Michael Novak's Shoddy Economic Analysis

Over at the First Things blog, Michael Novak has written a detailed post against what he sees as persistent criticism of the "American economic system" (is there any real doubt where his allegiances truly lie?). He wants to hone in on such criticisms using "the fires of critical thought". Except than when he gets down to his actually arguments, he shies away from critical thought and instead relies on ideologically-tinged obfuscation.

I wish to deal only with one point he made. He criticizes the assertion that income inequality is growing in the US, with the rich getting richer and the poor getting poorer. To make his point, he cites the result of a recent study by the Congressional Budget Office (CBO), analyzing the income growth of low income households with children over the past 15 years. One result of this study is that the income of the bottom 20 percent increased dramatically from 1991-2005. Novak concludes: "This is, of course, because the welfare reform act brought millions in the bottom quintile back into paying jobs. This seems to me like a good, Christian thing to do."

Novak seems to take his cue from the notorious Wall Street Journal editorial page, which jumped on the findings as a change to mock the "class envy" peddled by John Edwards and others. But there is a problem. This CBO study was commissioned by Republican Judd Gregg, and the choices of start and end dates were somewhat auspicious. 1991 was a year of deep recession, and 2005 was a boom. So, as noted by TNR's Jon Chait, if you start in a recession and end in a boom, then you expect incomes to be rising. Incomes of the poor, and of everybody else, always rise and fall with business cycles.

In fact, if you look at the data, you will see an interesting pattern. While the real income of the lowest quintile of households with children rose by 35 percent from 1991-2005, this increase was concentrated in the 1990s. In other words, real incomes of the poor rose by 51 percent from 1991-2000, and actually fell by 11 percent from 2000-05. To put it crudely, the poor got richer under Clinton, and poorer under Bush. If Novak is truly concerned with "critical thought", be would be touting the accomplishments of Bill Clinton, and deriding the economic performance under Bush!!

But of course, it is not that simple. It is actually really hard to disentangle the effects of policy and the economy on these changing patterns. Strong economic growth in the 1990s was the proximate cause. Clinton's sound budget-balancing policies certainly laid the groundwork for this boom, but it would be facetious to credit him with the IT-related expansion. But a remarkable fact about this period is that the rising tide really did lift all boats. In terms of policies, Novak mentions only welfare reform. This is somewhat disingenuous, as the CBO report describes three key changes: (i) welfare reform, requiring participation in activities as a precondition for cash benefits; (ii) a large expansion in in-work benefits, through the earned income tax credit; and (iii) an expansion in children's health insurance. Contrast this with the Bush years, when the income of the bottom 20 percent dropped precipitously. Of course, the administration cannot be blamed for the 2001 recession, but a valid question is whether the income of the poor have reached where they were at the peak of the last cycle. And the answer is no.

Novak is on even shakier ground when he discusses changes in middle-class incomes. Here's what he says:

"Incidentally, the middle class also gained significant ground between 1992 and 2005, in large part under President Clinton but going even higher under President Bush. The median family with children earned $8,500 more in purchasing power (after inflation) in 2005 than in 1990. Put another way, the level of income of the bottom half of the population moved much higher in about fifteen years. The steady progress of the middle-class family, as well as of the poor household, is also a good outcome, is it not?"

There are so many errors in this statement, I don't know where to start. Again, he is doing his "bottom of cycle to top of cycle" comparison, which makes no sense. Yet again, the real income of the middle quintile rose under the Clinton administration, and fell under Bush. But let's look a little deeper into median real income growth, based on Census data, as this reflects the true economic welfare of the middle class. During the Clinton years, between 1992-99, real median income rose by 14 percent. In contrast, it fell by 3 percent from 2000-05, and each year saw another decline until 2005.

Let's look deeper into the recent period, 2000-05. This was by no means a recessionary episode; the real economy expanded by 12 percent over this period, and productivity rose by 17 percent. What's going on here? Basically, the middle class stopped participating in the economic expansion. Workers are working harder, and are more productive, but their pay and living standards stagnate. Meanwhile, corporate profits soared. According to research by Robert Gordon and Ian Dew-Becker, the productivity gains went to the top 10 percent. This lies in stark contrast to the 1990s, where the large productivity gains (related in part to the IT boom) were shared more broadly.

Note that the rising inequality is a long-term phenomenon. The top hundredth of the US population had an 8 percent income share in 1980, and this rose to 16 per cent by 2004. The 1990s boom did not reverse this long-term trend, but it smoothed out some of its negative consequences by lifting all boats. Economists still don't fully understand the underlying dynamics. While, as noted by Jon Chait, Clinton's fiscal responsibility combined with downward redistribution stands in stark contrast in Bush's fiscal irresponsibility combined with upward redistribution, the patterns in pre-tax income are too stark for fiscal policy to play much of a role. Economists posit a number of explanations for these longer-term trends. First, there is "skill-biased technical change" or the idea that new technologies place a huge premium on brain over brawn. But there are problems with this hypothesis. Europe faced the same technology shock, but did not see a huge rise in inequality. Moreover, wages of engineers and computer scientists did not grow as would be expected. But CEO compensation doubled.

What are some other explanations? Well, first, globalization has changed the balance of power between labor and capital. Second, the continuous pattern of de-unionization has left workers adrift, as profits are not shared. Third, the stagnating minimum wage has reduced purchasing power at the bottom.

These are all big issues, deep issues, worthy of debate. But you would not notice any of this from Novak's little pro-capitalism rave. The mission statement of First Things is to forward a "religiously informed public philosophy for the ordering of society." How does peddling pro-rich policies, ignoring the real problems of the middle class, making facts subservient to ideology, and deliberately obfuscating the data achieve this goal?