The Stagnation Illusion

Ever since the Global Financial Crisis in 2008, the new normal for the world economy has been slow growth and stubbornly high unemployment. While the US recovery has outpaced Europe’s, there is a strong sense in the United States that the economy is still not on solid ground. Fewer than a third of voters believe that the country is headed in the right direction. While this is better than at the bottom of the recession, it is still low by historical standards.

Some economists have tried to make sense of this extended period of economic weakness by reintroducing the idea of “secular stagnation.” This is the notion that the United States and the world economy have run out of gas so we might be doomed to a prolonged period of slow economic growth with continuing high levels of unemployment and underemployment. The possibility of secular stagnation had been a front-burner issue during the Great Depression of the 1930s, and fears of its return haunted many even during the booming war economy from 1941 to 1945.

Concern about postwar unemployment was so great that a major beer company sponsored a contest to reward the best plan for achieving full employment after the war. But by the mid-‘50s, prolonged prosperity meant that the idea of secular stagnation was forgotten. As early as the 1960s, the theorists who had proposed the idea of secular stagnation were treated as intellectual dinosaurs; but today, the descendants of those dinosaurs walk among us and hold prestigious academic appointments. With the economic crash of 2008 and years of slow growth, secular stagnation has risen once more.

Today’s theorists of secular stagnation are mostly economists, and they are divided into distinct camps. One group, which includes Robert Gordon of Northwestern University and Tyler Cowen of George Mason University, suggests that we have reached an end to the rapid advances of technology that fueled economic growth ever since the cotton mills of early industrialization. For these apostles of technological stagnation, there is not very much that can be done other than for us all to rein in our appetites and accept that our children will probably not live as well as their parents.

Another group rejects this technological pessimism and insists that the problem of stagnant growth is a result of bad policies that can and should be changed. This group includes progressive economists such as Paul Krugman and Joseph Stiglitz. Their focus has been on the damage that the 2008 Global Financial Crisis did to the economy and the policy mistakes that have been made in recent years. While their description of reality makes more sense than that proposed by the other camp, they also ignore some critical issues.

On a deeper level, the return of the secular stagnation debate is actually a symptom of the problematic ways we think about the economy and its relationship to society, government, and the environment. In normal times, when the economy is stable, the conceptual toolkit of professional economists works reasonably well. But we are no longer in normal times; we are in a period when the basic structure of the economy has been transformed and the economists’ toolkit is badly out of date. This makes the public frustrated because nobody seems to have a credible plan for the future.

1.

Let’s start with the claim that technological progress has ground to a halt in the current period. This idea seems a bit counterintuitive when most of us struggle to keep up with televisions, thermostats, electronic devices, and next-generation appliances that come with increasingly complex capacities and instruction manuals. But the stagnationists are largely contemptuous of these gizmos. They think the smartphone is far less significant a technology than the big changes that came at the beginning of the 20th century — electrification, the automobile, and inexpensive indoor plumbing. They insist that those earlier breakthroughs did much more to change people’s way of life.

They could be right. If forced to choose, most people would give up their smartphones if they had to walk to an outhouse. (Although there are still many millions of people in the world who have smartphones but no indoor plumbing since the former is cheaper than the latter.) But decisions that people make based on creature comforts are hardly relevant to the issue of whether the pace of technological change is slowing, accelerating, or remaining the same.

The stagnationists do have a strong argument when we look at the speed of commercially available transportation. In 1873, Jules Verne published Around the World in 80 Days. Just 76 years later, in 1949, an airplane circumnavigated the globe in 94 hours — a 95 percent improvement over what was still a fanciful journey when Verne wrote. In the 66 years since 1949, we have only been able to cut that time by another 40 percent and that service is not commercially available. The story of land speeds is similar. Most of the fast commercial trains currently in operation in other countries run at slightly less than 200 miles per hour — a speed first attained by trains in the 1950s.

This slowing of technological progress in transportation might reflect physical limits or it might reflect shifting priorities. But the point is that transportation speed is actually the great exception. When one thinks of communications, the continuing gains are staggering when evaluated in terms of both quality and cost. Two people with smartphones or iPads located on opposite sides of the world can now video chat for hours on end without incurring any incremental charges. Similarly, the ongoing reductions in the cost of computer processing power make possible an unimaginable expansion in our collective access to information that historically lay hidden in libraries and archives. Moreover, ever-cheaper computer power means that we are just at the dawn of an era of smart machines including the driverless cars that are allegedly already on our roads.

When we look at energy, there are also big advances. While cars, trains, ships, and planes are not going any faster, they are traveling much more efficiently — going a lot farther on a gallon of energy or a kilowatt-hour of electricity, with even bigger gains coming in the future. An experimental vehicle achieved the equivalent of 12,265 miles to the gallon in 2005 — a bit more efficient than your father’s Oldsmobile. Advances in lighting technology have produced sharp declines in the energy needed to produce the equivalent of a 100-watt bulb. And we know that the cost of producing electricity with renewable technologies such as solar and wind have dropped sharply in recent years.

