Tag Archives: Robert Gordon

Waiting for the Tooth Fairy

Four prominent economists at the Hoover Institution have published a new paper claiming that President Trump’s policies could make the U.S. economy grow 3 percent a year. Perhaps it’s just a coincidence, but three of the four authors have been mentioned as people Trump might nominate to head the Federal Reserve Board after Janet Yellen’s term expires next February.

Let’s be clear: 3 percent annual economic growth would be quite an accomplishment. The U.S. economy hasn’t grown that quickly over a full year since 2005. There’s no doubt that Americans would feel much better off if the economy were to soar as the Hoover Institution economists suggest. Personally, though, I think we’re about as likely to get a visit from the tooth fairy.

The authors attribute slow U.S. economic growth to slow productivity growth and a drop in the percentage of adults who are in the workforce. I agree entirely. But they then go on to lay the blame on President Obama, without mentioning him. “Focused primarily on ‘stimulus’ in the short-term, the conduct of economic policy in the post-crisis years did little to reset expectations higher for long-term growth. That policy failure restrained those expectations, adversely affecting consumption and, especially, investment spending,” they say. The authors assert that lower taxes on businesses and on capital investment, less regulation, and slower growth of federal spending “would help turn the recent upswing in animal spirits into a significant improvement in economic activity.”

You may have caught this movie before. Back in the 1980s, President Reagan’s economic experts promised much the same. Tax rates were lowered, regulations scaled back, federal spending curtailed. Yet on average, output per hour worked in non-farm businesses — the most basic measure of productivity — grew more slowly during the Reagan years than it had during the miserable 1970s, when tax rates had been far higher. These policies were supposed to bring miraculous productivity growth, but as Reagan’s former budget director, David Stockman, said in 1986 “The fundamentals that I look at are not a miracle.” 

What’s the issue here? Our four authors claim that “economic policies are the primary cause of both the productivity slowdown and the poorly performing labor market.” But as I show in An Extraordinary Time, the connection between government policy and productivity growth is tenuous. Productivity gains stem mainly from innovations in the private sector, which work their way into the economy in unforeseen ways. Government can help by supporting education, scientific research, and infrastructure, but the productivity payoff from such investments is unpredictable. The evidence that tax rates or government deficits affect productivity growth is quite weak. This is true not only in the United States, but in other advanced economies as well. 

Some productivity experts, notably Robert Gordon, think slow productivity growth is with us permanently, which would mean Americans’ incomes will grow only modestly in the coming years. I’m not so pessimistic. Historically, we’ve seen unanticipated spurts of productivity growth as firms suddenly figure out how to take advantage of new technologies and new ways of doing business. That has happened before, as with the Internet boomlet of the late 1990s, and I think it’s entirely possible that it could occur again. But I’m afraid the claim that the government can give us faster productivity growth just by passing a couple of laws falls into the realm of wishful thinking.

Pushing Productivity

As I’ve talked to people about An Extraordinary Time, I’ve received a lot of questions about what government can do to improve productivity. Some readers have gone so far as to accuse me of advocating “no-growth economics” — and, not surprisingly, these critics tend to have their own favorite policy prescriptions which, they promise, will reinvigorate productivity growth and raise living standards.

So let me lay out my argument once more. I don’t assert that government is powerless to improve productivity. I do assert that productivity growth comes largely from innovative ideas put to use in the private sector. Government plays an important role in this. It’s very clear that government spending on education is important in developing a more highly skilled workforce. Government support for scientific research can have a payoff in terms of innovation, as Mariana Mazzucato has shown. Government spending on transportation infrastructure, when managed wisely, makes it easier and cheaper for producers and retailers to move goods and expand labor markets, giving workers a greater choice of jobs and allowing employers to draw on a larger pool of potential employees.

The challenge for policymakers, though, is that the timing and magnitude of these effects are highly unpredictable. It’s a good bet that if more students complete university degrees today, we’ll see some payoff in terms of higher productivity in the future. But when? And how much? We can’t answer those questions. With respect to research and development, it’s very clear that scientific discoveries themselves have no direct economic benefits. What matters is turning these discoveries into new products, services, and ways of doing business, and there is no way to predict whether that will happen or how important those innovations will prove to be. In this respect, the U.S. productivity boomlet of the late 1990s and early 2000s is instructive: the unexpected rise in the rate of productivity growth was attributable, in part, to research in computing and communications that had received public funding decades earlier. As president at the time, Bill Clinton was able to claim the credit for stronger economic growth, but he didn’t really have much to do with the public-sector investments that made it possible or with the private-sector innovations that drew on those publicly funded discoveries to bring our economy into the Internet era.

