What Americans Think About Their Economy

A new poll of Bush's handling of Iraq is out, but the same poll asks Americans about their satisfaction with the economy, and that's what caught my eye. It always does. Americans are not happy with the state of their economy, which either means that they are insane or that the media is so negative that Americans do not realize how good they have it. It's definitely the latter.

The health of an economy is measured by such things as GDP growth, GDP per capita, unemployment, inflation, budget deficit and cumulative debt. Additional issues include income inequality (we aren't doing that well if only the rich are getting better off), the trade deficit, and the exchange rate for the dollar.

People need some perspective before forming an opinion about the economy, but they never get that from the news media. There are two kinds of perspective that are needed: perspective over time and perspective over place. That is, on all of these measures, how do the current numbers compare to prior years in which we were much happier with the state of economy? In addition, on each of these measures, how does the American economy stack up against the other major industrialized nations of the world (i.e., the G7)? Today, I'll focus yet again on perspective over time.

First, let's consider how unhappy we were with the economy in 2006 according to the results of multiple polls that were reported along with the new polling results:


On average, about 57% disapproved of Bush's handling of the economy, whereas only 42% or so approved. This is about where the numbers remain in the latest poll. Let's see if we can figure what the problem might be. To begin, let's look at GDP growth over the years, including 2006 (unless otherwise noted, all economic data can be found here):


In this chart, as in the charts to come, the Bush years are shown in red. Everyone agrees that GDP growth of less than 2% reflects an unhealthy economy. Over the last 3 years, GDP growth has exceeded 3%, which no one would consider to be anything other than excellent. The economy stumbled for a couple of years when the stock market bubble burst and we were attacked on 9/11 (that same bubble caused GDP growth to be unusually high in the late 1990s), but otherwise you can't really ask for much better. Per capita GDP has increased smartly during Bush's term as well.

What about inflation and the unemployment rate? Both look very good in the context of time:


It's possible that Americans just forget how bad these numbers can be (and also forget that they have almost never been better than they are now). Remember the "misery index?" It consists of the inflation rate added to the unemployment rate, and here are the average numbers for various presidents:


I suppose you could be furious that the misery index was ever so slightly lower in the 1950s and 1960s than it is now, but you should understand that it really does not get much better than it has been in recent years. Why, then, are you so miserable?

Perhaps our "record-setting" budget deficit is the problem. Every year, we spend several hundred billion more than we take in from taxes. And our gross debt is now a whopping 9 trillion dollars, a fact that is often lamented by those who believe that our economy is in terrible shape. Is that why we are so unhappy? I don't think so. Here are the relevant figures expressed as a percentage of GDP:


Yes, our annual deficit and our cumulative debt are huge when expressed in absolute terms, but that's only because our economy is huge. Expressed as a percentage of GDP (which is the only sensible way to look at it), the situation is pretty typical and getting better. With regard to the budget deficit, it turned into a surplus during the bubble economy years of the late 1990s. When the bubble burst, as it had to, GDP growth slowed and the deficit increased for a time. However, the economy has recovered smartly since then. In 2006, all statistics looked good (including the budget deficit, which is now below average for the last 30 years), but we were unhappy anyway. Perhaps we long for the bubble economy that we loved so much during the last few years of the Clinton administration. Bubbles are fun, but, by definition, they are not sustainable.

Income inequality. Is that it? No. The pre-tax and after-tax income data reported by the Tax Policy Center are complete through 2004 (you can find the data here). The next chart shows what after-tax incomes look like from 1979 to 2004:


The chart breaks the population down into fifths (or quintiles), and the numbers are in constant 2004 dollars to remove the effects of inflation. As you can see, the upper quintile (i.e., the top 20%) exhibits a clearly increasing trend over the years. That's the income inequality problem that you have heard so much about. The blue line marks the beginning of the Clinton years; the red line marks the beginning of the Bush years. The rich were doing very, very well under Clinton, and income inequality was skyrocketing on his watch (but it was not his fault). The bump in the road that you see for the top 20% at the start of the Bush administration occurred because the stock market bubble crashed at about the same time we were attacked on 9/11. Shortly thereafter, the incomes of the top 20% began to increase again. But the point is that the income inequality issue is not a Bush phenomenon. It's been going on for a long time. It's not why we are unhappy now.

Are only the top 20% doing better? It looks that way at first glance, but let's zero-in on after-tax income for the middle quintile (i.e., median income, essentially):


The Bush years are in red. Do you see a big problem here, one that should cause so many people to be unhappy with the state of our economy? I don't.

