Reply to James Pethokoukis--and a Challenge
By David Henderson
Last week, James Pethokoukis of the American Enterprise Institute, an Institute with which I was affiliated in the late 1990s and early 2000s, wrote a piece titled “The dodgy austerity economics of the tea party.” Here’s a key paragraph:
Now there is evidence smaller government is good for growth over the longer run. But flash austerity would be quite an economic–and political–gamble to take when the economy is only growing at 2%ish, inflation is moribund, and unemployment remains highly elevated. And while TPRs [his acronym for “Tea Party Republicans”] think they have economic history on their side, that’s unclear.
Then he goes through the various pieces of evidence that advocates of cuts in government spending have presented for the idea that such cuts don’t hurt an economy but actually help it. In a couple of places, he cites my work.
TPRs also point to US economic performance at the end of World War II. From 1944 to 1948, spending as a share of GDP plunged to 9% in 1948 from 44% in 1944. Devout Keynesian Paul Samuelson predicted such shock austerity would cause “the greatest period of unemployment and industrial dislocation which any economy has ever faced.” It didn’t happen. While unemployment did rise from artificial wartime lows, George Mason University economist David Henderson points out that during the years from 1945 to 1948, it reached its peak at only 3.9% in 1946, and, for the months from September 1945 to December 1948, the average unemployment rate was only 3.5%. The private-sector gained as government retreated. While total output fell by 12% in 1946, private-sector GDP rose by nearly 30%.
Pethokoukis got my affiliation wrong–I’m a research fellow with the Hoover Institution and an economics professor at the Naval Postgraduate School in Monterey–but given my high respect for the economics faculty at GMU, I’ll take that as a compliment. More to the point, he correctly states my argument. But then, in an apparent attempt to refute my case with World War II, he quotes Richard Rumelt:
When hostilities ended in 1945, many expected that an expanded civilian work force, plus reduced federal deficits, would bring back the depression of the 1930s. There was indeed a brief recession in 1946, but as production was rededicated to consumers and rationing was lifted, people rushed to replace rusted-out automobiles and broken-down refrigerators. The returning soldiers got jobs, moved to newly constructed housing in the suburbs, and the postwar boom was on. And it was greatly accelerated by households’ renewed capacity to take on debt.
I don’t know what “renewed capacity to take on debt” means. What I do know is that the standard view that Americans drew down their savings from World War II to buy consumer goods is incorrect. Had they drawn down their savings, their saving [note the singular] as a percent of income would have been negative. In fact, it was positive, meaning that American households as a whole added to their savings. That’s in my Mercatus study that Pethokoukis cites above.
Second, Pethokoukis deals briefly with the 1990s economic boom that occurred while federal spending as a percent of GDP was falling substantially. He writes:
TPRs also cite the 1990s economic boom. After the Cold War ended, overall federal spending fell to 18% of GDP in 2000 from 22% in 1991. Real US GDP, however, grew by 40% with an average annual growth rate of 3.8%. Case closed? Keep in mind that a) the spending reduction was only as a share of GDP–it rose in both inflation and non-inflation adjusted terms, b) took place over the course of a decade, and c) happened at the same time as a private-sector productivity boom. Of course, Henderson speculates that perhaps the decline in defense spending freed up knowledge workers to help make technological miracles happen in the private economy.
He’s right that I speculated. It would be hard to establish that for sure. I’m not sure why the “Of course,” unless it means that as someone who thinks that government wastes resources because it spends other people’s money, I think that those resources are best used by people when they spend their own money. If that’s what he means by “Of course,” then it’s appropriate.
Here’s my challenge to Pethokoukis. I left it on his site as a commenter and have not heard back:
One thing I notice is that while you have criticisms of each of the cases others and I give where spending was cut a lot and the economy didn’t tank, you don’t actually give examples where spending was cut a lot and the economy did tank. I’ve been looking for those and can’t find any. Do you have any?