Great Stagnation or Big Shift? The Answer Matters

A new book by my old friend Tyler Cowen, The Great Stagnation, has taken the media by storm, leading Business Week to proclaim Tyler as “America’s hottest economist”, even though his book was initially published only as an e-book.  This is an important book because it pulls us beyond the short-term quarterly, monthly or even daily horizons that consume the attention of so much of our media pundits and analysts. It invites us to take a longer-term view of the changes that are re-shaping our economy and our society. The book is thought-provoking, well-written and concise but also profoundly misleading on a number of key points.  One might even suggest that it is dangerous, for reasons developed below.

Even though this book came out earlier this year (ages ago in Internet time), it is timely to revisit it on Labor Day when people are reflecting on gloomy charts like this.  It is precisely this kind of trend that lends so much credence to propositions of a Great Stagnation.

In essence, Tyler suggests that the US has been in a period of prolonged stagnation that began roughly in the early 1970s and shows no signs of receding in the foreseeable future – it is, for all intents and purposes, “the new normal.” Why did we enter this period of stagnation? The short answerTyler offers is that we ran out of three different kinds of “low hanging fruit”: free land, technological breakthroughs and smart, uneducated kids. 

Having diagnosed the problem, Tyler offers little in the way of a solution, other than a vague suggestion that we should improve the social status of scientists and “be ready when more low-hanging fruit actually arrives . . .”

Tyler’s book raises several important questions:

• Are we in a Great Stagnation?

• If so, what are the causes of the Great Stagnation?

• If so, what are the implications of the Great Stagnation?

Let's take a look at each of these questions in sequence.

Are we in a Great Stagnation?

To answer this question, we need to first decide on the metrics to use. Tyler focuses on an interesting metric – median family income. By the way, one of the best parts of Tyler’s book is the chapter in which he shows the extent to which the metrics for productivity and GDP are fundamentally distorted by the way government activity, health care and education are measured, systematically overestimating both quality and results. These sectors account for more than 25% of US GDP and also are three of the most rapidly growing sectors in the economy. As Tyler observes:

At the very least, we don’t know what results we have achieved, and that’s scary.  The future of our economy is hitched to sectors that are not well geared to produce clear results and measurable value.

But back to the metric that matters for Tyler. He shows that growth in median family income in constant dollars began to slow down in the early 1970s after a period of significant growth from 1945 on. The growth rate slowed, but there was still growth in this metric – median family income grew by 22% in constant dollars over the 31 year period from 1973 to 2004. It's important to note that Tyler chose as the benchmark the period from 1945 – 1973, the period immediately following World War II when the US population emerged from a period of great deprivation required for the the war effort and began to enjoy the fruits of a shift back to a civilian economy.

He picked this metric because “it is the single best measure of how much we are producing new ideas that benefit most of the American population.”  This is a puzzling statement.  The metric focuses only on the cash income benefit of new ideas, certainly an important dimension of benefit, but not the only one.

The period from 1973 to today has provided extraordinary benefit to all of us as consumers.  Across a broad spectrum of products and services, we have seen a proliferation of choices available to the consumer who now can obtain far more value at far lower prices, driven both by globalization and the advent of digital technology.

In just one example cited by Ronald Bailey in his review of Tyler’s book, the refrigerator so cavalierly dismissed by Tyler in 1970 cost nearly twice what it does today in constant dollar terms and offers an array of functionality like frost free refrigeration and ice trays that were simply not generally available in the early 1970s. (For those interested, Donald Boudreaux has a fascinating comparison between a Sears catalog in 1975 and today and Steve Horwitz weighs in with another analysis.)

Certainly this compensates in part for a slower growth in median family income – we get more choice (Tyler, think of proliferation of ethnic restaurants) and more value for less money while income is still growing. Tyler rightly points out that this improvement in value for price was also at work during the entire postwar period but unfortunately there is no metric to conveniently and accurately capture the magnitude of this improvement in either period.

So, the question of whether there is a “Great Stagnation” hinges in part on a debate over metrics. Is median household income the best measure of economic progress? Even if we accept this measure, the term “stagnation” appears to overstate the case – there still has been significant progress over the past 30 years when the term stagnation implies no growth at all.  A thought experiment proposed by Arnold Kling suggests why stagnation overstates the case: if you were offered a choice between receiving a 1973 income and goods and services available at that time or receiving a current income and goods and services available now, which would you choose?

