Government’s role in the economy stirs great controversy. Does the government help or diminish prosperity? Does it mess up incentive in the marketplace or help align incentive with the well being of society? Does it feed the excesses that lead to recessions or throttle them and prolong expansions?

Ideology or even logic and reason by itself will not adequately answer these questions. A logical hypothetical can be constructed to support both true and false beliefs. Empirical analysis can get us to a meaningful answer.

As we look at the data below I hope you will approach it with a clinical mindset of what does the data actually say. If it doesn’t obviously support your current beliefs, confirmation bias might lead you to twist the perspective or conclude the data is less meaningful than it is. If you think you already know something you cut yourself off from the possibility of learning and growing. The power of the beatitude, “Blessed are the meek, for they shall inherit the earth.” comes into play. Humility enables one to move closer to truth. Pride leads to destruction or in our case the weakest forty year period of economic growth since 1939.

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In the chart above the strongest period of growth in US history was the fifty-three years from the New Deal to the 1986 Tax Reform. The actual growth rate per person was 3.18%, but the best fit rate of 2.63% probably gives a better perspective. If this growth trend had continued the economy would be producing about 50% more goods and services per person than it is now. Ask yourself would you like having about one and a half times as much income as you do now? Before the New Deal the economy was in recession about 46% of the time. Since the New Deal it has been in decline about 12% of the time.

I remember the first time I charted the recession dates in the 1990s and was shocked by the difference between pre and post New Deal. I was sharing the revelation with someone. She didn’t believe me and was sure that FDR had ruined the economy. At the time I didn’t have any estimates of what GDP had been before 1929, so I couldn’t be sure that FDR hadn’t diminished the long term growth rate. Now I know the growth rate per person jumped about 85%.

If you don’t account for population growth the period before the New Deal and between the New Deal and tax reform both grew at about 4% while the period since Tax reform trended at 2.5%. From 1790 to 1933 population multiplied about 32 times and the number of states went from 16 to 48. Since the New Deal, the population expanded 2.6 times and we added two states.

With the possible exception of the last year and a half I expect the period from the New Deal to the 1986 Tax Reform was the one with the most government involvement in the economy. When the 53 years with the most government involvement is the period with the fastest growth in prosperity it’s hard to rationally argue that the government is bad for the economy.

Obviously not everything politicians and bureaucrats do benefits prosperity. People disagree about which policies are good and bad, but the data makes a strong case that good government more than pays for itself in the creation of prosperity.

So what policies stabilized the economy and enabled a faster long term growth rate? I don’t have the ability to determine the net effect of most of the individual policies, but collectively they seem to have made a dramatic difference in avoiding downward trends and shortening the downward spiral where declines in different parts of the economy reinforced each other.

The New Deal added automatic stabilizers to the economy such as bank deposit insurance and unemployment compensation. When a downturn came it didn’t take an act of Congress to mitigate the effects. When a bank went under, people didn’t also lose all the money they had in a bank. If thousands lost their jobs unemployment compensation reduced the blow to demand and thousands more losing jobs.

There were two recessions in the Great Depression. The 43 month recession that led to the peak unemployment rate of 26% in 1933 also came with rapid deflation. This recession created conviction for heroic measures by the Federal Reserve to not allow deflation. Historically deflation appears to be three or four times harder on an economy than inflation. When the second recession started in 1937 there was hardly any deflation and the downturn only lasted 13 months. Unemployment, which had improved to 11% hit a high of 20%, but the drop in production of goods and services was modest compared to previous downturns.

In addition to stabilizers there were also laws that better aligned self interest with the common good. In a well run economy the people who end up with the most after tax wealth are the ones who have done the best job of satisfying the needs and wants of others. Leading up to the Depression there were a number of people who cleverly used the financial markets to build great wealth by taking advantage of others. The creation of the Securities and Exchange Commission along with the Investment Company Act and the Investment Advisors Act eliminated many of these shenanigans and better aligned the profit motive with the well being of people.

Understanding government’s vital role in creating prosperity is a prerequisite to restore healthy income growth for everyone.

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