Wednesday, April 9, 2008

Why American Families' Incomes Rise When Dems are in Office and Fall with the GOP

Why American Families' Incomes Rise When Dems are in Office and Fall with the GOP

By Kathy G

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Last week I posted Larry Bartels' instantly famous graph -- you know, the one that showed when Democrat presidents are in power, people on the bottom of the income scale experience larger real income gains than those on the top, while when Republicans are in power, the situation is reversed. It also showed that Democrat presidents are associated with higher income gains for all income groups.

Several observers questioned what causal mechanism could be behind these results. Today at Dani Rodrik's place, Bartels himself elaborates on what factors are driving these outcomes. The short answer? The parties' different approaches to macroeconomic policy, tax policy, social spending, business regulation, and the minimum wage:

Douglas Hibbs did important work along these lines in the 1980s, documenting significant partisan differences in post-war macroeconomic policies. He found that Democrats favored expansionary policies producing substantially higher employment and growth rates, while Republicans endured and sometimes prolonged recessions in order to keep inflation in check. (Not coincidentally, unemployment mostly affects income growth among relatively poor people, while inflation mostly affects income growth among relatively affluent people.) In recent decades taxes and transfers have probably been more important. Social spending. Business regulation or lack thereof. And don't forget the minimum wage. Over the past 60 years, the real value of the minimum wage has increased by 16 cents per year under Democratic presidents and declined by 6 cents per year under Republican presidents; that's a 3% difference in average income growth for minimum wage workers, with ramifications for many more workers higher up the wage scale.

This sounds right to me.

I've neglected to mention the impact of macroeconomic policies, mostly because I'm not as familiar with the research on that topic as I am with the research on unions, the minimum wage, and the like. But it is important and it's something I'll look at more closely.

Over at Marginal Revolution, Tyler Cowen attributes most of the effect to macroeconomic policies, since the impact is concentrated in the second year, and, he argues, that's where you'd see the effect of monetary policy but not the other policies.. He warns that that macro policies such as the ones Democrats favor come with a cost:

Inflation is good for the poor in the short run, since many poor are debtors. But inflation is bad for the poor in the long run. Just ask anyone who lived through the New Zealand inflation of the 1970s.

So Bartels could have entitled his key graph: "Democratic Presidents live for the short run and we need a Republican President every now and then."

He has a point, but I think there's room for the Fed to set interest rates that are considerably lower than they have been recently, without setting them so low as to stimulate intolerably high inflation rates.

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