The Book “The Great Stagnation” Explains Why The US Economy Is Not Growing The fantastic wave of tech innovation that led to high growth is over. Invest in science in order to generate brand new technologies that will trigger new economic expansion

WASHINGTON – If you are a true believer in free enterprise and therefore think that what America needs right now is president Mitt Romney who will get us back on track with sound, tried and tested pro-business policies, implemented via the usual mix of lower taxes and less intrusive regulation, please read The Great Stagnation, by Professor Tyler Cowen of George Mason University, and think again.

The real issue is “no economically significant innovation”

Talk about a “paradigm shift”. The real issue is not, as we are led to believe, about a choice between pro-government Obama whose policies are focused on redistribution and income support for the middle class while penalizing growth and pro-business Romney who will unleash an economic rebirth while cutting entitlements. The real issue is that the great American economic expansion that took place between 1870 and 1960 was due to exceptionally favorable circumstances that, contrary to our beliefs and expectations of never ending abundance, were truly extraordinary and are now gone.

America had plenty of low hanging fruit

America had plenty of low hanging fruit: enormous amounts of arable land available for new settlers, waves of technological revolutions that made its use easier, (think of railways, the telegraph and electricity), while at the same time these technologies unleashed the most extraordinary industrial revolution in human history. And America had also plenty of eager new comers, many of them talented, who had come here willing to do their best. Well, all that low hanging fruit has been eaten, Cowen tells us. Its value has been consumed, and we do not have equally disruptive innovation these days that can cause a comparable increase in our rate of growth.

We have innovation today, but not as much

To be clear, there is still innovation; but not of the same caliber of what we had before. The transformation between the horse and the train or car is huge. The advantage of air travel versus any other modality is enormous. The difference between having a small foundry and a gigantic steel mill is huge. The difference between no electricity and electricity available for all possible industrial, educational, medical and home applications is also huge. The difference between no antibiotics and life saving medications is also fantastic. But today our progress is mostly about making improvements on old technologies.

We still believe we are as rich as we used to be

That said, the problem is that we behave as if we were still living in a high growth society driven forward by incessant innovation. Case in point, we still believe that we can afford a large and expensive state, including ever more expensive entitlement programs, while we no longer have the growing revenue base that made all of this affordable in the decades of ever increasing growth.

Public spending not productive

Besides, we do not really know how to calculate the real value of public investments. When the government spends money, we know what a given project costs. But we have no way to measure value. Which is to say that public expenditures most likely produce less value than we think and therefore add little to the common welfare.

The same applies to health care. We know that in America it costs a monstrous 17.5% of GDP. But the value we get for all this money is modest. If we compare the US with other rich countries that spend a lot less on health care, say 9 or 10% of GDP, their health outcomes in terms of basic statistics, including life expectancy, are better than what we come up with at a much higher cost.

Similar story for public education. More money spent in this sector and mediocre outcomes. In all international comparisons American students do rather poorly. So, more money does not get us more value.

Does any of this matter? Of course it does, because these are trillions of dollars that could be used more efficiently elsewhere.

We are still working with the basic inventions made decades ago

Still, aside from public expenditures, the critical point made by Cowen is that the pace of technological innovation has slowed down significantly. Indeed, with the exception of IT and the Internet, if we compare the life style of the American middle class a couple of generations ago to today, not much has changed. We still live in houses with central heating and air conditioning and drive the same cars. Sure enough, there have been improvements. But you cannot compare the added value of an energy-efficient modern refrigerator versus an older model with the difference between having a refrigerator and not having anything at all to keep food fresh. The first mass-produced refrigerators were game changers, as was the first mass-produced automobile or jetliner. Everything that followed is mostly tinkering.

ICT is the only real innovation

As Cowen points out, the only real contemporary innovations are in ICT, Information and Communication Technologies. Our parents did not have PCs, the Internet or mobile devices that now can work as computers. This is real, and it is big.

But the problem is that this sector, while immensely useful, so far at least, does not add that much to national growth. The ICT sector is capital intensive; but not labor intensive. Not much job creation; and therefore only a small contribution to national income. And paradoxically the impact of ICT on the rest of the economy has been to help companies reduce employment. Improved efficiencies made possible by IT solutions mean that traditional companies can do the same or better with fewer workers. But the problem is that the excess labor is pushed down the income ladder because these workers are not qualified to get the higher value jobs that require sophisticated knowledge. And a larger pool of semi-skilled workers means lower wages for all. Hence income stagnation.

Renewed efforts in science

According to Cowen the only way out of this is to encourage more people to get into science by, among other things, raising the social status of scientists in America. Well, this may be a long shot. But it is not a bad idea. Young people need to feel motivated to get into the only field that can give us hope of new breakthroughs that will trigger once again a very high rate of growth. More lawyers and more MBAs going into finance will not do the trick.

Until we get there, though, we have to adjust down the size of government and the size of entitlement programs designed for an era of ever-growing plenty that is unfortunately gone.

Politicians will not tell the truth

This should be the honest message delivered by honest American politicians: “We are no longer as rich as we used to be and as we (mistakenly) still think we are. So we have to lower our expectations until we shall be able to create better times”.

But this is not what we hear. Barack Obama wants your vote because he will magically calibrate public policies so that we shall have solid growth, fairness for all, reduced national debt and great, fully funded entitlement programs.

Mitt Romney wants you to believe that if we unleash the old American capitalistic spirit, now compressed by too much government interference and too many taxes, all will be well. Unfortunately, neither one is telling it to you the way it is.

Sustained low growth has huge long-term implications

The fact is that the innovation machine that was at the source of the extraordinary growth of our national wealth is and has been in low gear for decades. Because of this, US long-term economic trends, (leaving aside the additional disruption caused by the 2008-2009 financial crisis), show less growth and stagnating incomes.

Long term, the cumulative difference between a national economy growing at 2% a year as opposed to 3% is really huge.

Until we invent something truly disruptive that will cause once again great economic growth, we should be wise and adjust our expectations and life styles to these relatively leaner times.

But nobody seeking elective office would dare say any of this to the voters, assuming, (probably with cause), that they would shoot the messenger.

And so we shall continue to believe that we are richer than we are, this way delaying the inevitable moment of truth.

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