Over at Bloomberg, Noah Smith makes a point that I think is too often forgotten:
But what we really lack is any idea of the quantitative impact of any given reform. A good idea might produce a 1 percentage point increase in growth for three years, or a 0.01 percentage point bump for three months. A lot of the belief that we can reform our way to sustained higher growth really boils down to faith and hope.
There are many cases where that faith and hope has turned out not to be justified. For example, there is the case of the ALEC rankings. ALEC is short for the American Legislative Exchange Council, a think tank comprised of state senators and representatives from a number of large corporations in industries such as energy and pharmaceuticals. They employ a number of economists, including Arthur Laffer, the famous proponent of supply-side economics.
Every year, ALEC produces a report called “Rich States, Poor States,” in which it ranks states according to how business-friendly their policies are. ALEC claims that the policies it advocates determine which states will grow and which won’t. From the report’s website:
Rich States, Poor States not only identifies these policies but also makes sound research-based conclusions about which states are poised to achieve greater economic prosperity and those that are stuck on the path to a lackluster economy.
Alec lists 15 factors that it claims boost state growth rates. These boil down to low taxes, low levels of government spending and light regulation. In other words, these policies are similar to the ideas John Cochrane describes, and that pro-free-market economists have been promising us will boost growth since time immemorial. It’s a simple prescription: shrink the state, cut taxes and the economy will grow.
But do the policies work? Empirical evidence suggests that they don’t deliver. Menzie Chinn, an economist at the University of Wisconsin, applied his formidable statistics skills to investigating the impact of ALEC’s rankings on actual state growth levels. What he found was startling — the ALEC rankings didn’t predict a state’s growth within one year, three years or six years. In other words, if having ALEC-endorsed policies makes a state grow faster, either it must take a very long time, or the effect is too small to measure.
In fact, when Chinn controls for a number of other variables, such as urbanization rates, weather and access to waterways, he finds that there may even be a negative relationship between the ALEC rankings and growth — in other words, states that ALEC claims have more business-friendly policies might actually grow more slowly!
Chinn isn’t the only one who has analyzed the ALEC rankings. The Iowa Policy Project, a smaller rival think tank, conducted its own analysis and reached the same conclusion as Chinn. They investigated ALEC’s factors individually, and found that none of them had much of a relationship to growth.
What about other measurements of business-friendly policy? These fare slightly better. In 2013, economists Jed Kolko, David Neumark and Marisol Mejia analyzed 10 different indexes of state business climate, and found that two factors did predict higher growth. These are 1) simpler corporate tax codes and 2) less spending on welfare and other transfer payments. But the effect of these policies on growth was very small.
which is that you can make grand claims about the effectiveness of your proposals but the reality may be quite different. This problem is not confined to one party or the other. We’re not going to grow our way out of the hole we’ve dug for ourselves by cutting taxes and shrinking government any more than we are by increasing the minimum wage or expanding Social Security.
Unfortunately, the reality is a lot harder than that. No incremental change will help much. No cluster of incremental changes will help much. We need serious structural change to get anywhere and nobody can really quantify what the impact of any given structural change might be. I may think that relying on fundamentals is the only way to go but it’s darned hard for me to prove that let alone tell you how much difference that might make. And there’s somebody else who believes just as fervently that he or she can manage his or her way to prosperity who’s in the same fix.
We could rely on consensus but nowadays there is precious little consensus. But over-heated differences of opinion we have a-plenty.
If only those self defeating businessmen knew of Sir Menzie’s negative correlations, they’d stop moving to Indiana.
Reinforced by the findings of the conservative stalwart, Neumarck. And, no, they wouldn’t stop moving. They would take home more money since they would pay less in taxes. The long term consequences won’t be considered.
Steve