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such regulation is “killing frontier innovation.” Indeed, some have put forth the prevalence of poor government policies as one of the theories to explain the slow pace of this recovery. Poor Policies in Washington One of the theories that has been getting more traction recently attributes the slower recovery to poor policies enacted in Washington. In a June 2016 article about the US economy, Gregory Mankiw, professor at Harvard University and former chair of the Council of Economic Advisers for President George W. Bush, highlighted “policy missteps,” *? including misguided fiscal policy, as a possible contributor to the slow pace of growth since the global financial crisis. One unusual feature of this recovery has, in fact, been a contractionary fiscal policy. We have derived an approximate historical measure of fiscal policy changes by estimating changes in the cyclically adjusted federal budget as a percentage of GDP. We note that, by this measure, as far back as 1890, fiscal policy has been expansionary in all but three recoveries following a recession—with the fiscal policy in the current recovery being the most contractionary, as shown in Exhibit 16. In this recovery, the budget deficit as a share of GDP was reduced by 1.0% a year, compared to an average widening of the budget deficit by 1.3% a year in all other recoveries after severe recessions. The average increase in the size of the budget Two books published in 2016 and written by Swedes born in the early 1970s highlight the conflicting perspectives on productivity. Johan Norberg’s Progress cover used with permission of Johan Norberg and Oneworld Publications. All rights reserved. Fredrik Erixon and Bjorn Weigel’s The Innovation Illusion: How So Little ls Created by So Many Working So Hard cover used with permission of Fredrik Erixon, Bjorn Weigel and Yale University Press. All rights reserved. Exhibit 16: Change in US Budget Balance Following Recessions Fiscal policy has been an unusually large headwind to growth in this recovery. % of GDP 250 eseeee Average of All Expansions Average of All Expansions from Severe Recessions* 1.0 5 47 1894 1908 1921 1933 1938 1954 1958 1961 1970 1975 1982 1991 2001 2009 Year of Expansion Start Data through 2015. Note: Shows the change in the cyclically adjusted budget balance as a % of GDP for each episode. Source: Investment Strategy Group, Datastream, Global Financial Data. * We define “severe” recessions according to those identified by Carmen Reinhart and Kenneth Rogoff in “Recovery from Financial Crises: Evidence from 100 Episodes” (2014), as well as the 1937 recession (a continuation of the 1929 recession) and the two most severe post-WWII recessions (excluding the 2007 recession). deficit for all recoveries, including less severe ones, is -0.8%. A swing of 1.8 percentage points would have had a material impact on the pace of this recovery. Professor Alan Blinder of Princeton University and former vice chair at the Federal Reserve echoed the sentiment by stating that partisan politics have prevented progress in dealing with important economic issues.** Shambaugh has outlined various measures, such as infrastructure spending proposed by President Obama in his fiscal year 2017 budget, that would positively impact productivity and labor force participation. The budget was not approved. Summers has similarly called for expansionary fiscal policy through infrastructure spending, but such policies have not been pursued.** Increased regulation has also been blamed for some of the slow pace of this recovery. A September 2016 working paper by Martin Neil Baily and Nicholas Montalbano of the Brookings Institution on the slow growth of US productivity shows that while productivity in the most productive firms is growing rapidly, their best practices are not spreading to the rest of the players in a given industry.*” Exhibit 17 shows the widening gap between the productivity growth rates of firms at the frontier of innovation and 18 | Goldman Sachs | JANUARY 2017 HOUSE_OVERSIGHT_014551