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Is the era of fast U.S. economic growth coming to an end?

Image Credit: Robert Gordon

Image Credit: Robert Gordon

Are the good times really over for good?

A provocative new paper from economist Robert Gordon, “Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six Headwinds,” makes just that case, or at least questions the assumption “that economic growth is a continuous process that will persist forever. There was virtually no growth before 1750, and thus there is no guarantee that growth will continue indefinitely …  the rapid progress made over the past 250 years could well turn out to be a unique episode in human history.”

Indeed, as the above chart shows, growth may be headed on trajectory back to the zero-growth (or super slow growth) era before the Industrial Revolution.:

Doubling the standard of living took five centuries between 1300 and 1800. Doubling accelerated to one century between 1800 and 1900. Doubling peaked at a mere 28 years between 1929 and 1957 and 31 years between 1957 and 1988. But then doubling is predicted to slow back to a century again between 2007 and 2100

Or to put it another way, per-capita real GDP growth could slow down to a rate of a mere 0.2 percent by 2100. That is roughly what it was for the 400 years before the Industrial Revolution.

The core of Gordon’s argument is that we’ve already picked the low-hanging fruit of innovation and new advances have provided less economic oomph:

The analysis links periods of slow and rapid growth to the timing of the three industrial revolutions (IR’s), that is, IR #1 (steam, railroads) from 1750 to 1830; IR #2 (electricity, internal combustion engine, running water, indoor toilets, communications, entertainment, chemicals, petroleum) from 1870 to 1900; and IR #3 (computers, the web, mobile phones) from 1960 to present.

It provides evidence that IR #2 was more important than the others and was largely responsible for 80 years of relatively rapid productivity growth between 1890 and 1972. Once the spin-off inventions from IR #2 (airplanes, air conditioning, interstate highways) had run their course, productivity growth during 1972-96 was much slower than before. In contrast, IR #3 created only a short-lived growth revival between 1996 and 2004.

Many of the original and spin-off inventions of IR #2 could happen only once – urbanization, transportation speed, the freedom of females from the drudgery of carrying tons of water per year, and the role of central heating and air conditioning in achieving a year-round constant temperature.

As the next chart shows, U.S. productivity has slowed:

But Gordon thinks just maintaining current levels of growth will be difficult for six reasons:

1. Demographics:

The “demographic dividend” is now in reverse motion. The original dividend was another one-time-only event, the movement of females into the labor force between 1965 and 1990, which raised hours per capita and allowed real per-capita real GDP to grow faster than output per hour. But now the baby-boomers are retiring, no longer included in the tally of total hours of work but still included in the population. Thus hours per capita are now declining, and any tendency for life expectancy to grow relative to the average retirement age will further augment this headwind. By definition, whenever hours per capita decline, then output per capita must grow more slowly than productivity.

2. Education:

The second headwind already taken into account in the 2007-27 forecast is the plateau in educational attainment in the U.S. reached more than 20 years ago, as highlighted in the path-breaking work of Claudia Golden and Lawrence Katz (2008). The U.S. is steadily slipping down the international league tables in the percentage of its population of a given age which has completed higher education. This combines several problems. One is the cost disease in higher education, that is, the rapid increase in the price of college tuition …  This cost inflation in turn leads to mounting student debt, which is increasingly distorting career choices and deterring low-income people from going to college at all. Not everybody gets a scholarship … . There is an ongoing achievement gap between whites and Asians on the one hand and Hispanics and Blacks on the other, while the Hispanic percentage of our nation’s schoolchildren keeps increasing, dragging down the national average. Making matters worse is a new and growing gap between the educational preparation and achievement of American girls and boys; the female share of college graduates is now up to 58 percent.

3. Inequality:

The growth in median real income has been substantially slower than all of these growth rates of average per-capita income discussed thus far. The Berkeley web site of Emmanuel Saez provides the startling figures. From 1993 to 2008, the average growth in real household income was 1.3 percent per year. But for the bottom 99% growth was only 0.75, a gap of 0.55 percent per year. The top one percent of the income distribution captured fully 52% of the income gains during that 15-year period. If what we care about when we talk about “consumer well being” is the bottom 99 percent, then we must deduct 0.55 percent from the average growth rates of real GDP per capita presented here and elsewhere.

 

4. Globalization:

Foreign inexpensive labor competes with American labor not just through outsourcing, but also through imports. And these imports combine lower wages in emerging nations with growing technological capabilities there.

 

5. Energy and the environment:

Part of any effort to cope with global warming represents a payback for past growth. In 1901 the environment was not a priority and the symbol of a prosperous city was a drawing of a factory spewing pure black smoke out of its chimneys. The consensus recommendation of economists to impose a carbon tax in order to push American gasoline prices up toward European levels will reduce the amount that households have left over to spend on everything else (unless it is fully rebated in lump-sum or other payments). India and China are both growing more rapidly than the U.S. and taken together those two nations are responsible for double the carbon emissions of the U.S.,but they resist suggestions that their growth to high-income status should be curtailed by energy restrictions, since today’s rich nations of North America, Europe, and Japan were not regulated in the same way during their 20th century period of high growth.