Some of these gains are linked to advances in materials science that make possible new materials that combine light weight with tremendous strength and relatively low production costs. There is reason to believe that these new materials will transform a wide variety of different industries. So when we add in the continuing advances in biotechnology including new pharmaceuticals, new medical techniques, and various forms of bioengineering that have already extended lifespans and improved the circumstances of some portion of the elderly, it is hard to see how anybody could claim that technological advances have come to an end.

For all these reasons, those who argue that we have slow growth not because of a shortage of new technologies but because of policy mistakes have the better part of the argument. Paul Krugman and former Treasury Secretary Lawrence Summers, for example, have been insisting that the core problem is that starting in 2010, world leaders turned to austerity measures such as cutting government outlays as the way to create the conditions for a revival of economic growth. The theory was that the world was awash in too much debt — consumer debt, corporate debt, and government debt — and only by working down those debt levels would we restore economic growth.

Krugman, in particular, has been devastating in his critique of those he labels “Austerians” who believe in something he calls the “Confidence Fairy.” When business leaders are convinced that governments are bringing their deficits under control, the Confidence Fairy, like Tinker Bell, will flit from business leader to business leader persuading each one in turn to make large increases in business investment which will then generate the economic growth that is needed. But despite years and years of budget restraint, the promised uptick in business spending has not occurred.

Krugman and Summers favor as a policy direction a resumption of the stimulus measures that were employed in 2009 and 2010 to halt the rapid rise in global unemployment. They argue that because interest rates have remained at unprecedentedly low levels for years since 2009, governments around the world should take advantage of these low rates by significantly expanding their outlays for major infrastructure projects — rebuilding decaying roads and bridges and accelerating investments in clean energy projects. They argue that these increased outlays — rather than budget restraint — is what will persuade business leaders that they should start increasing their own investments.

However, these analysts are vague about how long this heightened government stimulus should last and what it will take to get us back to economic growth that will sustain itself without ongoing stimulus from the public sector. The stark reality is that during the last economic expansion, it was unusually high levels of new construction of single-family homes that powered the economy. Since nobody believes that we could or should ever get back to those artificial levels of constructing single family homes, something has to fill that gap in demand if the economy is to escape secular stagnation. Summers and Krugman, however, do not tell us what kind of outlays would provide that missing demand.

2.

The idea of secular stagnation came back as a way to make sense of slower annual rates of gross domestic product (GDP) growth and slower increases in personal income. But this is precisely where problems with the economists’ approach become apparent. There are a series of issues that economists recognize, but they have not yet been fully integrated into their policy prescriptions. The first issue is the fixation with rates of GDP growth. The simple reality is that it is much harder to achieve a high rate of growth for a very large economy than for a smaller one. But a 2 percent growth rate for a $10 trillion economy produces the same annual increment in output as a 4 percent growth rate for a $5 trillion economy. Assuming that the increments were distributed equally, individuals would get the same increase.

The second issue is that the distribution of these increments has been far from equal. In the United States, most of the income gains in recent years have gone to the top 1 percent of households. Not only do low-wage workers in the United States earn less than their European counterparts, but European countries have also been much more effective in using tax and public benefit programs to make sure that the final distribution of income is less unequal. This is the reason that the United States has far more children being raised in poverty than other developed nations. It follows that secular stagnation talk is a distraction from focusing on tax rules, benefit programs, and regulations that work to redistribute income toward those who already have way more than they need.

But a third issue is even more serious. Our current GDP measurement system was invented in the 1940s, when most people worked on farms or in factories — producing tangible and simple things such as bushels of wheat and tons of steel. Now, however, most of us produce services whose value is not so easily measured. Even many of the manufactured goods we produce are improved significantly from year to year, so it is difficult to separate changes in prices from changes in their quality. Most important, because the measurement focused on market transactions back in the 1940s, it did not include many of the things that make life worth living — economic security, access to clean air and water, personal safety, an interesting job, leisure time, and living in a good neighborhood.

This creates serious difficulties because of what Abraham Maslow long ago identified as the “hierarchy of needs.” Humans are similar to animals in having a persistent need for the basics — food, water, shelter, and physical safety. But once those needs have been addressed, we start wanting other things like companionship, good health, intellectual stimulation, aesthetic experience, natural beauty, and explanations of how the world works. This is happening in the United States even though we have left large numbers of people behind without adequate resources to satisfy their basic needs. As economic development proceeds, more resources are invested in satisfying those higher-level needs. But it is a much easier task to measure the output of a basic needs economy than one that prioritizes advanced education, entertainment, and economic security. As an economy is moving up Maslow’s hierarchy, the GDP measure is likely to signal that economic growth is slowing.

