Phillips, Laffer and Gatsby: on economists obsessing about curves

On Monday, if I make it through strikes, river floods, and tear gas, I’ll be taking a course on the Great Gatsby curve in Rennes. And as I scroll through articles on the topic, I’m struck by an air of déjà-vu. Though similar curves had been circulated by Miles Corak since 2006, the name was introduced by Alan Krueger, then chairman of the Council of Economic Advisers in a January 2012 address on inequality. Statistics, Krueger argued, show a negative relationship between inequality in the mid-1980s and intergenerational mobility across countries, one he called the “Great Gatsby Curve.”

Both the empirical existence and the theoretical foundations of the Gatsby curve have since been hotly debated within academia. It has been argued that no correlation, even less causation, existed across countries, nor across US local labor markets, that the relation disappears when other measures of mobility and inequality are used, and the examination of intertemporal relationships has yielded mixed results. The curve has also garnered public attention, with mentions in The Economist or by social mobility activists. Most prominently, Barack Obama, who had already argued that greater inequality would lead to lesser upward mobility in a 2011 address, used the research in a December 2013 speech on the economy. “In fact, statistics show not only that our levels of income inequality rank near countries like Jamaica and Argentina, but that it is harder today for a child born here in America to improve her station in life than it is for children in most of our wealthy allies,” he explained. However, some commentators opposed the use of such curve in the public debate. The Gatsby Curve is a “simplistic and distracting eye-catching bumper sticker,” they say, one that, in the wake of the Occupy 2011 movement, created a narrative that steers the country in a partisan and sterile redistribution debate.

PhillipscurveIt is much too early to see if the Great Gatsby curve is likely to live a life of its own in academia, policy spheres and public fora. But travelling curves are persistent phenomena in the history of economics. The Phillips curve, for instance, has become a kind of “myth.” Yet, James Forder explains, the story of the discovery of an inverse relationship between the unemployment rate and the rate of wage inflation in the UK by A.W. Phillips in 1958, its subsequent transformation by Samuelson and Solow, its use to back up inflationist policies in the 1960s, its 1970s relifting by Friedman and Phelps, all this is a total scam. The quantification of a wage-employment relation goes back to Irving Fisher in the 1920s. Samuelson and Solow had emphasized the risk that it would shift if used for policy-making. There never was a “missing equation” in postwar macro. No trace of the curve is found in the CEA reports before 1970. And the stagflation did not readily hoisted an “anticipation-augmented curve” or a “natural rate of unemployment” on the macro throne. At the onset of the 1970s, “the Philips Curve” became shorthand for “object of theoretical investigation” for macro theorists, just like “the Phillips curve has shifted” summarized a problem econometricians actively worked on. It is only in economic textbooks from the mid-1970s onward that the curve became an object with a distinct meaning, –the ‘tradeoff’–, and the mythical history above (why and how this stabilization occurred is a story yet to be told).

The journey of the Laffer curve also began with a famous tale. During a 1974 steak dinner with Dick Cheney and Don Rumsfeld, Chicago economist Arthur Laffer argued that too high a marginal tax rate was slowing economic growth, and, to make his point, grabbed a napkin and scribbled the famous bell curve. Four years later, the fourth guest, former Wall Street Journal editorial writer Jude Wanniski, popularized the curve in his supply-side economics tract, The Way the World Works.

Reconstruction of the Laffer’s napkin borrowed here

The foundation tale is about all what the Laffer curve had in common with its Phillips counterpart. While the latter was a visual representation of statistical evidence, later thought to reflect a mathematical relationship, the former was not a true curve, merely a visual, an insight, a promise that such empirical or theoretical relation might exist. And, as Yann Giraud relates in his history of the circulation and persistence of the Laffer Curve, its popularization and use in policy circles predated its academicization. The diagram was timely for those supply side Republicans who sense they needed more than the traditional discourse on cutting government spending, and early wielded it to claim that a tax cut would pay for itself and even permit more government spending in the future.

