimulus” — counter-cyclical federal activity aimed at offsetting depressed consumer demand emanating from a recession-battered private sector. The net result provides little if any boost to aggregate demand because the states — and to some extent private citizens — simply pocket the federal money and reduce their deficits and debts. Meanwhile, what federal taxpayers get is a permanent increase in the size of government.

We have all heard similar statements before which tend to be supported by references to $800 billion to $1 trillion stimulus packages and bailouts both in the US and Europe.

But have we really see an unusual expansion of government size? Quite the contrary. As I argued in a previous post, what we have seen during the current crisis is exactly the opposite. Relative to previous crisis government spending has been growing at a much slower rate this time. Paul Krugman makes an even more interesting comparison in blog, a comparison that reveals how inaccurate the above statement is. He compares government employment under the Obama administration to the Bush and Clinton administrations. The Bush administration is probably the most relevant comparison because it also started in the middle of a recession. Here is the chart from Krugman's analysis.

The data speaks for itself. 40 months into the Obama administration, the number of government employees (all levels of government) has gone down by 600,000. During the Bush administration the number had increased by about 700,000. A difference of 1.3 million. So where is the increase in government size?

Antonio Fatás

P.S. A few months ago I wrote a post with almost the same title discussing the mistaken view that some economists have of the link between taxation and labor market outcomes in Europe - another debate that seems to be heavily influenced by ideology and not enough by facts.