14 Points

From 1929 to 1930, the GDP growth rate was -8.62%. From 1930 to 1931, it was a somewhat less ominous -6.5%. If today’s economists and journalists were interpreting the release of this news in early 1932, papers may have printed headlines like this:

“In Hopeful Sign, Output Declines at a Slower Pace” or “Economy Turning Out of Steep Dive.”

These headlines are not from 1932 but from today’s print editions of the New York Times and Washington Post, respectively. By the way, GDP growth from 1932 to 1933 did not usher in the start of recovery; it was -13.1%, which is the worst year on record in the Bureau of Economic Analysis’s historic data.

If you saw the report that GDP in the second quarter of 2009 fell, you may be wondering how to reconcile negative GDP growth with such rosy pronouncements from the media, but if journalists themselves had the same question, their doubts were quickly put to rest, it would seem, from prominent economists. Who are these bulls, who insist that a positive change in the rate of decline is a sure sign that the worst is behind us? Christina Romer of the Council of Economic Advisors and chief economists from private investment firms offered quotes predicting recovery. One should note, however, that both parties have incentiveswhether political or financialto encourage recovery.

So, to be clear the news release from the Bureau of Economic Analysis, which is the agency responsible for calculating GDP, was that the economy continued to decline in the second quarter of 2009 (April through June). More precisely, when compared to the previous quarter, real GDP fell by another 0.26% (or an “annualized” 1% decline in the parlance of the BEA, which, for some queer reason, reports GDP percentage changes as “annualized rates.” This means that they take the real data and multiply it by 4, as if it happened for a year, even though it only happened for one fourth of a year).

Why was a decline in economic activity interpreted as sign that economic activity will soon start increasing? The answer is that the previous quarter-to-quarter growth rates were more negative. They were -1.7 and -1.4 for the first quarter of 2009 and the fourth quarter of 2008 respectively (multiply those by four to get the BEA figures).

The question is: does an increase in the rate of decline guarantee positive growth in the next quarter? Does it even increase the probability? The answer is no, but one can answer this question by doing the following simple experiment, which I did in Microsoft Excel:

• Download the BEA data (real GDP by quarter);
• Calculate the growth rate for each quarter and the change in the growth rate for each quarter (the growth rate this quarter - growth rate last quarter);
• Code the change in the growth rate as positive or negative (1=positive and 0=negative) and call it “Change-in- the-Growth-Rate Index;”
• Cut and paste the growth rate so that you match the next period’s growth rate with the index;
• Run a regression, where the growth rate of the next quarter is a function of the change in the growth rate index. ΔGDP_t+1 =  β*Index_t

What were the results of this exercise? There was no significant relationship between Change-in-the-Growth-Rate Index and the actual growth rate in the next period. More precisely, the 95% confidence interval was between -0.2% and 0.3%. We can be 95% confident that the actual effect of the previous period’s Change-in-the-Growth-Rate on the current growth rate falls within this range.

In non-economists prose, there is no reason to be optimistic about the BEA figures. There is nothing in our nation’s history, nor in economic theory, that justifies interpreting a slower decline in GDP as a sign of recovery. If there is room for optimism it is this: negative quarters of growth are quite rare in U.S. post-WWII history, and consecutive quarters of growth are rarer still. Usually, the U.S. economy grows, but the probability that it will grow or not has no relation to the change in the rate of growth in the previous period. In calculus terms, the second derivative does not predict the first derivative.

It would be nice if journalists, administration economists, and Wall Street economists would be clearer about interpreting the GDP data. If there are indeed signs of recovery in the data, such as trends in housing prices or some leading indicator, then great, but don’t tell us that a more positive change in the rate of change predicts that a growth increase is likely to follow.

On June 18^th, the NPR program On Point, hosted by Tom Ashbrook, had a very interesting episode on livable cities. He interviewed Tyler Brûlé of Monocle Magazine, whose research team issued a list of the top cities. The criteria are only available for subscribers, but Brûlé mentioned the homicide rate, environmental sustainability, quality health care, commuting patterns and other factors that add “friction” to urban life. Remarkably only one U.S. city came in the top 25: Honolulu. Ashbrook asked: why are U.S. cities so poorly rated? I believe the answer lies primarily in land use regulation.

U.S. cities are unique compared to their OECD counterparts in having highly concentrated poverty. The reason for this is that the U.S. gives more power to local governments to regulate land use. Anti-density zoning laws exacerbate economic and racial segregation, as I have shown with Doug Massey. Segregated cities have higher crime rates and lower measures of trust, which would depress livability measures. Moreover, anti-density zoning encourages sprawl by creating low density suburban enclaves as Rolf Pendall has shown. This leads to longer commute times.

So how did Honolulu get on the list? One guest on Tom Ashbrook’s show cited the influence of Japanese immigrants (roughly one fifth of the population). Another more rational explanation is that Hawaii has a uniquely centralized system of zoning laws. The reason is that it has no municipal governments. As far as I know it is the only state with this arrangement. In fact, the entire metropolitan area of Honolulu consists of one county which has sole regulatory authority over zoning, and a state level planning commission decides how land is classified. In New Jersey, there are 566 sub-county local governments with land use power. In short, legal institutions governing land use explain the mystery of Honolulu’s success and the relative failure of other U.S. cities to be more frictionless or otherwise pleasant places to live.

By J.T. Rothwell

In the period following World War II, the regions of East and South Asia were poor, un-industrialized, and mostly rural, with the exception of Japan. Today, the former Japanese colony of South Korea is thriving, as is the eastern region of China. Likewise, the former British colonies of Taiwan, Hong Kong, and Singapore have seen phenomenal increases in their living standards. Taking those five countries together in 1960, average real GDP per capita was a mere $444, using data from the Penn World Tables and the UN University’s World Income Distribution Data. A GDP per capita of $444 is extreme poverty, coming to just over $1 per person per day. In 2004, that average had soared to $22,000 or roughly $60 per person per day. This surge in prosperity was so impressive that it has been dubbed the East Asian “miracle.”

At the heart of the miracle really is something truly extraordinary: relative equality in income. Figure 1 shows a basic chart of initial income distributions (using the Gini Coefficient) and subsequent growth rates (from 1960 to 1990) for the major East Asian economies and a selection of a few other developing countries -namely South Africa, India, and Brazil. These other countries are generally considered success stories in their regions, and yet they had both less equality and weaker growth than the Tigers. Interestingly, even within East Asia, the tigers had much less inequality than unsuccessful Asian countries such as the Philippians.  Looking across regions, in the early 1970s, the Gini coefficients in East Asian countries were much lower than those in South America and Africa (38 or so compared to 50). The question is: why does equality enhance development?

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