May 10, 2016

Macroeconomics and the Welfare State, Part 1

The Western world is facing a major economic problem: the growth rates of the European and American economies have fallen to historically low averages. I highlighted this problem in my 2014 book Industrial Poverty, where I pointed to how GDP growth has essentially been cut in half over the past 50 years. 

On May 2 University of Chicago economist John Cochrane made somewhat the same point in the Wall Street Journal:

Sclerotic growth is America’s overriding economic problem. From 1950 to 2000, the U.S. economy grew at an average rate of 3.5% annually. Since 2000, it has grown at half that rate—1.76%. Even in the years since the bottom of the great recession in 2009, which should have been a time of fast catch-up growth, the economy has only grown at 2%. Last week’s 0.5% GDP report is merely the latest Groundhog Day repetition of dashed hopes.
The growth decline in Europe came earlier and has caused them a lot more pain over the years, but more and more evidence suggests that the United States has now reached a point where we, just like Europe, will have to do without high GDP growth for the foreseeable future. Cochrane's point about the average growth rate over the past 15 years comes on top of recent news that President Obama is the first of our nation's chief executives who will not preside over a single year of three-percent growth.

As my book explains in great detail, and as Cochrane suggests in his Wall Street Journal article, the trend of slow growth predates the Obama presidency. But that does not mean Obama can draw a sigh of relief and disregard the problem; on the contrary. His presidency started with the Great Recession, but most of his eight years in office have consisted of the recovery from that crisis.

If Congress and the White House had agreed on the right kind of fiscal policy, we would have been in a strong recovery now, possibly reminiscent of what we saw after the recession in the early 1990s. The fact that we have not seen anything near that kind of recovery tells us that something has changed at the systemic level in the U.S. economy.

Before se speculate on what that change might be, let us first look at growth in the European and American economies in recent years. First, Europe:

As the dashed line shows, the European common-currency zone - the euro-zone economy - has not grown at more than two percent per year since the first quarter of 2011. That was five years ago. It has been almost nine years, since Q3 2007, that the euro zone saw growth in excess of three percent.

As for the U.S. economy:

Its annual growth rate has exceeded two percent on several occasions since the Great Recession. Three percent happened in only one post-recession quarter, Q3 2010.

Since the last quarter of 3+ percent growth, the euro-zone has grown at, on average, 0.38 percent per year. During the same period of time the U.S. economy expanded at 1.21 percent per year.

Despite these differences, the United States is not saved from the ailment of weak growth. The reason is similar to that which weighs down the euro zone: big, intrusive government. There is plenty of evidence to this (for example, see my book Industrial Poverty) which raises an interesting question: since the decline in growth is a long-term phenomenon, does this mean that there is a long-term trend in government expansion that explains why Europe started seeing a growth decline already some four decades ago?

The simple answer is: yes. Europe underwent a rapid government expansion in the first decades after World War II. It was the era of the welfare state. Its most radical form was conceived by sinister minds in Sweden - among them Nobel Memorial Economics Prize laureate Gunnar Myrdal - and implemented over four decades of consecutive socialist governments. Other European governments followed suit, more or less rapidly, though over time the differences between various European welfare states have become much smaller than the similarities.

America's more recent decline in growth has to do with a significantly delayed - and downscaled - expansion of the welfare state. However, the differences between the American and European welfare states have become small enough that it will not take more than one Hillary Clinton presidential term to close the gap.

In the sequels to this article I will discuss the consequences for the U.S. economy from putting a full-scale welfare state to work here. Focus will be on the macroeconomic consequences of the welfare state, especially over time.

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