Great Partisan Growth & Inequality Divides

Alan Blinder has a question for you:

Is History Siding With Obama’s Economic Plan?, by Alan S. Blinder, Economic View, NY Times: Clearly, there are major differences between the economic policies of Senators Barack Obama and John McCain. Mr. McCain wants more tax cuts for the rich; Mr. Obama wants tax cuts for the poor and middle class. The two men also disagree on health care, energy and many other topics. …

Many Americans … are [un]aware of two important facts about the post-World War II era, both of which are brilliantly delineated in … “Unequal Democracy,” by Larry M. Bartels…. Understanding them might help voters see what could be at stake, economically speaking, in November.

I call the first fact the Great Partisan Growth Divide. Simply put, the United States economy has grown faster, on average, under Democratic presidents than under Republicans.

The stark contrast between the whiz-bang Clinton years and the dreary Bush years is familiar because it is so recent. But while it is extreme, it is not atypical. Data for the whole period from 1948 to 2007, … show average annual growth of real gross national product of 1.64 percent per capita under Republican presidents versus 2.78 percent under Democrats.

That 1.14-point difference, if maintained for eight years, would yield 9.33 percent more income per person, which is a lot more than almost anyone can expect from a tax cut.

Such a large historical gap in economic performance between the two parties is rather surprising, because presidents have limited leverage over the nation’s economy. … But statistical regularities, like facts, are stubborn things. You bet against them at your peril.

The second big historical fact, which might be called the Great Partisan Inequality Divide, is the focus of Professor Bartels’s work.

It is well known that income inequality in the United States has been on the rise for about 30 years now… But Professor Bartels unearths a stunning statistical regularity: Over the entire 60-year period, income inequality trended substantially upward under Republican presidents but slightly downward under Democrats, thus accounting for the widening income gaps over all. …

The accompanying table, which is adapted from the book, … shows that when Democrats were in the White House, lower-income families experienced slightly faster income growth than higher-income families — which means that incomes were equalizing. In stark contrast, it also shows much faster income growth for the better-off when Republicans were in the White House — thus widening the gap in income.

The table also shows that families at the 95th percentile fared almost as well under Republican presidents as under Democrats (1.90 percent growth per year, versus 2.12 percent), giving them little stake, economically, in election outcomes. But the stakes were enormous for the less well-to-do. …

The sources of such large differences make for a slightly complicated story. In the early part of the period — say, the pre-Reagan years — the Great Partisan Growth Divide accounted for most of the Great Partisan Inequality divide, because the poor do relatively better in a high-growth economy. 

Beginning with the Reagan presidency, however, growth differences are smaller and tax and transfer policies have played a larger role. We know, for example, that Republicans have typically favored large tax cuts for upper-income groups while Democrats have opposed them. In addition, Democrats have been more willing to raise the minimum wage, and Republicans have been more hostile toward unions.

The two Great Partisan Divides combine to suggest that, if history is a guide, an Obama victory in November would lead to faster economic growth with less inequality, while a McCain victory would lead to slower economic growth with more inequality. Which part of the Obama menu don’t you like?

Here is a summary on this topic I did for the 2006 election in a WSJ econoblog with Justin Wolfers:

Mark Thoma writes: In the last 30 years, a considerable amount of work has been devoted to an area of economics known as "political business cycles." Researchers in this area look at the relationship between electoral outcomes — the outcome of elections and the economic policies of the party in power — and the subsequent performance of the economy. 

Broadly stated, there are two kinds of research on political business cycles. One type watches how the parties that win elections — or are in control — affect the performance of the economy. (For an overview of seminal work in this area see this paper by Allan Drazen. Also, see more recent papers here, here and here.)

The other class of research looks at the question from the opposite side. These researchers study how the performance of the economy helps decide which party wins an election. (For a good grounding in this type of work, see some important papers here and here.)

Here are some large research findings as summed up by Drazen:

• Inflation — In the U.S., there is evidence of a post-electoral increase in inflation prior to 1979, but no evidence thereafter.

• Monetary Policy — There is evidence of a pre-electoral increase in money growth rates from 1960 to 1980, but none thereafter. Money growth, or the percentage change in money supply, is an important measure of monetary policy prior to 1980, when the Fed started to focus on the federal-funds rate as the main monetary policy tool. There is no evidence for the U.S. of an electoral cycle in the federal-funds rate.

• Spending on Programs — There is evidence of pre-electoral increases in government transfers (such as food stamps, Social Security and other cash payments) and other fiscal policy spending. This appears strongest before 1980.

• Output — There is a clear partisan effect on economic activity, with real GDP being significantly higher under Democrats than Republicans in the first half of their terms. There is no significant pre-electoral increase in aggregate economic activity, meaning there is no evidence for pre-election manipulation of the economy.

Drazen also summarizes empirical work on the second kind of research, focusing on how the performance of the economy helps to determine who wins an election. Aggregate economic conditions before an election, specifically per capita output or income growth (and to a lesser extent inflation), have a significant effect on voting patterns.

A robust finding in the political business cycle literature is the last item on the first list, stating that output tends to be higher in the first half of Democratic administrations. If this is true, then it might be expected that the stock market performs better when Democrats are in power. Evidence in favor of this hypothesis comes from this 2003 paper by Pedro Santa-Clara and Rossen Valkanov, "The Presidential Puzzle: Political Cycles and the Stock Market." In the paper, the authors look at excess returns, i.e. returns over and above the returns on Treasury bills, using data from 1927 through 1998. Their estimates show that returns are, on average, 9% higher when Democrats are in power. (See this chart of returns by political party from University of California, Berkeley professor Hal Varian’s description of the paper). They note that much of the difference in returns arises from smaller firms performing much better under Democratic administrations.

Precisely why this is the case is difficult to answer. And the paper doesn’t come to any strong conclusions about the driving force behind the difference in returns. Nor does it explain why the difference persists, though it does rule out a few plausible reasons for these findings. Whatever the reason for the difference in returns, the evidence suggests that returns are distinctly higher under Democratic administrations. Therefore, if you are an investor, you may want to hope for the continued reemergence of the political left and for a Democrat to win the next presidential election. …