Asymmetrical Information - Megan McArdle

03.04.13

Don't Have Enough to Worry About? Here's One More Thing: Low Growth May be Here to Stay.

We're all waiting for growth to return. What if it doesn't?

I'm on a reporting trip this week, so blogging will be light for the next couple of days.  Here's something to chew on while I'm gone: what if the current doldrums are the new normal?  Not just for a few more years, but for a couple of decades?  

I know, you've all read Tyler Cowen's Great Stagnation (I mean--you have, haven't you?  If not, what are you waiting for?).  So this thesis isn't entirely new to you.  But two new pieces to add to the mix: Jim Tankersley talks to a bunch of analysts about when we'll return to growth, and Tyler Cowen asks whether we're once again in the early 19th century, growth-wise:  

If we turn to the industrial revolution, what do we see? Relatively high productivity from “restructuring,” (machinery replacing labor) but relatively low productivity from innovation or total factor productivity. Robert C. Allen, in his “Engels’ pause: Technical change, capital accumulation, and inequality in the British industrial revolution” (pdf, the final version is in Explorations in Economic History, 2009) estimates TFP from the time at about 0.69% a year, hardly a stunning number (the number runs in the 2%-3% range for the 1920s and 1930s) and actually that early number is close to what we are seeing today for TFP.

From 1780 to 1840, output per worker rose 46% and the real wage index rose by only about 12%, noting that none of these numbers are close to exact. (Contra Ricardo, the share going to land is declining steadily and capital is capturing the gains.) The significant real wage gains come after 1840 and — in my view — even more after 1870. After 1830 TFP is growing at the higher rate of about 1% a year, still not impressive by the standards of the early 20th century however.

During the early 19th century, there is much creative ferment, but much less in terms of products which translate into gains in living standards for the average person.


On the one hand, is this really so bad? We are already very rich.  No one in America starves to death, or freezes to death (freak accidents excepted).  We enjoy excellent health and scads of leisure.  In material terms, our poor are better off than the poor of any other era in history.  

But I think it is a real problem, because we are not prepared for low growth: culturally, economically, or psychologically.  The peasants of 1800 did not expect to be noticeably better off than their parents.  The children of today still carry the cultural expectation that 2-3% annual income growth is the normal state of affairs.  Yes, I know, they haven't gotten that for quite some time.  But culturally, we experience this as a deviation that needs to be explained, usually in terms of someone who's stealing the surplus.  We don't see it as the natural state of affairs, or even a possible natural state of affairs, though it is actually the growth that is highly abnormal.

This has obvious political implications: if the growth doesn't arrive, voters will assume that the guy in charge has somehow screwed things up.  And the fights over a no-longer-growing pie will become more and more vicious.  The modern welfare state was built by and for a rapidly growing economy.  It is a lot easier to redistribute when you are taking a little bit ot of someone's annual raise than it is when you are asking him to give up some of what he's already got.  This is one of the reasons that I don't by the "Republicans are doomed" narrative which has lately been popular on the internet: if the taxes needed to support public sector employees and the welfare state have to come out of stagnant middle class incomes--and eventually, the laws of mathematics say they will--then the Democratic coalition is going to shatter.  How much of our 21st century welfare state could be financed by heavier corporate taxes on our 19th-century-style economy?  It seems unlikely to be enough.

I don't say that the Republicans are in good shape, mind you.  The politics of stagnant growth are ugly for everyone.

Then there is the cultural front. If we are in for a prolonged period of nothing-much-happening, we will need to make some adjustment.  Imagine tossing aside the whole idea of "advancement" as a life aspiration for yourself and your children.  I find this nearly impossible to do: my brain just sort of hits a blank space, like a missing tooth.  You don't feel anything in particular, just wrongness.  But this is the world of most people in 1790.

The majority of people in 1810 lived in small villages with stable populations and traditions that offered substantive alternative life narratives to material progress.  The majority of people today do not; our communities are consumption communities. 

Not you, you say? You are not some shallow consumerist clod? So you never or rarely go to restaurants, buy expensive equipment for some artistic or athletic hobby, spend top dollar for high-end cooking ingredients or tools, visit movie theaters, go to bars with friends, travel for leisure, or attend live performances of music or sporting events? Just church, public festivals, and the occasional make-your-own-music night at home?