This debate suggests that Don Boudreaux may be right when he asserts that “what has stagnated isn’t the economy but, rather, economists’ and statisticians’ capacity to measure economic activity and its contribution to human well-being.”

What are the causes of the Great Stagnation?

For the sake of argument, let’s grant that we are in a period of Great Stagnation.  What are its causes? Tyler strongly argues that the causes – disappearance of “low hanging fruit” – are deeply embedded in demographics and science and are not likely to go away.  The future is dim – he urges us to think of this as “the new normal.”  Well, then again, maybe it’s not so dim.  Tyler tends to waffle a bit here, leaving open the possibility that we might soon encounter some new forms of “low hanging fruit” – he says we need to be ready for it when it arrives.

Tyler is a bit slippery when trying to establish causation for the three categories of “low hanging fruit.” For example, “free land” might have been a significant factor in driving economic growth of the US in the 19th century but certainly paled into insignificance by 1945, so it has little to do in explaining the growth of median family income either during the “boom years” from 1945 – 1973 or the “stagnation years” from 1973 to 2004. (For a more detailed critique of the three low hanging fruits, see David Henderson’s review - pdf, scroll down.)

As a general principle, we should be careful about arguments for stagnation.  As Brink Lindsey points out, we have faced such warnings throughout time, recently ranging from the “secular stagnationists” led by Alvin Hansen in the 1930s to the Club of Rome’s warnings about “limits to growth” in the 1970s.

Perhaps there might be other causes of the slower growth in median family income, causes that are far less deeply embedded in demographics and science as Tyler suggests. I have written about the “Big Shift” in The Power of Pull and quantified key dimensions of this transition in the Shift Index.

In brief, this perspective suggests that the causes of mounting performance pressure in our economy, both at the individual level and the institutional level, stem from the emergence of digital technology infrastructures that require a re-thinking of our institutions and practices.  Not surprisingly, this digital infrastructure really began to take hold in the early 1970s with the advent of the microprocessor and digital networks.

In this context, I would argue that we are facing a growing mismatch between push-based institutions and practices that emerged during our last great infrastructural shift in the late 19th and early 20th century (think railroads, electrical power and telephones) and the pull-based world taking shape around us.

What is the consequence of this mismatch?  Well, as consumers we all benefit because we do receive far more value at lower cost.  Research in the Shift Index showed that “creative talent” (even though I despise the term) received significantly higher cash compensation during the Great Stagnation years – so they also are benefiting because of growing bargaining power.  Who loses? Well, the rest of the workforce. Under increasing pressure, companies are scrambling to automate and squeeze more out of the remaining workers while keeping a tight rein on their salaries – hence the slowdown in median household income growth.

For those who are concerned that we have entered into a long-term stagnation driven by intrinsic forces, it helps to take an even longer-term view than Tyler does.  For this, we might re-visit  Ray Kurzweil’s amazing chart that take us back to the beginning of human time and show the improvements that we have seen unfold exponentially over millennia, not just a few decades.

What are the implications of the Great Stagnation?

So, why does all of this matter?  Here is where I fear that Tyler’s perspective is dangerous.  If we buy his argument that we are in a Great Stagnation and that the causes are deeply embedded in science and demographics, we must accept the inevitable – lower growth for an indefinite future.  There is nothing we can do. Tyler even admits so much at the end of his book, offering a weak recommendation of increasing the status of scientists. Instead, he urges us to learn from the Japanese example of how they handled their slow growth economy of the past 25 years, focusing on small quality improvements, like improved French pastries and automatic umbrella wrappers at the entrance to stores (I kid you not, p. 87).

Some of my libertarian friends like Peter Boettke have actually argued that Tyler has written a book subversive of the liberal establishment.  The logic is that, if we accept that we are in a much slower growth economy for the foreseeable future, we must rein in the spending of our government. Perhaps, but let’s not forget that the option is to maintain or even increase spending levels and raise taxes significantly to bring down the deficit.

If we are facing an inherently low growth economy, then incentives to support growth become less compelling – we are fighting the inevitable.  Instead, the focus of many will shift from stimulating production to ensuring “fair” distribution of the inherently limited resources available to us.  We move from a positive sum world where all can gain through economic growth to a zero sum world where the pie is relatively fixed and the only debate is “fairness” of the shares of that fixed pie. Politics becomes even more polarized as we descend into a “you win, we lose” world.