Through history, there have been a handful of developments that have led to extremely large increases in productivity: think of the steam engine, the electric light, the construction of the Interstate Highways. Bob Gordon, in his wonderful book The Rise and Fall of American Growth, highlights the importance of the the public water systems built in the early twentieth century in rapidly improving public health. For the most part, though, productivity improvement arrives slowly due to marginal improvements in technologies and business processes. When it comes to economic growth, lightning does not strike often.

So when a politician promises to make the economy grow faster, beware. Yes, everyone agrees that it’s easy to juice the economy in the short term: a big tax cut, some added deficit spending, or a cut in interest rates all are likely to do the trick, at the risk of unfortunate consequences a year or two hence. But over the long run, higher living standards depend overwhelmingly on the growth of workers’ productivity. Regardless of what governments do, in most times and in most places productivity grows slowly, which means that living standards improve only gradually. Like it or not, this is, as I assert in my book, the trajectory of an ordinary economy.

Is the Age of Innovation Over?

For all their bushels of data and their powerful econometric tools, economists still know precious little about what makes economies grow. Yes, in general it seems that having a central bank that keeps inflation under control is helpful, and it’s probably good when entrepreneurs and investors aren’t living in constant fear their assets will be confiscated. But for every theory about the sources of growth one can find counterexamples. There have been fast-growing countries with high taxes and with low taxes, with relatively equal income distributions and with income controlled by a powerful few. Some people insist on the importance of the rule of law, yet China continues to boom despite a legal system that inspires little confidence. Others emphasize democracy, but Korea grew at a rip-roaring pace for a quarter-century before its military rulers surrendered power in 1987. Still others emphasize capital formation–but if that were the key, Jordan would be growing much faster than Israel, and Vanuatu would be outpacing both.

The famed economist Edmund Phelps recently waded into this debate with a book called Mass Flourishing, which I review in the current issue of the business journal Strategy+Business. Phelps believes the key to economic growth lies in innovation. Openness to innovation explains the 19th-century growth surge in Western Europe and the United States, Phelps claims, and the United States’ openness to innovation made it wealthy. Now, a decline in the pace of innovation threatens prosperity, in the United States and other countries as well. The culprit, he asserts, is corporatism—the inclination of interest groups to use the government to block economic change. This problem has been worse in Europe, but even in the United States,  he contends, “the waning of innovation was largely behind the increased joblessness and downward pressure on wages that have been endemic to the post-1972 period.”

The claim that innovation is on the wane is an interesting one. But how does one prove it? Phelps attempts to do so, in part, by measuring the market capitalization of a country’s enterprises compared to the value of the companies’ physical capital; the gap between the two, he contends, reflects investors’ view of the value of unexploited ideas for making better use of that physical capital. It’s a clever idea, but very America-centric; Phelps’s measure will make companies in other countries, notably Germany, appear less innovative than American companies simply because they make less use of stock markets to raise capital.

Another way to measure innovation is to count patents. Many patents, however, are granted for “discoveries” that are hardly innovative, and many highly innovative ideas are not patented. Some scholars have looked at R&D spending as a share of output, but what of the many innovations that never saw the inside of a laboratory? My own work on A&P, for example, has shown the economic importance of innovative methods of retailing, but the company’s rapid shift from neighborhood stores to supermarkets relied on a merchant’s well-honed senses, not on scientists or engineers.

Others who have looked at this issue, like the Northwestern University economist Robert Gordon, end up arguing that some innovations are just more important than others. The period of what he calls the Second Industrial Revolution, roughly from 1870 to 1900, brought such innovations as the telephone, the motor car, and electric generation. These technologies, Gordon says, took decades to refine, leading to an extended period of rapid economic growth. By contrast, the computer-related technologies of the Third Industrial Revolution, he says, have had a comparatively small effect in improving productivity. Gordon thinks this and other factors will lead to slower economic growth in the future.

This is an important debate. Phelps insists that the formula for growth is for government to spend more on public goods, such as infrastructure and education, while attacking regulatory barriers, business conspiracies, and labor rules that slow the pace of innovation. Gordon, by contrast, seems less optimistic about the ability of government to foster growth and drive the economy faster. His message is not a hopeful one. But the sheer number of innovations I see around us makes it hard for me to believe that the age of innovation lies in the past.