A wartime factory worker in 1940s Fort Worth, Texas
Wikimedia Commons/Library of Congress, Prints and Photographs Division

On opening up my online edition of the Wall Street Journal this morning,  I found a provocative essay on the editorial page concerning economic growth. Entitled Why the Economy Doesn’t Roar Any More by Marc Levinson, the post asked this fundamental question: Why, after eight consecutive years of low-growth recovery from the end of the Great Recession in 2008, has the American economy never boomed once, and why is it not growing now at the long-term average of 3.23 percent? So far this year, the U.S. economy has been growing at an average annualized rate of 1.1 percent according to the Federal Reserve Economic Database (FRED). In June the World Bank revised downward their estimate of this year’s world GDP growth from 2.9 percent in January to 2.4 percent. In the words of the World Bank, this lower growth ” is due to sluggish growth in advanced economies, stubbornly low commodity prices, weak global trade, and diminishing capital flows.”

A Perplexing Question for Keynesians

For Keynesians this is a very embarrassing, and for them a perplexing question. Keynesians are the proponents of the reigning economic orthodoxy in most of the developed world today. They are today the dominating influence in North America, Europe, Japan, and Australia, as well I suspect as in many other countries. Therefore, why should it be that their very best advice to governments has led to what could only be described (and charitably at that) as stuttering, stalling economies?

The answer according to many Keynesians is the Keynesian version of secular stagnation. There can be little argument the world’s economies are generally stagnating, and that that stagnation is secular. The word “secular” in this context means the stagnation is not tied to the business cycle, but is long-term. If we do not discover what is causing the stagnation and remove those causes, there is every prospect the stagnation would continue forever. Variations of the Keynesian idea of secular stagnation posit free-market failures of one kind or another leading companies to reduce investments. The Keynesian view of these market failures is that because of them companies can not find ways to invest their capital profitably; therefore they do not increase productive capacity and the economy stagnates.

Marc Levinson’s explanation in his WSJ essay is one of these variations on Keynesian secular stagnation. His take is free-markets are generally self-limiting to low growth and that growth of 1.5 to 2 percent per year is the normal growth for free-markets. Rather than aiming for higher growth, Levinson says the presidential candidates should get real. He writes, “It might be wiser to accept the truth: The U.S. economy isn’t behaving badly. It is just being ordinary.” He goes on to write:

Historically, boom times are the exception, not the norm. That isn’t true just in America. Over the past two centuries, per capita incomes in all advanced economies, from Sweden to Japan, have grown at compound rates of around 1.5% to 2% a year. Some memorable years were much better, of course, and many forgettable years were much worse. But these distinctly non-euphoric averages mean that most of the time, over the long sweep of history, people’s incomes typically take about 40 years to double.

Why do Americans persist in believing growth of a little over 3 percent should be normal? His claim is that in the period of living memory, which extends roughly from the end of World War II to the present, economic growth was initially fueled by pent-up demand, denied by war-time needs. Rosie-the-Riveter, like the lady operating a lathe in the theme image above, and her boy friend or husband who was off fighting the war, sacrificed for the war effort. By the end of World War II,

they were ready to satisfy needs for goods they could not fulfill during the war. Later, during the ’50s, through the ’90s, demand was further stoked by technological advances and unprecedented increases in productivity. In short, Levinson believes that from the late 1940s to the the end of the 1990s, the economically developed nations lived through a Golden Age, which is now ending.

These are somewhat similar to the views of Tyler Cowen, a professor of economics at George Mason University and Chairman and General Director of the Mercatus Center at George Mason University. In 2011 he published a famous pamphlet entitled The Great Stagnation: How America Ate All the Low-Hanging Fruit of Modern History, Got Sick, and Will (Eventually) Feel Better. Its main theme was that the U.S. economy had reached an historical technological plateau in which all of the factors that spurred economic growth for most of our history are substantially spent. The technological advancements of our present time do not promise the same increases in productivity as the advancements between 1880 and 1940, such as breakthroughs in transport, refrigeration, electricity, mass communications, sanitation and increases in the numbers of people educated and their level of education.

But is our current level of stagnation the best we can do? That is what we should consider next.

Markets, Technological Advancements, Governments, and Economic Growth: A Neoclassical Perspective

Modern economics began as a serious academic field of study in 1776 with the publication by a Scottish moral philosopher of An Inquiry into the Nature and Causes of the Wealth of Nations, usually shortened to The Wealth of Nations. In his very first pages Adam Smith writes about the importance of the division of labor in increasing productivity, highly influenced by the technology available to industry. In Book I, Chapter II, Smith begins to identify what drives the most famous concept identified with him: his “Invisible Hand”:

It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.