But that signal might well be false or misleading. Think, for example, of Chinese cities where air pollution has gotten so bad that elite families are moving their children to places with better air quality. As the Chinese spend tens of billions on new technologies, the air quality is bound to improve. But clean air does not have a price, so it will not be measured directly in GDP. So while it will look as though Chinese economic growth has slowed, this ignores the huge improvement in welfare that comes when tens of millions of people no longer have to breathe toxic air. In other words, China will have chosen to take some of its economic growth in the form of the nonmonetized output of cleaner air.

In developed countries, we have already reached the point where we produce ever-greater flows of nonmonetized or only partially monetized outputs. Since governments do not charge a price for most of their services, national income accountants value most of the output of government services as equal to the payroll cost of the employees who produce the service. So, for example, all of the medical advances that result from the efforts of the 6,000 scientists who work at the National Institutes of Health are not directly included in GDP. Similarly if school reform efforts are successful, the value of improved educational outcomes will also not be counted in GDP. And, of course, the higher levels of individual economic security provided by Social Security benefits or Europe’s more generous social programs also are not directly reflected in the GDP data.

But for many people in Europe, North America, and Japan, what they want most are more of these nonmonetized services such as good education, good health care; the chance to live in neighborhoods with amenities such as well-functioning transit systems; high-quality leisure time; a cleaner environment; personal and economic security; and employment that is both interesting and rewarding. But these nonmonetized outputs are not like widgets that can be produced by a single company and stocked in huge numbers by big-box retailers. All of these are forms of collective consumption that require the government to play a coordinating and financing role.

So, for example, in the United States, prices have risen much faster than inflation over the last 30 years for four key elements of consumption. These are housing in attractive neighborhoods, good healthcare insurance, quality childcare both for preschoolers and after school, and tuition and fees for higher education. These are the kitchen table issues that have led many families either to load up on debt or to make huge compromises such as putting up with long commute times. But in each of these four cases, the society’s capacity to increase the supply of these desired goods depends on governmental action.

This is where things get complicated. Think of it this way: we each have two distinct kinds of income streams. We get monetized income in the form of dollars from our employer or our pensions or returns on our saving. But we also get nonmonetized income such as cleaner air to breathe, longer life spans, more and better videos to stream, and living in a city with more ways to have fun. But when the tax collector comes, he or she takes only from the monetized flows. However, since our societies have been moving up Maslow’s hierarchy, the monetized part of our income stream has been growing fairly slowly. The problem with the slow growth is that it makes us acutely aware when the government tries to take a bigger share of the visible part of our income.

In a word, the longstanding revolt against taxes in the United States and in other developed societies has a real foundation. Most people think of their income as equal to the dollars that they receive; they don’t think of those other flows as income even though much that they value comes through collective consumption. So when the government tries to take more of their slowly growing dollar income, they get angry and they resist. We can think of this as a kind of “money illusion,” but it is very deeply rooted.

So the contradiction is that much of what citizens want and need are items of collective consumption that government must help to provide. But those same citizens have been insisting that governments make do with fewer resources because they do not want taxes on their slowly rising money income to increase. In most of the developed economies, tax revenues as a percentage of GDP were no higher in 2013 than they had been in some earlier years. In the United States and the United Kingdom, the level in 2013 was below the 1969 level. The consequences is that all the more affluent economies are now stalemated; the path to producing more of what people want is blocked by tight government budgets and resistance to higher taxes.

It follows that secular stagnation is a misleading label for what is really a problem with our institutions. This is precisely where the arguments of Krugman and Summers do not go far enough. It is not just that the economy needs another round of stimulus; it is that for sustained economic growth we need to reconfigure the relationship between the public sector and the private sector.

3.

Some of this becomes clearer if we think about the previous epoch of secular stagnation. The problem in the 1930s was that we had a mass production economy, but we did not have the institutions in place to support the needed mass consumption. The reforms of the New Deal and the immediate postwar period were all about reconfiguring the relationship between the public sector and the private sector to facilitate mass consumption. Once those reforms were in place, suburban-led development took off and secular stagnation disappeared.

Today, with an economy that centers on services and various types of collective consumption, it makes sense that we again need different institutional arrangements. But this need has been obscured by our prevailing schools of economics that focus on abstract units of production and consumption, rather than focusing on what the economy produces at a given point in time.

There are multiple ways to restructure the relationship between the public sector and the private sector to facilitate a new era of sustainable economic growth. That is the debate we ought to be having. But this conversation has not even started because we have been busy arguing about austerity, secular stagnation, and an end to technological advances. It’s been seven years since the global economy collapsed in 2008. We do not have more time to waste.