Why Economic Growth is Slowing Down

 

The two main themes on this website, “It Does Not Add Up,” are that the U.S. national debt is too high and that our economy is growing too slowly.  How can we shrink the debt (as a percentage of GDP) and how can we make the economy grow faster?  I make use of all sources of information which shed light on these two fundamental issues.
CaptureToday I briefly discuss the work of the Northwestern University Economist Robert Gordon, summarized in his new book, “The Rise and Fall of American Growth.”  His basic thesis, see the above chart, is that human civilization experienced essentially no economic growth up until about 1700, then slow growth occurred mainly in the UK and US up until about 1870 followed by explosive growth mainly in the US up until about 1970.  Since 1970 growth has slowed way down except for a brief spurt from 1994 – 2004.
According to Mr. Gordon, these growth periods were caused by Industrial Revolution #1 (steam, railroads), IR #2 (electricity, internal combustion, modern plumbing, communications, petroleum), and IR #3 (computers, internet, mobile phones), all of which led to productivity growth spurts which have by now largely run their course. Not only are we out of industrial revolutions but there are, in addition, stiff headwinds working against economic growth.  For example:

  • The First Headwind: Rising Inequality. Downward pressure on the wages of the bottom 90%. Increased inequality at the top. Educational outcomes strongly correlated with socio-economic status.
  • The Second Headwind: Education. Stagnation in high school graduation rates and poor performance on international tests measuring achievement. High debt levels for college graduates.
  • The Third Headwind: Demography. The labor participation rate has dropped form 66.0% in 2007 to 62.6% today, only half caused by baby boomer retirements.
  • The Fourth Headwind: Repaying debt. The public debt, on which interest is paid, is now 74% of GDP and is predicted by the CBO to steadily increase. This will inevitably lead to either higher taxes or slower growth in future transfer payments.
  • The Fifth Headwind: Social deterioration at the bottom of the income distribution. Increasing number of children are born out of wedlock for high school graduates and dropouts, much higher for blacks than for whites. For mothers aged 40, the percentage of children living with both biological parents declined from 94% in 1960 to 34% in 2010.
  • Other Headwinds. Globalization and Global warming.

Mr. Gordon makes a voluminous case for the slowing down of economic growth, the basic reasons why this is happening, and the social forces which are making it worse. Next: How should public policy respond to this huge challenge?

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What’s Wrong With U.S. Manufacturing Policy

 

The Brookings Institution’s Martin Baily has an informative article, “what’s wrong with U.S. manufacturing policy,” in a recent issue of the Wall Street Journal.
Capture1Says Mr. Baily, “Of the 5.7 million manufacturing jobs that disappeared in the 2000s, only 870,000 have returned so far, according to the Bureau of Labor Statistics, and the claim that millions more are coming back is nothing more than a myth. … If the U.S. is serious about promoting a recovery in manufacturing, it will stop measuring success by the number of people employed in the sector and start supporting the technological advancements that are making factories more productive, competitive and innovative.”
CaptureAccording to Mr. Baily the technological shift taking place is powered by three developments:

  • The internet of things in which machines are able to communicate with each other.
  • Advanced manufacturing including 3-D printing, new materials and more accurate digital logistics.
  • Distributed innovation in which crowdsourcing is used to find solutions to technical challenges more quickly.

Such advances must be supported even if it means putting robots in place of workers.  It follows that:

  • there will still be good jobs in manufacturing for those with big data, programming and other specialized skills
  • a shortage of qualified workers means we want highly qualified immigrants to stay in the U.S. instead of returning to their home countries
  • propping up uncompetitive jobs with tax breaks and subsidies won’t work for long and just interferes with introducing a lower corporate tax rate to drive new investment
  • new trade agreements strengthen U.S. manufacturing by reducing foreign barriers to U.S. goods
  • Displaced workers Should be supported with retraining programs especially through community colleges
  • Government can further help with infrastructure improvements and expedited permitting processes.

Conclusion:  U.S. manufacturing will continue to thrive in a rapidly changing environment as long as it is properly supported with intelligent government policies.