So, there are definite political consequences to the views expressed by Tyler, even if he may not like or even endorse them.  But the implications are far more profound than that.  They cascade into how we live our professional and personal lives.

This perspective shapes our mindset about what is possible.  If we are truly in a zero sum world where growth evaporates, it materially affects our mental calculus.  Why invest a lot of effort and take significant risk if the potential to drive new forms of growth is so limited? A zero sum view of the world fosters a very conservative, risk averse mindset – with more limited upside, we naturally tend to focus more on preserving what we already have.

Lower expectations have a perverse way of becoming self-fulfilling prophecies. If we expect less, we invest less, work less and get less in return.  The Great Stagnation becomes the Permanent Stagnation.Now, of course, if Tyler is right in his diagnosis, there is little we can do about this – acceptance becomes the only reasonable approach, as he suggests.

But, what if he is wrong?  I have offered an alternative hypothesis, focusing on a growing mismatch in institutions and practices arising from a Big Shift driven by technology infrastructures.  This is still a profound shift, but it is a shift that we can make; we are not trapped in a stagnating world where we must accept the inevitable loss of low hanging fruit. Moreover, there is a huge reward for us if we embark on this journey.  Rather than diminishing returns, we face for the first time the opportunity to harness increasing returns in business beyond the technology sector. Rather than the Great Stagnation, we can unleash the Great Resurgence.

So, if this is right, what needs to be done? As my friend, Steve Denning, eloquently points out, it was management that helped us to reap the rewards of the previous infrastructure and it will be management again, perhaps a new generation just coming into the workforce, that will drive the changes needed to tap into the true potential of our new infrastructures.

Government certainly has a role to play in creating the conditions for this Big Shift to play out more rapidly. Our current policies were framed in a push-based world and there is an increasing mismatch here as well.

As John Seely Brown and I suggested in the Epilogue to The Only Sustainable Edge, we need to reassess all government policies through the lens of what is required to accelerate talent development.  And we don’t just mean education policies, but all policies, ranging from immigration to financial regulation and intellectual property laws. They all have a role to play in talent development and talent development will help us to navigate through the Big Shift as smoothly as possible. In this context, massive bail outs and artificially low interest rates may actually be slowing down talent development by reducing pressure on those who continue to pursue outmoded practices.

And you know what? That lens provides an opportunity for us to come together around the potential to drive a new wave of economic growth, rather than moving ever farther apart as we bicker over the crumbs of an increasingly stale pie.

If we were to adopt this lens and truly understand the opportunity ahead of us, we would remove the ability to excuse current government policies.  If I were Obama, I would buy and distribute a copy of Tyler’s book to every voter (yes, I know, it would add to our deficit, but it would be for a good cause) with a cover note saying something like this: “Don’t blame my administration for this slow recovery, low household incomes and low growth of the economy overall.  See, one of the most brilliant economists in the US says that this is an inevitable result of factors beyond our control.  We must simply accept the inevitable.  This is a time for sacrifice. Vote for me and I will make sure we have fairness.”

Through the lens of the Big Shift we should demand that all of our institutional leaders (business, government and education) aggressively address the obstacles that are slowing the transition from one institutional regime to another and increasing short-term pressure on all of us. Impatience rather than complacency should guide us. We should not accept excuses. My next blog post will address a book that helps to make the case for urgency.

Comments

[Igniter]

An excellent case for why 'social tech' is the best growth opportunity for capital and humanity right now.

Also, this fits really well with the transition illustrated by Ervin Laszlo in Macroshift. This is a systemic civilizational shift. Sparked by new technology with trajectory determined/dependent on values/mindset. Tyler in effect looking at this from the old perspective, while you're seeing it from the emergent perspective. You're are standing on different civilizational trajectories.

Some of my earlier thoughts on this: http://igniter.com/post6800
Some excerpts from Macroshift: http://igniter.com/post242

[Sandy]

As someone working on the ground in regional economic development, I find the framework you've laid out to be the one laden with the most possibility. Now we need to create the framework for pragmatic actionability.

I do quibble with this point:

"..we should demand that all of our institutional leaders (business, government and education) aggressively address the obstacles that are slowing the transition from one institutional regime to another and increasing short-term pressure on all of us."

