04 November 2010

Matching Results With Government Policies

In a recent opinion post, an economist postulated that a divided government in Washington would be good for the US economy.

By "divided government", he meant a situation in which not all the three political institutions — the White House, the senate and the house of representatives — are in the hands of a single political party.

He supported his claim with some statistics drawn from the past four decades.

Firstly, median GDP expanded 3.3 per cent per year when there was divided government, compared with 3 per cent (presumably, this means 3.0 per cent) per year when there was unified government.

Secondly, median unemployment was 5.7 per cent when there was divided government, compared to 6.1 per cent when there was unified government.

Thirdly, the equity markets (measured by the S&P 500 index) increased at a median rate of 13.5 per cent per year when there was divided government and 9 per cent (again presumably, this means 9.0 per cent) per year when there was unified government.

Do the data support his claim?

It is not clear whether the data were statistically significant; that is, they did not happen by mere coincidence.

Assuming there is some acceptable degree of statistical correlation, which is the cause and which is the effect?

Most importantly, there is a considerable time lag between formulating a policy, guiding it through possibly almost unending debate in the House and the Senate, where the bill may meet lengthy or obstructive delays, and passing of the bill (the passage is considerably less tortuous in the British parliamentary system).  Once the bill becomes law, it may still be challenged in the courts or frustrated by the states.

After overcoming these hurdles, much time is needed before any policy can halt and then reverse the momentum of the adverse economic situation, not to mention producing discernible results, by which time the political scene in Washington may have changed.  Ironically, the politicians in the new government may get to enjoy the benefit of the policies when these bear fruit eventually, even if they had, while they were part of the previous government, opposed those same policies strenuously, but the electorate has a short memory.

For example, the Democrats inherited an economy that was already heading into trouble in 2007-2008 (during which time the government was divided), but the unified government of 2009-2010 was unable to introduce enough changes quickly enough to be able to point to the fruit of their efforts (preventing the unemployment rate from getting much worse was just not good enough) before the 2010 mid-term Congressional elections, and the party in power was duly punished.

As for the stock market, it often behaves rather irrationally.  It may reflect current conditions (the result of past government policies) and/or perceptions of future conditions (the result of current government policies, as well as, past government policies).  It may reflect interest rates and money supply, both of which are the purview of the US Federal Reserve, an entity that operates independently of the government.

The claim that a divided government in Washington will be good for the US economy may be valid, but the data are inadequate to prove the point.

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