Learning By Doing III. Limiting the Influence of Lobbyists

 

The eclectic entrepreneur/economist/law professor, James Bessen, suggests how to boost our stagnant economy in a new book, “Learning by Doing: the real connection between innovation, wages and wealth.” The idea is to make fuller use of new technology by putting more emphasis on practical vocational training, ending government favoritism for established businesses, and by removing regulatory roadblocks to job mobility and entrepreneurship.  He also thinks that the greatest hindrance to progress on these fronts is the influence of lobbyists and, more generally, “the growing role of money in politics.”
CaptureHow do we limit the ability of lobbyists, with their huge financial resources, to slow down the opening up of new technology to the broadest possible group of participants?  Some people would say this can only be done by curtailing the use of money in politics.  But this is virtually impossible.  Spending money to get your message out is really just a form of speech and the First Amendment to the Constitution says that “Congress shall make no law abridging the freedom of speech.”
Rather than trying to restrict the ways in which lobbyists can spend their money, we could alternatively try to immunize our elected representatives from its effect, in one or both of these two different ways:

  • Pass a Balanced Budget Amendment to the Constitution. Such an amendment would likely create the discipline needed for Congress to be able to set priorities and decide what is more or less important with regard to the overall economy. Spending programs, tax revenue, and the effects of regulation would all have to be considered together to maximize economic efficiency. Lobbyists would have far less power to push one particular program independently of how it relates to everything else.
  • Term Limits for national office. Knowing that one’s time in office is limited would help provide the strength to make the difficult tradeoffs necessary for good legislation and make officeholders more immune to special interest influence.

Conclusion:  Rather than making a likely futile attempt to reduce the amount of money in the political process, change the process sufficiently so that money doesn’t have as much influence!

“We’ve Got to Do Something about Income Inequality”

 

This is what I hear over and over again from my liberal-minded friends.  Their solution is to raise taxes on the rich and give to the poor.  This might help a little but not nearly enough.
The best way to help middle- and lower-income people is to give them more opportunities for self-advancement by providing more upward mobility in society.  Right now the middle class is being “hollowed out” as shown in the chart just below.
CaptureThere are three major reasons for this:

  • Economic Globalization which provides low cost goods from around the world and thus puts pressure on low- and semi-skilled workers in the U.S.
  • Rapid technological advancement which puts a higher premium on educational attainment and advanced skill acquisition.
  • Slow economic growth averaging only 2.3% since the end of the Great Recession in June 2009.

Globalization and technological advancement are strong worldwide forces likely to continue indefinitely.  We will simply have to adapt to them with long term strategies such as improved educational outcomes at all levels (early childhood, K-12 and post-secondary).  But speeding up economic growth is under our direct control with tried and true methods which are not being fully utilized at the present time. Such as:

  • Tax Reform. We should lower tax rates for individuals across the board, paid for by shrinking deductions for the wealthy. This will give middle- and lower-income workers, as well as new entrepreneurs, more money to spend, thereby boosting both supply and demand in the economy.
  • Increasing the Earned Income Tax Credit paid for by using some of the increased revenues from shrinking deductions for the wealthy. This would encourage more people to take and hold onto entry level jobs, thus boosting the economy by increasing the size of the workforce.

In other words, much can be done to reduce income inequality.  Redistribution of tax revenue is fine as long as it is done in a way which increases economic growth, rather than just punishing the rich.

“Manana Is Not a Credible Fiscal Plan”

 

Thus spoke George Osborne, Great Britain’s Chancellor of the Exchequer, in a recent speech to the Economic Club of New York.  “By applying a consistent and long-term economic plan, we can ensure that our best days lie ahead.  If we reduce our high debt so we can weather new shocks, and take the difficult decisions to make our economies more productive, we can provide rising living standards for our citizens.”
CaptureAccording to Mr. Osborne, any long term economic plan needs to include three elements:

  • An activist monetary policy to do whatever it takes to sustain sufficient demand in the economy.
  • A credible commitment to sustainable fiscal policy. Some have argued that fiscal consolidation is incompatible with economic recovery. But recent experience, e.g. sequestration in the U.S. and a balanced budget in the U.K., has shown the reverse.
  • An ambitious program of supply-side reform. The U.S. has a booming technology sector and the fracking revolution. The U.K. has cut its corporate tax rate to 20%, welcomes disruptive innovation and is pushing ahead on shale gas.

