John Taylor's Chart Gets Hammered by Justin Wolfers

I had a blog post just the other day about some charts drawn up by John Taylor. In those charts, he detailed the correlation between investment and employment since 1990. He also had another chart that showed when government increased spending, that unemployment tended to rise, though the correlation in this chart was not as strong. But then came Justin Wolfers on the Freakonomics blog to spoil the part.

In a blog post from March 30, Wolfers pointed out something very interesting. He asked the question, why did John Taylor use 1990 as his start point? In fact, if he went back to say 1970, what would the chart look like? Well, Wofers made just that chart.

Well whoops. Apparently investment and unemployment are not all too well correlated. Wolfers tries to explain this by saying:

On balance, times in which the investment share is higher, are slightly more likely to be good times. But I’m not sure why. Is it—as Taylor asserts—that high investment shares create good times? Or is it that good times encourage investment? Or is it a third factor—perhaps in good times the government doesn’t need to prime the fiscal pump, and so the investment share is higher? Or is it something else?

I am not sure that I entirely agree with his conclusion. To me, the fact that there is such a strong correlation since 1990 cannot just be disregarded as a fluke. And why the entirely different pattern between 1970 and 1990? Wolfers says that the sample size is too small, but is 20 years really too small of a sample size? Instead, I think that this graph indicates a change in the economy between those two time periods.

But still, here I sit wondering what that change could be. Stagflation has entered into my mind, and a breakdown showing the points during the 1980s separate from the 1970s would be nice. Still though, it is not as if any of this really matters, because these economic data are subject to so many variables that trying to isolate any one thing as the cause through correlation studies is impossible. Theoretically, we know that with higher investment would come less unemployment. However, if the government is furnishing that investment, they will not be as effective at investing in the short term (corruption, fat union contracts), and in the long term that investment will not even pay off leading to a sluggish economy comparatively (money was spent on a wasteful investment instead of a better one). So however the debate on this chart ends up does not really matter to me. Theoretically we already know the answer; empiricism is just the refuge of the illiterate economist.