"The Great Stagnation - Is There a Way Out?"

February 23, 2011

Thought of the Day

“The Great Stagnation – Is There a Way Out?”

February 23, 2011

We have become a nation inflicted with attention deficit disorder. Real investment, a situation that requires time and patience, is unlikely to succeed when the focus of private equity investors – those who provide capital to innovators, entrepreneurs – is on an exit strategy, rather than on building a business.

Tyler Cowen, an economics professor at George Mason University, has produced a thirty-nine page e-book, The Great Stagnation, which tackles the question of why innovation in our economy has slowed, with the consequences being slowing acceleration in median income and diminished growth in standards of living. The book, as David Brooks in the February 14th issue of the New York Times http://www.nytimes.com/2011/02/15/opinion/15brooks.html, writes, “has become the most debated nonfiction book so far this year.”

Cowen references work done six years ago by Jonathon Huebner, a physicist working at the Pentagon’s Naval Air Warfare Center in China Lake, California. Huebner claims that, measured by scientific advances and U.S. patents granted per decade divided by the country’s population, innovation peaked in 1915. No one would argue that products such as electricity, in-door plumbing, the automobile and washing machines greatly improved the standard of living for millions of people. Futurologists would argue, however, that technology is developing at exponential rates – chip density, genome sequencing, internet connectivity and nanoscale machinery are catalysts for further waves of innovation, perhaps in fields that today we cannot imagine.

David Brooks puts an interesting twist to the story, suggesting that the slowdown, which no one can deny, is reflective more of a shift in values, rather than the nature of the technological change. He writes: “It could be that in an industrial economy people develop a material mind-set and believe that improving their income is the same thing as improving their quality of life. But in an affluent information-driven world, people embrace the postmaterialist mind-set. They realize they can improve their quality of life without producing more wealth.”

Professor Cowen suggests that three factors were a cause: The first was the availability of cheap land. In its early years, westward expansion in the United States became policy under the moniker Manifest Destiny, a policy that promoted (and excused) the right of Americans to seize land, first from Native Americans and, later under President Theodore Roosevelt, in the Pacific and beyond. The second factor was the abundance of what he calls “low hanging fruit.” The development of products such as the steam and combustible engines, in the early 19th century, foretold the manufacturing of the auto, train and flight in the late 19th and early 20th century. And, the third factor was the virtually universal spread of education. Cowen points out that at the start of the 20th century one in four hundred eighteen year-olds went to college. Today, it is about 40%.

There is little debate about the facts – incomes have stagnated and the rate of improvement in standards of living has distinctly slowed. The question is does this trend suggest an inexorable trend into the nether regions? My son, in a review of the book for “Seeking Alpha” http://seekingalpha.com/article/253611-book-review-the-great-stagnation, suggests that further changes are occurring. He writes: “Big societal changes begin in small increments. The internet may not be forming jobs on the scale of the auto industry in its heyday, but at least it provides an opportunity for individuals to become entrepreneurs, however small.”

Government, education and healthcare have become the dominant sectors of our economy, according to Professor Cowen. With the passage of Obamacare, all of these sectors (with the notable exception of private education) have now come under the purview of government. In the late 19th century, at the height of innovation, government (using government consumption numbers) accounted for about 5% of our economy. Today it accounts for 15-20%. Because of the way in which GDP is measured, for government cost not price is the basis. Thus Cowen writes: “The larger the role of government in the economy, the more the published figures for GDP growth overstates improvements in our living standards.”

There are, in my opinion, four factors that could reverse the trajectory that Tyler Cowen’s book describes. The first would be a slow down in the expansionary role of government. The protests we are witnessing in states across the country suggest the magnitude of the debate and the possibility of that eventuality. The second would be changes in immigration policies that would favor the highly skilled. This is an issue on which there seems to be agreement. The third would be improving basic education – substituting the “illusion” of education for the reality – and here again the seeds of reform are present, as the documentary “Waiting for Superman” so poignantly demonstrated. And the fourth, and the least visible at this time, would be a change in the tax code that encouraged investment and penalized very short term trading.

Tyler Cowen’s book deserves the praise and attention it has received. The book should be required reading in Washington; at thirty-nine pages even ADD inflicted politicians should be able to handle it. He has placed in debate issues that are critical to our future, but I also suspect that my son has pointed to a possible answer – an economy that requires fewer people to produce the same level of goods is forcing more individuals to become entrepreneurs. Self reliance is a valuable trait, one that has been missing in our consumption dominated society.