GardnercurveAcademic economists only began to address the Laffer curve after the Kemp-Roth tax cuts of 1978 and 1981 had failed to generate growth, to increase public deficits, and had resulted in the slashing of government spending. As other scientists and public intellectuals, such as Martin Gardner, increasingly mocked the whole profession for the ideas embodied in the Laffer curve, Don Fullerton and James Buchanan and Dwight Lee provided analytical models and estimations of the shape of the curve for various tax rates. None of them found that actual tax rates were high enough to discourage taxpayers from offering more factors. Economists then moved from testing the Laffer curve to studying the consequences of tax cuts (Feldstein vs Goolsbee), but by that time, Giraud notes, policy-makers had already made the curve asymmetrical, then largely relinquished it. It is unclear that academic proofs had any influence in that evolution.

Edit: see also Elisabeth Berman and Laura Milanes-Reyes’s quantitative survey of the uses of the Laffer Curve by Democrats vs Republicans at the US congress. They show that both  Democrats and and Republicans initially used the Laffer Curve as a “knowledge claim,” a theory of taxation to be debated with help of experts. Yet, after a period of transition, the Democrats came to use the Laffer Curve as “part of an ironic political narrative about failure of the Reagan administration.” Their paper illustrates how “politicization of knowledge” occurs, especially under political polarization (like today).

It will be interesting to see how the Great Gatsby curve, born at the frontier of academia and policy, will travel in the decades to come.

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4 Responses to Phillips, Laffer and Gatsby: on economists obsessing about curves

  1. “No trace of the [Phillips] curve is found in the CEA reports before 1970.”

    Interesting. Can you document that assertion? I’d like to read more.

    In Time magazine, 31 December 1965, there was an article on Keynes and the economic policy of the 1960s. No use of the word “Phillips” in it, but they do say:
    Labor Secretary Willard Wirtz argues that the Government should continue pushing and stimulating the economy, even at the risk of some inflation, in order to bring unemployment down to 3%.
    So they were clearly aware of the trade-off.

    • jamesforder says:

      Perhaps I can help with that. The point I believe Beatrice is making is that before 1970 ‘the Phillips curve’ – that idea, that name – do not feature in the Reports of the CEA or many other places where it might be expected. That is important because the historical story I was criticising and correcting says that the curve was a discovery made by Phillips in 1958, that it was immediately taken up by policymakers as offering a policy menu, and this led to the acceptance of inflation. One point of my criticism is that there is desperately little reference to the work of Phillips in the policy literature in the 1960s, so the part about immediate acceptance is not true. Indeed, if the whole story were true, all through that decade, the CEA should be telling us which point on the curve they wanted to hit. Not only do they not do that, they never even mention the curve.

      As to ‘the trade off’ more generally, there is an important distinction to be made between recognizing that lowering unemployment creates a danger of inflation, as indicated in the Wirtz quotation, and the idea that there is a sustainable menu of options available to policymakers. Understanding of the existence of a policy conflict was indeed under constant discussion in the 1960s. But it is under constant discussion all through the 1950s as well (and much of the 1940s), and so owes nothing to Phillips. On the other hand the treatment of that problem as a menu is a very different thing. That raises various issues of interpretation, which I have considered in Macroeconomics and the Phillips curve myth. An illustration of the kind of issue comes from Wirtz putting the point in terms of a ‘risk’ of inflation – that, probably, is a proposal to test the feasible limits of expansion rather than actually to accept inflation on an ongoing basis. Policymakers who were prepared to accept inflation, on the basis of the Phillips curve, any related idea, or any other idea, were a very rare thing in the 1960s and 1970s – as I hope my book shows.

      • Thank you, Mr. Forder. Seems like you really have your ducks in a row on this. That Wirtz quote, I can easily read it as “even at the risk of some sustained inflation”. But Wirtz didn’t actually use the word “sustained”. Perhaps I am deceived by the Phillips curve myth. Thanks again.

  2. Pingback: Phillips, Laffer and Gatsby: on economists obsessing about curves via /r/economy | Chet Wang

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