US economy

A blip down the rabbit hole with Kevin Hassett

Two weeks ago Kevin Hassett, head of the President’s Council of Economic Advisers, said that by one measure, wages in the US were growing at four percent. This didn’t sound right, so we poked around and figured out that he had annualized a one-quarter growth number. One-quarter growth numbers are noisy, and so economists tend to look at percent change over a whole year for wages. We said as much, said we’d gotten in touch with Mr Hassett, and that we’d follow up when he responded. He’s responded.

Here’s why we can’t let this go: wage growth is the only way to figure out whether last year’s tax cuts worked. The only thing missing in America’s now nine-year recovery has been higher wages. After the bill passed, businesses were supposed to invest in new equipment, making workers more productive and raising their pay. The pay is the proof. Here’s the other reason we can’t let this go: arguing over a one-quarter change in wage growth isn’t really what you’d call “economics.” It’s what you might call “public economics.”

Academic economists argue fiercely but slowly. They challenge each other in peer-reviewed papers that take years to publish. They ask to share data sets. They question assumptions, which they call “priors.” Public economists respond quickly to new data. They are eager to explain it. And they are, above all, certain. Academic economics is a barely comprehensible argument that never ends. Public economics is a series of clear assertions that immediately evaporate.

Mr Hassett says that changes to the tax code represent what economists call a “treatment.” We have to measure what’s happened since the treatment, and since it hasn’t been a year yet, we can’t use the year-on-year numbers. His point is that since we only have the numbers from one quarter since the treatment, we go with the numbers from that quarter. (We now have numbers from the second quarter as well, on which more in a second.) Single-quarter numbers do bounce around, he concedes — they blip. But if you can explain the blip, he argues, then maybe it has meaning:

We have this… prior that we should see a movement. Suppose that we saw a movement of that size absent any other policy change. If I don’t have a prior that rationalizes that, it’s a blip. But if you have a coherent economic model that suggests you’re likely to see that, you should update your priors.

Olivier Blanchard says Mr Hassett’s logic is “impecabble, but hardly convincing.” Formerly the chief economist at the International Monetary Fund, he’s now at the Petersen Institute for International Economics. Asked about Mr Hassett’s approach, he restates it as a kind of Delphic poem:

You see a wage increase. It is either a blip or for real. If your prior is that the tax reform should lead to wage increases, then you see it as for real. If your prior is that the tax reform is unlikely to lead to wage increases, then you see it as a blip. So, we learn that Kevin thinks that the tax reform will lead to a major wage increase. Surprise…

Here are two measures of wage growth, averaged semiannually. This is not at all a normal way to look at anything, but fair enough, we’ve had exactly two quarters of data since the treatment, so:

With the second quarter of data, we can see that wages are growing at 3.2 percent since January. That’s faster than before. But it doesn’t look here like growth has broken free since the Tax Cuts and Jobs Act. Mr Hassett made some interesting points. As more people return to the workforce (he calls it a “stampede”), they’re returning to lower-wage jobs, skewing growth down. And the Atlanta Fed’s wage tracker, which measures raises for single workers to account for older, higher-wage workers retiring, does show that wage growth is rising faster for lower earners. (For higher earners, it’s dropping.)

But we also feel a bit like we’ve gotten trapped at the bottom of a rabbit hole with Mr Hassett. We were curious about a clear assertion of public economics: by one measure, wages are growing at four percent. We got into an academic discussion about it. But when we talked to some other economists, they all said the same thing. The problem is not that Mr Hassett is wrong, necessarily. It’s that we can’t possibly know yet whether tax cuts are driving wage growth, because not enough time has passed.

Here’s Alan Auerbach, professor at Berkeley and a well-respected tax economist:

I don’t think there’s any problem with arguing that we should look at what’s happened since the tax reform in order to estimate the effects of the tax reform. I think the basic problem is that we can’t be that confident based on one quarter’s growth figures what has happened to fundamentals, given how noisy such series are over the short term. I think we’ll need more time to tell.

Here’s David Autor from MIT, chronicler of the China shock to US labour:

If the tax cut genuinely caused wages to grow more rapidly, then we should see a sustained set of wage increases over a number of years. Drawing inferences based on what happens in just one quarter can be quite misleading… Declaring victory now is just cherry picking. The ECI data may reveal a positive long-term change in trend — which would be great — but it might not.

Every administration selects data that supports a certain model of how growth works. The difference with this White House, says Mr Blanchard, is that it’s “willing to take credit for outcomes which may be fleeting.” It pays off in the short run, he says, but not when an outcome becomes a blip. “They compensate for the risk,” he says, “by being willing to shift the focus away and towards the new good numbers.”

Academic economics is a slow, skeptical argument. Public economics is a series of confident statements. Every head of the Council of Economic Advisers, in every White House, necessarily participates in both disciplines. But we should not treat them as the same thing.

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