WHICH MIGHT BETTER BE CALLED IRRATIONAL EXPECTATIONS:

Chicago Economics on Trial: Nobel-winning economist Robert Lucas on the high cost of the welfare state, why he voted for Barack Obama, and how Milton Friedman changed his life. (HOLMAN W. JENKINS, JR., 11/05/11, WSJ)

Robert E. Lucas Jr., 74, didn't invent the idea or coin the term, but he did more than anyone to explore its ramifications for our model of the economy. Rational expectations is the idea that people look ahead and use their smarts to try to anticipate conditions in the future.

Duh, you say? When Mr. Lucas finally won the Nobel Prize in 1995, it was the economics profession that said duh. By then, nobody figured more prominently on the short list for the profession's ultimate honor. As Harvard economist Greg Mankiw later put it in the New York Times, "In academic circles, the most influential macroeconomist of the last quarter of the 20th century was Robert Lucas, of the University of Chicago."

Mr. Lucas is visiting NYU for a few days in early September to teach a mini-course, so I dash over to pick his brain. He obligingly tilts his computer screen toward me. Two things are on his mind and they're connected. One is the failure of the European and Japanese economies, after their brisk growth in the early postwar years, to catch up with the U.S. in per capita gross domestic product. The GDP gap, which once seemed destined to close, mysteriously stopped narrowing after about 1970.

The other issue on his mind is our own stumbling recovery from the 2008 recession.

For the best explanation of what happened in Europe and Japan, he points to research by fellow Nobelist Ed Prescott. In Europe, governments typically commandeer 50% of GDP. The burden to pay for all this largess falls on workers in the form of high marginal tax rates, and in particular on married women who might otherwise think of going to work as second earners in their households. "The welfare state is so expensive, it just breaks the link between work effort and what you get out of it, your living standard," says Mr. Lucas. "And it's really hurting them."

Turning to the U.S., he says, "A healthy economy that falls into recession has higher than average growth for a while and gets back to the old trend line. We haven't done that. I have plenty of suspicions but little evidence. I think people are concerned about high tax rates, about trying to stick business corporations with the failure of ObamaCare, which is going to emerge, the fact that it's not going to add up. But none of this has happened yet. You can't look at evidence. The taxes haven't really been raised yet."

Given the recent history of taxes as a percentage of GDP, it is fair to say that Mr. Lucas's "people" are imprisoned by a delusion.

Posted by oj at November 5, 2011 11:01 AM
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