This paper raises basic questions about the process of economic growth. It questions the assumption, nearly universal since Solow’s seminal contributions of the 1950s, 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. Rather, the paper suggests that the rapid progress made over the past 250 years could well turn out to be a unique episode in human history.
The paper is only about the United States and views the future from 2007 while pretending that the financial crisis did not happen. Its point of departure is growth in per-capita real GDP in the frontier country since 1300, the U.K. until 1906 and the U.S. afterwards. Growth in this frontier gradually accelerated after 1750, reached a peak in the middle of the 20th century, and has been slowing down since.
The paper is about “how much further could the frontier growth rate decline?” 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.
Even if innovation were to continue into the future at the rate of the two decades before 2007, the U.S. faces six headwinds that are in the process of dragging long-term growth to half or less of the 1.9 percent annual rate experienced between 1860 and 2007. These include demography, education, inequality, globalization, energy/environment, and the overhang of consumer and government debt. A provocative “exercise in subtraction” suggests that future growth in consumption per capita for the bottom 99 percent of the income distribution could fall below 0.5 percent per year for an extended period of decades.
This is a paper meant to provoke, as the author admits. I view this as sort of a Ghost of Christmas Yet To Come sort of thing — a possible future but not a predestined one. A warning. Here is why:
1. The U.S. is doing so many things wrong, policywise, that there is a huge upside from doing things right. Regulation, tax, education and entitlement reform could all boost growth. Heck, here is a whole list from McKinsey of stuff government could do:
1. Pay teachers more but get rid of tenure so the bottom five percent of teachers can be replaced by even average ones.
2. Encourage more high-skilled immigration.
3. Reduce regulatory barriers to new business creation.
4. Replace payroll taxes with more economically efficient ones.
5. Phase out and eliminate pricey and market-distorting subsidies like the mortgage interest deduction.
6. End Too Big To Fail.
7. Eliminate the tax code’s bias against investment.
8. Move toward market-friendly entitlement reform like Wyden-Ryan.
9. Create a patent system with the length of legal protection depending on the cost of innovation and imitation.
10. Establish more innovation prizes.
11. Have fewer kids in college getting liberal arts degrees, more in business-run worker training programs.
12. More investment in basic research, not in crony-capitalist, industrial policy schemes like Solyndra.
3. Am I to assume that there won’t be another incredible wave of innovation — genetics, robotics, nanotech, AI — over the rest of the century? I would bet there will be as long as entrepreneurs and innovators are rewarded and respected, and government does well the basic things it should: infrastructure, rule of law, defense, basic research. Another Industrial Revolution? There may be several, with the cycles accelerating.
4. As Asia and Africa catch up to the West (including Japan) economically, we will have billions of additional educated minds focusing on science and technology. It matters less where the innovation happens as long as societies are open to accepting those innovations and the creative destruction they bring. The more economic freedom the better.
Bottom Line: Low or no growth does not have to become the Permanent New Normal unless that is the path we actively or passively choose as Americans and as a global society in the 21st century. If nothing else, Gordon’s paper should serve to jolt us awake to that reality and the risk that confront us.