Are we facing a generation of stagnation?

A book by Tyler Cowen is certain to be thought provoking and original. His latest work is no exception and has very serious implications for the future of politics and political debate if his argument is correct. In The Great Stagnation: How America Ate All the Low-Hanging Fruit of Modern History, Got Sick, and Will (Eventually) Feel Better he puts forward an argument that has wider relevance for everyone, not just Americans, and alarming implications.

The thesis goes as follows. Technological innovation peaked in the later 19th century and has been declining ever since (in this he follows the argument of Jonathan Huebner who dates the peak of innovation to 1873). In the twentieth century most of what happened was the application and working out of innovations made before 1914 and although there has been some innovation (notably in communications) this is not life transforming in the way that earlier examples such as the invention of the internal combustion engine or the application of electricity were. Partly as a consequence of this decline there has been much less growth and much less productivity growth over the last thirty years than is commonly realised. One result of this has been a stagnation of median real incomes in the US (Cowen considers and rejects various arguments that say this stagnation is illusory).

He goes on to argue that economists have systematically overestimated real productivity growth and the size of GDP. The reason in his view is the way that government spending (which makes up a very large part of GDP) is counted, which values expenditure at cost, which assumes that there are no diminishing returns to government spending – something clearly untrue. Consequently we are not as rich as we think we are and we are not going to become richer in the future at the rate we expect.

The problem for Cowen is not just that innovation, which drives economic growth and productivity gain, has slowed down. It is also that the effects of innovation are different for people in developed economies now as compared to those in developing economies today or in today’s developed economies over fifty years ago. This is because the innovations made in the later nineteenth century had big impacts in terms of productivity and transforming lifestyle when they were first introduced. This is partly because of their nature – they brought about a big change in foundational aspects of daily life – and partly because they enabled societies (and particularly American society) to make large and easy productivity gains by ‘picking low hanging fruit’. He identifies three major categories of ‘low hanging fruit’ in the US case: bringing abundant unused land into production; applying technology and new organisational techniques to manufacturing; educating large numbers of bright but uneducated children. Today all of these still bring big gains in parts of the world such as Africa, China and India but no longer do so in the US or other OECD countries.

Moreover, almost half of the economy in places such as the US is now made up of sectors that are dominated by government, above all healthcare and education. These are areas where it is very difficult to make significant productivity gains, given the way they are delivered, and it is clear that at present spending in these areas faces significant diminishing returns or even negative returns (as much evidence from both education and healthcare suggests).

All of this has a number of interesting and serious implications, not all of which are spelt out. It explains why growth in the developed world was so rapid after World War II but has slowed down dramatically (if we accept his arguments about national accounts) since the 1970s. Another implication is that while the world economy as a whole will continue to grow over the next twenty to thirty years, the bulk of that growth will take place in emerging economise such as China, Brazil, India, and the so-called ‘next eleven’, that is in parts of the world where there is still low hanging fruit of easy productivity gains. By contrast real rates of growth in the OECD countries will be low for a prolonged period.

There are a number of possible rejoinders to Tyler which are more positive and upbeat. One, which he considers but rejects, is that he is underestimating the effects of the new innovations in things such as communications. His response is that while things such as Google, YouTube, Facebook and Twitter make people’s lives more pleasant and so raise utility they do so by benefiting people in purely private ways that do not have significant positive spillover effects. In particular they do not generate large numbers of high paid jobs in the way that earlier innovations such as the introduction of the motor car did.

A larger implication however is that this makes shrinking the size of government even more necessary and in a real sense unavoidable. Given the clearly diminishing or even negative returns to government spending, its size and crowding out effects must play a significant part in the ‘great stagnation’ that Tyler identifies. The even more striking conclusion we may draw is that what is really needed is a productivity revolution in areas such as education and healthcare. The key here is almost certainly radical innovation in the way these services are produced and delivered. Given that the methods used in both areas are essentially the same as those used over a hundred years ago the scope for gains is enormous.

"A larger implication however is that this makes shrinking the size of government even more necessary" that is assuming the majority of the population is not content with its lot. Where is the drive to innovate, if government persuades the electorate that public pensions will look after it in its old age, that health service delivery is only effective and equitable through government provision, and private enterprise is frowned upon as something people do when they are greedy and self-serving. Agreed, proper innovation in education could lift productivity; however, does anyone see the efforts made so far having any real impact in these areas? Granted, initially change will require a shuffling around of resources before any real savings can be made (as the less effective teachers/methods are pensioned off), but the day that both savings are made (ie government is shrunk) and productivity is increased seem far distant from my standpoint.

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