A depressing economist, not a depressed economy

Posted: May 01, 2003 12:00 AM

In the '70s, the late Arthur Okun devised the "misery index" -- simply adding together the inflation rate and the unemployment rate. It still remains a handy device for summarizing the overall economic discomfort of American citizens.

From 1970 to 1979, the misery index averaged 13.4 percent, ranging from a low of 8.8 percent in 1972 to a high of 17.6 percent in 1975. From 1980 to 1989, the misery index averaged 12.8 percent, but it fell dramatically from 20.6 percent in 1980 to 8.9 percent by 1986. From 1990 to 1999, the index maintained an average 8.8 percent, while briefly hitting a record low of 6.1 percent in 1998. The misery index subsequently rose to 7.6 percent in the recession of 2001 but has been heading down since then.

This March, the unemployment rate was 5.8 percent. Inflation over the past three months was at an annual rate of 0.8 percent, if you leave out energy (which we must because oil prices have fallen). That puts the misery index at 6.6 percent -- very close to a record low. Yet that cheerful fact seems to makes some people more miserable, particularly New York Times columnist Paul Krugman.

In his 1994 book Peddling Prosperity, Krugman acknowledged that "without any question, the negative effects of taxes are significant." Yet he went ahead and questioned those effects on the basis of a single statistic -- productivity. "Today's conservatives," wrote Krugman, "must defend their position against their own dismal productivity record." By that standard, Krugman ought to be hugely impressed with President Bush: Productivity soared 4.8 percent last year -- the biggest increase ever. Yet today's liberals do not have to defend their position against a conservative president's unprecedented productivity record. They can just change the subject.

The problem, if you want to call it that, is that when output per hour worked grows by 4.8 percent a year, the economy could grow by 4.8 percent without adding any jobs. If your sole objective is to raise productivity -- which was Krugman's 1994 goal -- then you should hope to maximize output and minimize employment. If your sole objective is to raise employment, which is Krugman's newest goal, then it would make sense to lower productivity by maximizing employment and minimizing output. One way to do that is by overtaxing productive workers to subsidize leaf-raking, as we did in the 1930s.

Krugman has conveniently stopped worrying about productivity and switched to worrying about jobs. The author of The Age of Diminished Expectations has to have something to worry about. Krugman recently wrote The Return of Depression Economics, and has now turned to advocating Depression policies. In a recent New York Times column, he writes that "Franklin Roosevelt's Work Progress Administration put the unemployed to work doing all kinds of useful things; why not do something similar now?"

Well, unemployment rate was 20.3 percent in 1935 when the WPA began, and it was still 19.1 percent three years later. Today, the unemployment rate is only 5.8 percent, much lower than the 6.9 percent unemployment rate in 1993, when Krugman was more concerned about productivity.

To propose reviving Depression-era programs when unemployment is unusually low and productivity unusually high seems eccentric. So does the arithmetic by which Krugman defended his nostalgia for the WPA. He took a 10-year estimate of revenues supposedly lost by the Bush tax plan and divided it by the 1.4 million extra jobs the administration predicts would be added over just two years. Dividing the two-year job gain by the 10-year tax cut allowed Krugman to pretend the new jobs would cost $500,000 each.

Replying on his web page to those who criticized this new math, such as Don Lufkin, Krugman said, "No serious economist thinks that a tax cut or spending increase will have any effect on employment more than a couple of years from now." That remark defines seriousness as 1962 demand-side economics, thus ignoring work incentives. Lower marginal tax rates encourage more people to join and remain in the labor force (particularly spouses and the otherwise prematurely retired), which can leave employment permanently higher.

For Krugman to treat spending increases as equivalent to lower tax rates also ignores the well-documented fact that government purchases hurt private employment by drawing real resources away from productive private uses. In any case, Krugman's device of dividing a two-year job gain by a 10-year revenue loss was deliberate fraud, pure and simple.

I do agree, however, that the administration's constant repetition of the estimated 1.4 million new jobs is nearly as annoying as the opposition's constant repetition of the estimated $726 billon revenue loss. Both figures are just estimates, and both miss all the important points. There are many reasons for easing the tax rates on dividends, for example, that are equally valid regardless of any impact on jobs or productivity. For one thing, punitive taxes on dividends are widely avoided in ways that do damage to both the economy and corporate governance (e.g., by fostering unbearable corporate debt).

Benefits to the economy from faster growth should definitely not be measured only in terms of a promised 1 percent addition to the 134 million jobs we already have. Faster economic growth raises incomes and wealth for those who have jobs too, not just for the 8 million between jobs.

It makes little sense for the administration to promote faster growth merely as a method of bringing unemployment down a bit faster. But it makes no sense at all for Paul Krugman to judge a whole package of varied tax proposals merely in terms of their short-term impact on employment. If we just wanted to "create jobs" and didn't give a damn about productivity and prosperity, then we could all grab a rake and work for Paul Krugman's new WPA.