Unemployment: Lessons of history
By Richard K. Vedder and Lowell E. Gallaway
If we ask the question, “Are there lessons to be learned from history?,” the likely answer is, “Yes.” On the other hand, if we inquire, “Do we learn from the patterns of history?,” the probable answer, regrettably, is, “No.”
To illustrate this cognitive dissonance, all we need do is explore the history of the last two major business cycle downturns in America, that beginning in the third quarter of 1981 (National Bureau of Economic Research dating) and the present episode, which the NBER dates as commencing in the fourth quarter of 2007.
The NBER fixes the trough of the first cycle as occurring in the fourth quarter of 1982. At that time, the political environment in Washington was one of divided power, Republicans controlling the White House and holding a slim majority in the Senate, while the Democrats had a healthy majority in the House of Representatives. Put bluntly, bipartisanship was not the order of the day.
In a hearing immediately following the announcement that the unemployment rate had risen to double digit levels, the Chairman of the Joint Economic Committee of Congress, Henry Reuss, a Democrat, described the early years of Ronald Reagan’s Presidency as follows: “Collectively, we scurried to the bidding of the economic royalists, the supply-side ideologues, the special interest lobbyists and the self-appointed arbiters of morality who spoke in its name. Fear muddled our judgment and poisoned our debate. It drove the weak and susceptible among us to espouse strange and indefensible economic ideas. And it drove a majority among us to adopt the most reprehensible tax and spending changes of my public career.”
The policy issues of the time were simple enough. The Reagan administration felt that the 1981 tax reductions would be sufficient to produce recovery. Its stance was to “stay the course.” From the other side of the political spectrum came proposals for emergency public works programs, repeal of the 10 percent cut in income taxes that was scheduled to go into effect in 1983, and more rapid growth in the money supply.
In the event, Reagan and his people held their ground and, in January 1983, the unemployment rate began to decline. From the beginning of the cycle downturn, the unemployment rate ran up from 7.4 percent to a peak of 10.6 percent in the fourth quarter of 1982.
Six quarters later, unemployment stood at 8.5 percent. Almost two-thirds of the cyclical increase in unemployment had been eliminated by pursuing the Reagan administration’s policy of “staying the course.”
Even more dramatic was the pattern of growth in real gross domestic product following the cycle trough. In the next six quarters, annualized real GDP growth rates ranged between a low of 5.1 percent and a high of 9.3 percent.
Fast forward to the fourth quarter of 2007, which the NBER designates as a cycle peak. At this juncture, the unemployment rate is reported to be 4.8 percent. It then commences to rise. Six quarters later, in the second quarter of 2009, it stands at 9.3 percent. This is exactly the point that the NBER recognizes as the trough of this cycle.
At the opening of this scenario, the political climate in the nation’s capital was similar to that of 1981. A Republican administration that had enacted a significant tax reduction was in power and it was confronted by a Democratic Congress that had expressed its antipathy toward the tax legislation. However, by the time the cycle trough had been reached, things had changed. Both the White House and the Congress were in the hands of the Democrats.
The change in political fortunes led to a policy response that differed significantly from that of 1982. In the lame duck portion of George Bush’s Presidency, a small stimulus spending package was approved and, once Barack Obama took office, a massive ($876 billion) spending bill was approved.
Obama’s Chair of the Council of Economic Advisers, Christine Romer, assured the nation that this would keep unemployment below 8 percent. Combined with a substantial monetary easing by the Federal Reserve, the end result was the same policy approach advocated by Democrats in late 1982, which had been rejected by Ronald Reagan.
This policy initiative was in place prior to the NBER trough, giving it an excellent chance of succeeding. However, subsequent to mid-2009, the unemployment rate continued to rise. In the fourth quarter of 2009, it reached 10.0 percent. Unemployment moderated somewhat in 2010, but still was 9.6 percent in the fourth quarter.
This was six quarters beyond the cycle trough and the unemployment rate is higher than it was at the bottom of the cycle.
What about the pattern of GDP growth? The story here is a grim one. Over those same six quarters, the best single quarter annualized growth rate is 3.7 in the first quarter of 2010 and the worst is a 2.6 percent decline in the fourth quarter of 2009. For the entire six-quarter interval, the average annualized GDP growth rate is 1.6 percent.
These two episodes are revealing. In a sense, they provide a controlled experiment that evaluates the efficacy of emergency spending initiatives by the federal government.
In the first case, 1981-1984, such an approach is eschewed. The result is a marked reduction in unemployment and an extremely robust surge in GDP.
In the second episode, though, the emergency spending approach is invoked and both the unemployment rate and the rate of growth in GDP are largely unresponsive.
What does this tell us about the lessons of history? For one thing, it suggests that little was learned from the experience of the early l980s. When confronted with a similar situation in 2009, the makers of public policy ignored the evidence from the earlier time to pursue a policy agenda that had been rejected expressly at that time.
The results of that decision have been near disastrous. Hopefully, something will be learned from this.
[Richard K. Vedder and Lowell E. Gallaway are Senior Fellow and Research Fellow respectively at the Independent Institute (www.independent.org), Distinguished Professors of Economics at Ohio University, and co-authors of the book “Out of Work: Unemployment Government in Twentieth-Century America.”]