6. Debt:

Already in 2007 U.S. households suffered from an unprecedented overhang of debt equal to 133 percent of disposable income. The government debt was then manageable but has since begun to explode. Consumers have gradually been paying off debt, and this is one reason why the economic recovery has been so tepid. As a matter of arithmetic the ratio of government debt to GDP can be reduced by a mix of higher taxes, lower expenditures, and lower entitlement benefits (including higher retirement ages). But the same arithmetic implies that higher taxes and/or lower transfers

So what to do to avoid the Great Slowing? Gordon isn’t too optimistic:

Some of the headwinds contain a sense of inevitability. The most daunting is the interplay between globalization and modern technology, which accelerates the process of catching up of the emerging markets and the downward pressure on wages and real incomes in the advanced nations. …

There is also an inevitability to the subtraction from growth implied by headwind, the future repayment of consumer and government debt. U.S. consumption grew faster than real GDP over a long period, fueled by increasing consumer and government debt, a process that cannot continue forever. Over a substantial number of years in the future consumption must grow more slowly than production …

It is headwind (1), the demographic turnaround, that seems on the surface to be the most inevitable but is could potentially be counteracted. The retirement of the baby boomers causes hours per capita to decline and thus reduces growth of income per capita relative to productivity. A method to raise hours per capita is to increase the ratio of those of working age to those of retirement age. As a matter of arithmetic, this could be achieved by a more rapid inflow of immigration. One potential option would be unlimited immigration of high-skilled workers. As Steve Jobs is reported to have told Barack Obama shortly before he died, “we should staple a green card to the diploma of every foreign worker who attains a graduate degree in science or engineering.” For decades Canada has encouraged the immigration not only of skilled applicants but also those who are already rich and by so doing has transformed its culture from British colonial blandness to international world-class diversity.

I will have much more to say about the paper later — there is something in it for everyone — but its overall argument does sync with the Great Stagnation thesis of Tyler Cowen in that an innovation slowdown has led to a productivity slowdown and a growth slowdown. And of course what alarms me is that Washington is current pursuing a government-centric redistribution agenda rather than a market-centric innovation and growth agenda, which makes Gordon’s dire scenario all the more likely.

 

2 thoughts on “Is the era of fast U.S. economic growth coming to an end?

  1. Part of the problem with this and all such comparisons of growth rates of nearly everything (GDP, share prices, social problems) over different periods is that they are extremely sensitive to the choice of starting and ending points. Particularly problematic is the choice of dividing the period 1996 – 2004 from the subsequent period dominated by the worst economic contraction since the great Depression. Another problem is using only U.S. statistics as a proxy for the world. The extraordinary expansion of the very long period, 1891 – 1972 [why not subdivide this into 8-year segments as well? because this would tend to disprove the author's hypothesis that that the growth was steady over the period] was due first, to the relatively low base from which the United States, still predominantly an agrarian nation, and one emerging from the long depression of the 1870s – early 1890s, grew to become an urban, industrial one; and second, due to the fact that the rest of the world almost destroyed its productive capacity in World War II; for twenty-five years thereafter, the U.S. enjoyed the closest thing to an economic free lunch.

    Such surveys (one could hardly call them ‘studies’) also ignore the very real differences in output caused by innovations such as the improvement of roads and water communications over the 17th and 18th centuries, the implementation of crop rotation, etc. Because the base line is low by comparison with post-Industrial Revolution, the effects appear to be insignificant, but actually these led to very significant growth in population, despite the frequent pestilences which were still a feature of life in those pre public-sanitation days. Unfortunately, the data is very spotty and full of holes, so that aggressive estimates must be made to bridge the gaps in our knowledge. Still, these were real historical phenomena, and cannot be ignored if one is going to make the pessimistic assumption that the base line for economic growth of the human race is almost zero, even before one allows for changes in education, scientific knowledge and communication which are not likely to be reversed over any period as short as a century or two, unless there be a world-wide physical cataclysm of extreme proportions.

    It is also important to note that percentage changes do not take account of baseline levels of productivity or of absolute differences in prosperity. China is growing much faster than the United States, but the average Chinese still enjoys nothing like the level of material comfort of the average American. Comparisons even with Western Europe are fraught with difficulty in this area. Similarly, with education levels. It may be because our public schools are so dumbed-down that more schooling is an absolute necessity, but almost no other nation sends such a high proportion of its residents to universities, and unlike our primary and secondary schools, our universities score extremely well in international comparisons. That women are now doing better than men in school is only meaningful to overall productivity if women continue to have a lower work-force participation rate than men; there is evidence that this trend is continuing to shift, and may reverse itself. Finally, there is the question of market efficiency: if the U.S. has fallen into an economically self-destructive pattern, ultimately there will be a response. Either the centers of economic growth will shift to those countries where this pattern is less established, or the U.S. will begin to import more constructive practices from abroad. Certainly, internationally mobile capital will not remain where it is consistently earning a lower return than it could obtain elsewhere.

    Predicting long-term trends is almost as futile an exercise as determining those stocks most likely to outperform over the next decade, or what life will be like in fifty years. (Have you ever seen the future projections of the GE Pavilion from the 1939 World’s Fair? It has been recreated at Disney World.) If these trends the author identifies persist indefinitely, yes, growth will tail off. And if each successive July is hotter than this last, then the worst paranoid fears of Al Gore and his ilk will be realized in short order. But as I learned early on in my investment career, trees do not grow to the sky; neither do their roots reach down to the center of the Earth.

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