Jul 31 2011

Nobelist Robert Lucas Sees Light at the End of the Economic Tunnel

Published by at 9:31 pm under Wave Guide 1: Economic Growth

That was the week that was: Gallup reported that President Obama’s job approval rating fell to a record low of 40%. And the crisis of confidence in Obama was bluntly verbalized by billionaire Democrat Steve Wynn:

This administration if the greatest wet blanket to business, and progress and job creation in my lifetime…

The Huffington Post cited first quarter GDP growth of only 1.3% and a Q1 number that was revised downward to only 0.4% (from the previous estimate of 1.9%) as evidence that U.S. economic recovery will “remain slow through 2011.”

As if this weren’t enough bad news, some normally attentive readers of 21stCenturyWaves.com apparently became afflicted by negative “animal spirits” and questioned in emails to me whether a 2015 boom is in the cards!

Yes it is, and you can see more here:
The Maslow Window — Summary.”

Nobel economist Robert Lucas believes that this chart is the secret to the coming prosperity.

In his Milliman Lecture at the University of Washington in May, the Nobel economist Robert Lucas expllained that the U.S. (and other modern economies) growth trend since 1870 is 3% (2% per person), and

this ongoing miracle is mainly due to free-market capitalism.

In plots (see above) of per capita GDP growth since 1870 of 8 large, successful economies (e.g., UK, U.S., France, Germany, Japan), the “catch-up” in growth occurred after WW II but stalled in the 1970s; a 20-40% gap in income levels has appeared relative to the U.S.. According to Lucas, “European tax and regulatory structures discourage savings and work effort relative to the U.S…”

The 20-40% gap represents cost of larger welfare state.

In Lucas’ chart below, the long-term real U.S. growth rate of 3% is plotted against the U.S. recession of 2006 to 2011. It’s clear that current growth — except for the last 6 months (see above) — recovered to nearly 3%, but the rapid post-recession growth chatacteristic of most recoveries is not seen. Instead, GDP remains down by about 10% from the long-term trend.

How long will the U.S. growth gap continue?

Lucas asks:

Is it possible that by imitating European policies on labor markets, welfare, and taxes that the U.S. has chosen a new, lower GDP trend? If so, it may be that the weak recovery we have had so far is all the recovery we will get.

Recently, Stanford economist John B. Taylor (Wall Street Journal, 7/21/11) reminded us again that government economic policies really do have effects, and an empirical (rather than a political) approach to understanding them is invaluable.

For example, with lessons learned from the 1930s’ Great Depression and the 1970s’ Great Inflation, the 80s and 90s were a time of extraordinary job creation: 44 million new jobs. With lower tax rates and limited government spending, the result was economic growth, and

the federal budget moved into balance.

As the 21st century opened, ambitious politicians from both parties wanted to “tame the business cycle, increase homeownership, or provide the elderly with better drug coverage.” The avalanche of unintended consequences is well-known and includes:

a financial crisis, a great recession, ballooning debt and today’s nonexistent recovery.

Despite the U.S.’ current weak recovery, the road to near-term, JFK-style prosperity is clearly visible based on empirical, long-term studies of international economic growth by Lucas, Taylor, and others.

The only question is which U.S. political party will best manifest prosperity in 2012; the candidates who do it best will win.

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