The Merits of Cochrane's Case
By David Henderson
Now I do.
John made the case, contra Noah Smith, that it was plausible, with enough reversals and abolitions of regulations and government spending programs, to raise the growth rate of real GDP to 4% a year for a decade or more. He didn’t lay out any empirical estimates, e.g., ending this regulation or this government spending program will temporarily increase the growth rate of real GDP by x percentage points.
In an article that just scratched the surface of deregulation and government spending cuts, I showed how one could raise the growth rate of real economic wellbeing by about 3/10 of a percentage point per year for a few years. I did this in a challenge to Paul Krugman in the pages of Fortune in 1995. So John’s 4 percent for, say, 5 years or so, is plausible.
My article is “The Case for Small Government,” and it’s in Fortune, June 26, 1995.
When macroeconomists look at U.S. data on real (inflation-adjusted) GDP, they notice something interesting: The economy’s growth rate seems pretty stable. Many then conclude mistakenly that economic policy doesn’t matter much. This tendency is bipartisan. Robert Lucas, a libertarian/conservative economist at the University of Chicago and someone who is likely to win the Nobel Prize for economics within the next ten years, once said, “I think this economy is going to grow at 3% a year, no matter what happens. Forever.” Exhibit A for liberal economists is Paul Krugman of Stanford. In these pages (Fortune, May 1), in a piece mainly devoted to defending the welfare state, Krugman wrote: “[T]he underlying growth rate of the U.S. economy has been a very stable 2.5% right through the past five Administrations.”
Krugman asserted that any politician who claims he can raise the economy’s growth rate “by as much as three-tenths of a percentage point is naive–or worse.” Maybe, but that doesn’t mean a politician can’t add three-tenths of a percentage point to the growth rate of economic well-being.
I then went on to make some back-of-the-envelope calculations of the effects of cutting government spending:
Look at the numbers. Simply to have a benchmark that allows us to look at changes, assume that today’s $7 trillion GDP, with its current makeup of government and private-sector production, is a measure of economic well-being. To raise the growth rate by one-tenth of a percentage point, you would have to increase economic well-being by $7 billion. Three-tenths of a percentage point, therefore, is $21 billion. Is a politician naive if he promises a $21 billion increase in economic well-being? Not at all. Privatizing the Postal Service alone could achieve that goal for one year. One more fat example along these lines: Say the Department of Defense spends $10 billion a year on a weapons system over a period of ten years. To get members of Congress to vote for that system, the Pentagon usually has to promise to have it produced in various key members’ districts, even though that’s hardly the most efficient use of taxpayers’ money. Unconstrained by congressional pressures, let’s say that the Pentagon might have been able to acquire the same quality of weapons system for $60 billion instead of $100 billion. Again, for the nation’s GDP, it doesn’t matter whether the government spends $100 billion inefficiently or spends just $60 billion and leaves $40 billion in taxpayers’ hands. But for our economic well-being, it matters a lot. If the government procured weapons efficiently, Americans would be better off by $40 billion.
Of course, eliminating one program or streamlining procurement policies at one department would not permanently increase the U.S. growth rate. You can’t privatize the Postal Service twice. But these examples just scratch the surface. The simple fact is that government has gotten so huge that just by eliminating a few programs a year you could increase the growth rate of economic well-being by three-tenths of a percentage point for at least five years.
Here’s how. Assume conservatively that moving a function from the government to the private sector would lower its cost by one-third. Therefore, you would have to move only $63 billion a year in functions out of government to get to $21 billion in savings. That’s only about 4% of the U.S. budget. If you did this every year for five years, you would cut the federal government’s budget by about 20%.
Moreover, privatizing government activities isn’t the only way to cut back government and make everyone better off in the process. There’s another way to achieve a higher growth rate in economic well-being: deregulate. At the height of the Interstate Commerce Commission’s power, its budget was well below half a billion dollars a year. But Thomas G. Moore, a senior fellow at the Hoover Institution and a leading transportation economist, points out that the ICC’s budget measures only a tiny fraction of the damage this one agency has done to the U.S. economy. By keeping rates high and restricting the items truckers could carry, the ICC caused a lot of trucks to go out half full and return empty. The ICC’s so-called gateway restriction also meant that if a trucker had only two licenses, one to deliver from, say, Charlotte, North Carolina, to Indianapolis, and the second to deliver from Indianapolis to Memphis, the only way he could legally deliver from Charlotte to Memphis would be to drive to Indianapolis first, even if he had nothing to deliver there. This restriction wasted millions of gallons of fuel and thousands of man-years every year. The longer delivery times that the ICC spurred by restricting entry also induced businesses to hold much higher levels of inventory than would have been needed had transportation been cheaper.
Moore estimates that deregulation under Presidents Carter and Reagan increased shippers’ economic well-being by about $60 billion, most of which was in the form of lower prices. As recently as two years ago, Moore predicted that ridding the nation of federal and state trucking regulations would save shippers as much as $20 billion a year. That is happening now. Last August, Congress eliminated almost all remaining interstate and intrastate regulation of the trucking industry, and President Clinton, the House of Representatives, and the U.S. Senate have all agreed that the ICC should be abolished.
Not surprisingly, when I wrote for Fortune, I sometimes had to make compromises. One big one I remember is in the last paragraph. The published version says “Bill Clinton is hardly Juan Peron.” My submitted version said “Bill Clinton is hardly Juan Peron and Hillary is not quite Eva.”