In the U.S. things are moving in the right direction and so the focus needs to be on keeping the momentum going.  Monetary stimulus has accomplished much but now a sound exit policy is needed.  Sequestration has slowed down the growth of government debt but has not ended it.  Further progress will require entitlement reform, especially for Medicare and Medicaid.  But first, the Affordable Care Act needs to be improved to do a better job of controlling the overall cost of healthcare.  Infrastructure improvement, tax reform and expanding trade are the supply side keys to increasing productivity and shared prosperity.
Activist monetary policy, credible fiscal policy, and ambitious supply side reform: these are the policies which will lead to future progress!

Raising America’s Pay

 

The Economic Policy Institute has just issued a provocative new report, “Raising America’s Pay: Why It’s Our Central Economic Policy Challenge”.  It is based on the now widely accepted view, as summarized in the chart below, that wages for the typical (i.e. median, not average) American worker have been stagnant since the early 1970’s, even though productivity has continued to increase at its historical rate.
CaptureFirst of all, the authors make reasonable arguments that:

  • The slumping of hourly wage growth for the vast majority explains the overall trends in income inequality.
  • Wage stagnation stalls progress in reducing poverty.
  • Wages are the root of economic security for the vast majority. This includes the fact that Social Security benefits depend upon wage earnings before retirement.

Then they ask: “Why has wage growth faltered for the vast majority, and what can be done?”  Here is where the report becomes controversial!

  • The authors do agree that globalization of markets and technological change have contributed to the wage growth slowdown but argue that this overlooks the impact of labor market and tax policy and business practices as follows:
  • Falling top tax rates have increased the income share of the top 1 percent.
  • The Federal Reserve has prioritized low rates of inflation over low rates of unemployment in recent decades and high unemployment suppresses wage growth.
  • The erosion of the inflation adjusted minimum wage and the share of the workforce represented by a union explain much of the entire rise of wage inequality over this time period.

The authors are completely correct that stagnant wages for American workers is a critical, even “central,” problem facing the economy at the present time.  The question, of course, is how to address this problem most effectively.  In my opinion, the authors have completely neglected to take into account how a faster rate of economic growth would contribute to a solution of the problem and how this could be accomplished.  I will address this question in my next post in a couple of days.
They conclude by saying that this report is only the first in a multiyear research and public education initiative of the EPI.  We have a lot to look forward to!

Is Capitalism in Crisis?

 

The economist and public lecturer, Richard Wolff, gave an address in Omaha NE last night, entitled “Capitalism in Crisis: How Lopsided Wealth Distribution Threatens Our Democracy”.  His thesis is that after 150 years, from 1820 – 1970, of steadily increasing worker productivity and matching wage gains, a structural change has taken place in our economy.  Since 1970 worker productivity has continued to increase at the same historical rate while the median wage level has been flat with no appreciable increase. This wage stagnation has been caused by an imbalance of supply and demand as follows:
Capture

  • Technology has eliminated lots of low skill and medium skill jobs in the U.S.
  • Globalization has made it less expensive for low skill jobs to be performed in the developing world at lower cost than in the U.S.
  • At the same time as jobs were being replaced by technology and disappearing overseas, millions of women entered the labor force.
  • A new wave of Hispanic immigration has caused even more competition for low skilled jobs.

In addition, stagnant wages for the low skilled and medium skilled worker have been accompanied by an increase in private debt through the advent of credit cards and subprime mortgage borrowing.  This enormous increase of consumer debt led to the housing bubble, its bursting in 2007-2008, and the resulting Great Recession.
Five years after the end of the recession in June 2009, we still have an enormous mess on our hands: a stagnant economy, high unemployment, massive and increasing debt and a fractious political process.  How in the world are we going to come together to address our perilous situation in a rational and timely manner?
Mr. Wolff believes that capitalism’s faults are too severe to be fixed with regulatory tweaks.  He also agrees that socialism has proven to be unsuccessful where it has been tried.  He proposes a new economic system of “Workers’ Self-Directed Enterprises” as an alternative.
I agree with Mr. Wolff that capitalism is in a crisis but I think that it can be repaired from within.  The challenge is to simultaneously give our economy a sufficient boost to put millions of people back to work and to do this while dramatically shrinking our annual deficits in order to get our massive debt on a downward trajectory as a percent of GDP. How to do this is the main focus of my blog, day in and day out!