No one is sure why income inequality is increasing, and there is a debate about whether it is a real phenomenon or simply reflects where income is reported on tax forms. But the point is that the average person is getting better off and has never been so well off even if the rich are doing even better than that (as they have been for the last 20 years).

Perhaps we are unhappy because on the rich are getting all of the tax breaks? Let's take a look:


As you can see, the less you make, the higher the percentage of your earned income that you keep. The lowest 20% now keep 95% of what they make. The richest 20% keep only 75% or so. In other words, the tax code is progressive. Also, you can see that everyone benefited from the Bush tax cuts. The poorest 20% have never kept such a high percentage of what they earned. The second poorest quintile is also doing very well in this regard. Thus, increased income inequality is not occurring because of the Bush tax cuts no matter how much you want that to be true. If you doubt that, remember what incomes for the rich looked like during the Clinton years. The rich were more heavily taxed while he was in office, but their incomes skyrocketed anyway.

Perhaps the trade deficit is the culprit. Our trade deficit is large and growing, even when expressed as a percentage of GDP:


The trend started before Bush took office, and it is the result of globalization. It is a sign of a strong economy, not a weak economy, and you can put a stop to it only by erecting trade barriers (e.g., with China), which makes everyone worse off. Do you really want to do that? Moreover, unlike GDP growth, there is a debate about whether or not the trade imbalance is a bad thing:

Milton Friedman, the Nobel Prize-winning economist and father of Monetarism, argued that many of the fears of trade deficits are unfair criticisms in an attempt to push macroeconomic policies favorable to exporting[3] industries. He stated that these deficits are not harmful to the country as the currency always comes back to the country of origin in some form or another (country A sells to country B, country B sells to country C who buys from country A, but the trade deficit only includes A and B). In fact, in his view, the "worst case scenario" of the currency never returning to the country of origin was actually the best possible outcome: the country actually purchased its goods by exchanging them for pieces of cheaply-made paper. As Friedman put it, this would be the same result as if the exporting country burned the dollars it earned, never returning it to market circulation.
...
Friedman and other economists have also pointed out that a large trade deficit (importation of goods) signals that the country's currency is strong and desirable. To Friedman, a trade deficit simply meant that consumers had opportunity to purchase and enjoy more goods at lower prices; conversely, a trade surplus implied that a country was exporting goods its own citizens did not get to consume or enjoy, while paying high prices for the goods they actually received.

And here is a recent article showing that economic growth in America is better when the trade deficit increases compared to when it decreases. The article concludes with this:

But at the very least the data fail to show any discernable negative effect on economic growth from a rising trade deficit. Absent any real evidence, the standard assumption that trade deficits are a drag on growth should be re-examined before it is repeated again uncritically.

My point is not that Milton Friedman is right and the doomsayers are wrong. Instead, my point is that this issue is not clear cut (unlike, say, low GDP growth, high inflation, and high unemployment, which are obviously bad).

This same point applies to the weakening dollar. People instinctively want a "strong dollar," but it has been weakening against foreign currencies like the euro instead. Over the last 5 years, the value of the Euro has increased relative to the dollar, as shown in this chart:


The most important point to make here is that this is most definitely not an indication that European economies are doing better than the American economy -- not by a long shot (as I'll remind about yet again tomorrow). Instead, it is largely a reflection of higher interest rates in Europe, which are expected to increase even more relative to the rates in America. The strong euro is deeply lamented by many Europeans because it makes their exports too expensive for other countries. Don't believe me? Consider what Nicolas Sarkozy, who just elected as the president of France, had to say about this:

Sarkozy demands 'radical' policy shift

Nicolas Sarkozy, the front-runner in France's presidential race, has launched a ferocious attack on the European Central Bank and its president Jean-Claude Trichet, accusing Frankfurt of battling an inflation "that no longer exists" while Europe's export industry withers on the vine.

The Gaulliste candidate demanded a radical shift in policy to drive down the euro and match the devaluation tactics of the Asian powers.
...
Mr Sarkozy said, if elected, he would propose a plan to fellow EU leaders forcing a change in monetary policy to stop the "deindustrialisation of Europe". He said the ECB's strong euro policy was the overriding cause of woes threatening the survival of Airbus.

Again, like the trade imbalance, but unlike GDP growth and unemployment, it's just unclear whether it's good to have a weak dollar or a strong dollar. Not knowing that, the news media harps on these issues all the time, and that's most likely why Americans fail to appreciate the strength of their fabulous economy. Our economy is not only as good as it has ever been (unless you count the bubble economy years), it is better than any large economy on the planet (as I'll show again tomorrow). Perhaps that's not good enough for you, but, if not, you should consider having your head examined, because that's where the problem lies.