For the next couple of sessions we tackle some of the most pressing issues facing 21st century economies: stagnation and inequality. The Solow model will help set the scene but we shall need to break out of its restrictive assumptions to start finding answers. Recall that the Solow model emphasises perfect competition and smooth, continuous efficiency; effectively, finance and politics are pushed out of sight. Needless to say, the model does not make much of a case for State intervention, except perhaps for nudging the savings rate towards its Golden Rule level.
For session 4 we start with looking at the evidence of so-called secular stagnation. Our focus is on the United States but we shall touch on similar trends for other advanced economies. We make frequent reference to recent, cutting-edge research to help gain insights.
We soon find that a principal concern is the slowdown in total factor productivity growth – the fountainhead of rising living standards. We discover that the problem may be far worse than previously thought. Since the end of the Second World War US GDP growth has averaged around 2% per annum. But some recent estimates suggest that over three-quarters of that trend represent transitional factors. “Core” (steady state) US growth may already be close to zero.
Yet surely something is wrong. Every day we hear stories about the latest gizmos that make up the 4th Industrial Revolution. AI, driverless cars, biotech advances – surely these must count for something? Taking a brief historical sweep of innovation it seems reasonable to argue that we are witnessing the emergence of yet another General Purpose Technology that could transform society’s future.
So we shall meander through several arguments to try and explain this apparent paradox of technological advance and GDP stagnation. Firm conclusions are hard to come by, understandably. But, while our destination is unclear, enjoy the scenery, it’s really worth soaking in.
Argument #1: GFC & policy legacies
Are we just seeing the after-effects of a particularly nasty recession that we call the GFC (Great Financial Crisis of 2008 onwards)? We note that easy monetary policy may have over-cushioned inefficient (and unproductive) zombie companies. Successful innovation often requires creative destruction; you can’t make omelettes without breaking eggs. So maybe the central banks’ well-meaning policy of low interest rates needs to be toughened up – clear out the dead wood and all that.
Moreover, as we shall discuss, the State has hitherto played a huge role in supporting innovative activity (especially DARPA’s “starring” role in making the iPhone smart). Yet the State’s increased debt burden – following its 2008 rescue of the finance system, may have weakened its risk appetite. That would be a shame because, left to its own devices, private markets will typically underinvest in projects that are necessarily infected by radical uncertainty.
It is hard to come to firm conclusions but there may well be something in this line of argument. The key problem, however, is that the evidence of a slowdown in TFP growth significantly predates the GFC. For a full story we need to look further.
Argument #2: Measurement Error & Aggregation Issues
Superficially there is something to be said for the idea that stagnation reflects GDP measurement shortfalls. But scratching deeper below the surface suggest that while mis-measurement could lead to an understatement of the level of per capita GDP there is a compelling view that measured growth has not been significantly biassed.
What does emerge of interest is that once aggregate data are unbundled into various sectors and firms there is clear evidence of sharp divergence in productivity performance between the frontier and the laggards. This is interesting because it suggests that any tech pessimism (see below) does not extend to all companies. Some firms are doing very well; it is disappointing that there are not more of them!
Argument #3: Tech Pessimism
Bob Gordon’s famous comparisons of new technology with flushing toilets and paved roads cannot be ignored. He makes an entertaining case for the view that innovation is not what it used to be and is certainly not strong, or impressive enough, to counter macro headwinds of unhelpful demographics, the peaking of educational attainment, excessive debt and growing inequality. We supplement Gordon’s thesis with evidence of a deceleration in Moore’s Law and a marked slowdown in ideas productivity growth. We also consider the view that diminished industrial competitiveness has dulled incentives to research new ideas.
The pessimistic view has plausibility but, in my view, is a bit too pessimistic. So, in the interest of balance, we turn to a more optimistic thesis – you ain’t seen nothing yet!
Argument #4: Diffusion Dynamics
Using historical evidence on the steam engine and electrification a convincing argument can be made that the path from ideas to diffusion (implementation in wider technologies) does not happen quickly. Indeed it can take several generations. The fourth industrial revolution is just in its infancy. And, arguably, the full benefits of its IT predecessors has still not been fully embraced.
Looking at the rise in R&D spend by chip-makers and others it is hard to escape the conclusion that there is still plenty of room for optimism.
Introducing Risk, Challenging Convention
We conclude this session’s journey through secular stagnation by talking about r-star and its slow motion “crash” in recent decades. The story is undoubtedly linked to the (apparent) slowdown in trend GDP growth – we saw it in our Solow steady state equation. But we can also put forward a richer narrative that introduces risk and its impact on both savings and investment.
We’ll be coming back to that risk topic in future sessions, especially in trying to understand business cycles, the nature of finance and the challenges posed for monetary policy.
Hopefully, our discussion has also encouraged you to think about models and their assumptions. We have found that there is strong evidence to support active engagement by government in the supply-side of the economy. That said, in examining innovation and entrepreneurship we should also question conventional views that advise stability and the absence of bubbles. Maybe we should live life dangerously; risk-taking is arguably the feedstock of TFP and the future growth of living standards. So does demand management smoothing conflict with a buccaneering supply-side spirit? Hold those thoughts please for future sessions.
21 Feb 2020