I say we must create a parallel process in order to move ahead. Today's institutional leaders are the gatekeepers of new ideas. They are more interested in jockeying for political position, maintaining their relevance and revenue streams. They stand to lose more with any changes and will defend to the end the old ways.

[TallDave]

"rein in" not "reign in."

Interesting piece. BTW, you may want to look at the TFP growth difference between durables and non-durables, it is interesting that only one of these seems to be affected by TGS.

[pschaeffer]

JK has already made this point. However, much (most) of the growth in median family income is a consequence of higher LFP (women working).

A missing point is that median family income would have risen considerably more, were it not for this rise in inequality. Per-worker productivity has risen over 20% since the 1970s. Note that per-capita productivity has risen more because of smaller families and greater overall LFP.

[Corey]

My view is that the cause of the developed countries current stagnation is a lack of innovation in the education sectors. All over the world there are massive government monopolies or massive public cash fueled interventions in education markets.

Lower income citizens rely heavily on education to climb the income ladder but the response to the sudden increase in demand by the education establishments around the globe has been to drastically and regularly increase tuitions and fees.

We will be stuck in stagnation until the higher education market is forced to compete for students by lowering tuitions and increasing innovation. Innovation is especially needed; college professors still educate the same way they did 50 years ago.

New sites like khanacademy.org and Western Governors University offers some hope for the future but there is a lot more room for this market to grow.

[IC]

Gloomily the charts show an L shaped recovery (plunged and flat-lining).

American exceptionalism optimized technology to deliver winner takes all. Resulting in the largest groups headed by the fewest wealthy people. Resulting in 4 layer cake employment economy.

* The super rich (icing on cake).
* The creative class (highly educated)
* The creamy middle (jobs squeezed out by automaton or shipped overseas).
* The bottom layer (low skilled working poor service workers).

What American values need changing to create work for those disrupted and squeezed out?

32 hour work week...

[Peter Bleyleben]

For 50 years after WW2 we thought 'it is just us' -- and we added Regulations over Regulations -- Some just stupid, many really important to 'create a better society' -- but all 'cost resources'.. Increasingly we compete with the rest of the world -- that compete without 'nice-to-have' environmental, social, etc 'costs': The steady purchasing value decline of the dollar over the last 30 years in a global sense proves our increasing cost-disadvantage:
Having had dinner in Paris lately compared to 30 years ago? Compare the bills....

[JK]

1. This may or may not be a quibble...you've glossed over the components of the metric "median family income." Many of us remember when that meant a single wage earner's contribution to the family. Now the norm is two (or more!) wage earners with one (or more!) jobs.

2. While durable goods have decreased as a relative percentage of income, this is another example of picking metrics carefully. see http://news.yahoo.com/blogs/lookout/fed-official-heckled-t-eat-ipad-20110311-122230-439.html for a recent similar thought.

[Bob Allen (@CuriousAgilist)]

"Become less efficient. Which means you will get less done. Which, ironically, will make you more productive, as long as you choose the right things to get done." KATHERINE BELL, HBR

"The goal needs to shift from one of making a system that teaches children a curriculum more efficiently to one of making the system more effective by inspiring lifelong learning in students..." STEVE DENNING, Forbes

I'd love to hear someone try to defend the notion that the current state of the world economy (when compared with just about any point in history) is the result of a fixed-size-pie model.

Resources (on this planet) are limited. No argument there. To behave as if human potential is limited is folly.

[John Robb]

John, the personal income metric was a big deal to me too.

http://globalguerrillas.typepad.com/globalguerrillas/2009/03/parasitic-predation.html

Liz Warren did a good job on the details of this stagnation.

Thing is, the stagnation is already over. We are in decline now.

[gregorylent]

ignore government .. nothing accelerating the shift will come from there .. it is beyond redemption ... AND NOT NEEDED!

[JC]

I'd also note you're a tad sloppy on how you interpret the word stagnation, initially asserting that it implies no growth (a trip to the dictionary finds it means slow or no growth). There's a pretty big difference between no growth and slow growth given the overall topic at hand.

[JC]

It's q quibble, but I don't understand your opening sentence. The proclamation would make more sense it the book was a hardcover release? There is something illegitimate about an e-book. Is there some sort of correlation you are asserting here?