Then in Book IV, Chapter II, he writes concerning a supplier’s industry in producing a good desired by others,

…by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain; and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it.

The emphasis in this quote is mine. After the marginal utility revolution of the 1870s, driven by the scholarship of Carl Menger, Leon Walrus, and William Stanley Jevons, humanity learned Adam Smith’s Invisible Hand was the intertwined effect of the law of supply and demand with the law of marginal utility, sometimes referred to as the law of diminishing marginal utility. Together, they determine the quantity and prices of goods produced and offered for sale, and separately the quantity and prices of goods at which consumers would be willing to buy. As long as government does not attempt to influence the markets, market forces will drive those two points to coincide. The law of supply and demand describes what happens when markets are close to equilibrium, and the law of marginal utility tells us what happens when the markets are in disequilibrium and the supply and demand curves shift.

So here is the point of this long, hopefully not discursive, discourse! In 1956 Robert Solow, an American economist, and Trevor Swan, an Australian economist, independently developed a neoclassical economic growth model known now as the Solow-Swan growth model that is consistent with the neoclassical laws of economics. The main virtue of this model is that it separates the determinants of economic growth into inputs of labor and capital, plus increases in productivity caused by technological progress and a more capable, educated workforce. I describe this growth model in the three posts The Solow-Swan Model and Where We Are Economically (1), (2), and (3). Using this model, Solow calculated in 1957 that about 80 percent of US GDP growth per worker was due to technological progress.

More to the point, the Solow-Swan model predicts in the absence of technological progress or increases in workforce capability that an economy will be driven persistently toward a stable general equilibrium with a constant, no-growth GDP. The economy will remain that way until the equilibrium is perturbed by changing technology creating both new demand and the savings for investment that would enable the supply of that new demand. This highlights the importance of improving technology to fuel new economic growth.

Enter the villains of the play: the various levels of governments beginning with the federal government  that retard entrepreneurial risk-taking to advance technology. This has been going on for a long time throughout the industrial world as evidenced by the year-over-year change in labor productivity averaged over the countries of the U.S., Canada, France, Germany, Italy, Japan, and the U.K. Marc Levinson offered the time-plot of this average shown below as evidence that the “Golden Age” of relatively high GDP growth was over.

What this demonstrates is that total factor productivity, the factor that increases GDP per worker in the Solow-Swan model with increasing technological power, has a decreasing growth rate that looks soon to become negative.

Other evidence in the United States is provided by the fact that the number of companies dying in a year and the number being born are becoming perilously close to each other. In fact there have been a few years recently (2008-2011) where more died than were born, and that situation looks like it might recur soon. It used to be even in the depths of a recession, more firms would be born than died.

As I already wrote, there is absolutely no question we are living in an age of secular stagnation. The question is why? Marc Levinson believes this is the natural state of affairs as shown by history; that the golden age of more rapid economic growth between the late 1940s to the late 1990s was an unnatural economic period as proved by history. Tyler Cowen believes the United States has picked all the easy, “low-hanging fruit” of technological and sociological democratic advances fueling growth, and we must work harder for a longer period of time to develop the harder-to-achieve technological means for further growth.

But is it not premature to make such judgements? After all, we have a very large number of examples of government failures, as opposed to market failures, retarding growth. A list and explanation of all the government failures retarding economic growth would fill many books, so I will content myself by listing links to my posts where they are discussed.

• The Causes of the Great Depression
• Why Did the Great Depression Last So Long?
• Causes of the 2007-2008 U.S. Financial Crisis
• Economic Effects of the Dodd-Frank Act
• The Burden of Government Regulations
• The Debilitating Effects of Obamacare
• The EPA, CO2, Mercury Emissions, and “Green” Energy
• Economic Effects of Current Tax Policy
• Economic Damage Created by the Fed
• The Rahn Curve, Hauser’s Law, the Laffer Curve and Flat Taxes
• Big Corporations Abandoning the U.S. at an Increasing Rate

To these examples of government economic failures must now be added the very high level of federal debt (currently around 105% of GDP), whose finance through the sale of treasury bonds will increasingly cut into the capital available to firms for investment. Once total investment falls below replacement investment levels, our GDP will begin to decay in earnest.

Who needs Keynesian secular stagnation to explain our very real secular stagnation? Government interference in the economy works very nicely as an explanation.

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