Yeah, me neither.  

The average modern adult lives like the aristocracy, or at least the landed gentry, of two centuries ago. Even the consumption communities based around not consuming so much are making an explicit choice about consumption--a choice which binds the community together in the continual process of deciding.  Your average 18th century peasant didn't make lifestyle choices; they just had lives.

Arguably no-growth culture needs deep, binding cultural ties to replace the consumption identities that modern adults forge.  But I can't even imagine what that would look like in the context of the modern economy, with its constant churn. And oh, yes, the economy.  Our entire economy is built on the assumption of growth, a point that I tried to make in this piece on European demographics.  Debt finance, for example, mostly only makes sense if you think that incomes are going to grow pretty fast.  There's a reason for the biblical bans on usury: in a zero-growth world, lending money at interest is quite likely to ruin people.  If you're short of funds this year and need to borrow to cover the difference, you're likely to be even shorter of funds next year, when the money has to be paid back, plus interest.    

Of course, it's not as if we invented debt finance in the 19th century.  But we did invent mass credit, and I think you can argue that this is because of the growth: because it suddenly made sense to buy things on time, if you could expect your income to be higher in the future.  The same goes for companies. The early part of the industrial revolution was financed by retained earnings.  But the later part--the part with the big capital investments--was financed by debt.  

A low-to-no-growth economy changes these sorts of calculations dramatically.  It alters the return on all sorts of investments, not just cash ones.  Consider, for example, whether it makes sense to plow ever-greater sums into college educations if wages are stagnant?  Yes, it may be individually rational, but let's zoom back to 30,000 feet and look at the whole society.  If we are plowing hundreds of billions into college loans with low-to-no wage growth, this implies one of two things.  The first possibility is that like the Red Queen, we have to run faster and faster just to stay in place, putting more and more workers through years of education just to enjoy the same incomes we had before.  The other is that most of this education is just reallocating a fixed number of "good jobs", and that gatekeepers are getting to charge higher and higher fees precisely because everyone's prospects are dimming.  

Of course, this hardly touches the surface of the economic institutions that are fundamentally dependent on growth.  Unions don't seem to do so well without a growing surplus to win for their workers.  Local governments are in for some disastrous changes.  Real estate should be stagnant-to-declining, at least outside of a few boomtowns with tight building restrictions. And Social security, of course . . . no, wait, all pensions.  No, hold that: retirement.  

Previous generations of retirees were skimming off the top of a rapidly growing surplus.  The coming generations may be asking workers to give up what they already have--to live less well than their parents--so that Grandma and Grandpa can rest their bones for a few decades.  

Or take the debates over the budget.  I'll focus on health care, because I write about it quite a bit.  Over the past couple of years, health care cost inflation has abated markedly, something that's been hailed as a great victory by budget wonks.  If we can hold down costs like this going forward, our budget problems will ease quite a bit. (At least, in the 2030s--over the next two decades, age is at least a big a driver of Medicare's deficits as the rising cost of caring for each beneficiary.)  

But the reason that health care cost inflation seems to have slowed is the economy: people are cutting back on anything requiring a copay, which these days, means everything.  Now, perhaps the economy will bounce back, and growth will stay low.  But what if growth stays low because the economy isn't growing?  

Suddenly, the budget problems don't look better.  They look worse.  Health care cost inflation running at 6% when your economy is growing a 3.5% is a big problem.  But health care cost inflation rising at an annual rate of 1.5%, when the economy is growing at 0.5%, is an even bigger problem.

Government accounting is explicitly based on the assumption that spending grows, in real terms, every year--difficult to achieve unless the economy grows at least as much. Debt finance, pension fund accounting, expanding educational opportunities . . . most of the hallmarks of modern Western life assume high growth rates.  If the growth doesn't materialize, a savage readjustment will be required.  

Of course, we don't know what will happen; the economy could roar back to 3% annualized growth tomorrow.  But given how deeply we'll be hosed if it doesn't, we should probably start thinking about some contingency plans, just in case.