My Review of Tyler Cowen’s New Book

Tyler Cowen’s new book, The Great Stagnation, is terrific. If you want to understand what’s going on with the economy, you should buy it right now. In fact, buy two.

Oh, oh, I’m supposed to write more? Ok.

I should start by saying that if I was still writing for BusinessWeek, I would never be allowed to review Tyler’s book, because he cites me copiously and even graciously dedicates it to “Michael Mandel  and Peter Theil, who have blazed the way.”  (Thank you!) But the fact is, The Great Stagnation is so important and so readable that I’m going to violate every possible  conflict of interest rule.

Since 2009, I’ve been arguing that there’s an innovation slowdown which is the root cause of many of our current economics ills (See here for the  June 2009 BusinessWeek cover story, “Innovation Interrupted”)*.  Since then I’ve been writing and blogging about the  innovation shortfall thesis. (For example, in March 2010 I wrote a policy memo for the Progressive Policy Institute titled “Why the Jobs Crisis is Actually an Innovation Crisis”)

That’s why I was so pleased to see Tyler’s new book. He incorporates my original innovation shortfall thesis–which mainly focuses on technological change over the past decade–into a much broader argument that stretches back forty years. What’s more, he does a great job of making his case in clear terms (readable!). Tyler argues:

…the American economy has enjoyed lots of low-hanging fruit since at least the seventeenth century, whether it be free land, lots of immigrant labor, or powerful new technologies. Yet during the last forty years, that low-hanging fruit started disappearing, and we started pretending it was still there. We have failed to recognize that we are at a technological plateau and the trees are more bare than we would like to think. That’s it that is what has gone wrong….there are periodic technological plateaus, and right now we are sitting on top of one, waiting for the next major growth revolution.

Why is Tyler’s “technological plateau”  so important? It gives you a coherent explanation of how we got into this mess. Tyler writes:

In essence, we’ve been making plans—whether consciously or not—as if we would have ongoing productivity growth of 3 percent or more, along with the asset prices that would accompany such a boom. When you combine plans based on 3 percent gains with a reality of much inferior performance, sooner or later you get a crash.

In other words, it was a collective misperception of current growth rates.

We were all, more or less, overconfident. It gets increasingly harder for me to escape the conclusion that many millions of people were complicit, whether intentionally or not.

Going forward, Tyler raises several important questions.  How do we encourage technological progress? How do we manage slow growth? And if and when we get a new round of technological breakthroughs, how do we manage those?  These are his suggestions

  • Raise the social status of scientists
  • Be part of the solution to the current rancor, not part of the problem. Don’t demonize those you disagree with.
  • Have realistic expectations.
  • Be ready for when more low-hanging fruit actually arrives because sometimes low-hanging fruit is dangerous
  • Be prepared for a recession that could last longer than we are used to.

Let me comment on two of these. First, the point about raising the social status of scientists. In his state of the union address, President Obama made a big deal about innovation. But he did not highlight a single current scientist. Instead, he featured two brothers,  Robert and Gary Allen, who own a  Michigan roofing company.  Good politics–but perhaps not the right message to kids.  

Second, don’t demonize those you disagree with. The point Tyler is making that politics becomes a lot harder in a slow-growth economy, where expectations have to be ratcheted down.  The center has a real purpose.

Finally, Tyler wrote this book in a short Kindle e-book format. It’s worth getting a Kindle just to read his book –I did!

One View of State Budgets and Higher Education

I start out with the belief that investment in higher education is in general a good thing. However, I’ve been worried by the decline in real college grad wages.

 I came upon this 2009 Brookings paper, “The Causal Impact of Education on Economic Growth:Evidence from U.S.”, by P. Aghion , L. Boustan , C. Hoxby, and J. Vandenbussche. Let me take two excerpts from the beginning and end of the paper: 

Should countries or regions (generically, “states”) invest more in education to promote economic growth? Policy makers often assert that if their state spends more on educating its population, incomes will grow sufficiently to more than recover the investment.

 //giant snip//

We find support for the hypothesis that some investments in education raise growth. For the U.S., where all states are fairly close to the world’s technological frontier, we find positive growth effects of exogenous shocks to investments in four-year college education, for all states. We do not find that exogenous shocks to investment in two-year college education increase growth.

This suggests that the money would used equally productively elsewhere. We find that exogenous shocks to research-type education have positive growth effects only in states fairly close to the technological frontier. In part, this is because research-type investment shocks induce the beneficiaries of such education to migrate to close-to-the frontier states from far-from-the-frontier states. Put another way, Massachusetts, California, or New Jersey may benefit more from an investment in Mississippi’s research universities than Mississippi does. Finally, we show that innovation is a very plausible channel for externalities from research and four-year college type education. Exogenous investments in both types of education increase patenting of inventions.

What conclusion should I draw from this paper?  Should we put more money into research-related education spending and four-year schools, and less into two-year colleges? Or are we missing something important here?

Really? Ireland/Iceland/Greece Outperform Germany?

Is it true that the three basket-case countries of Europe–Greece, Ireland, and Iceland–have outperformed Germany on real GDP and productivity growth? Or do the implausible official numbers demonstrate the bankruptcy of the global economic statistical system?

I was nosing through the just-released OECD Economic Outlook (top secret project, don’t ask), and I noticed something very interesting.  The Outlook includes forecasts through 2012 for all sorts of macroeconomic variables,  so we can now look at a 15-year time period (1997-2012) which includes the ten years of  tech+housing boom (1997-2007) and the five years of the financial bust. Here are two charts comparing the strongest economy in Europe, Germany, with the three basket cases, Greece, Ireland, and Iceland. We’re looking at real gdp growth and total economy labor productivity growth:


These charts show that the three basket-case countries of Europe–Greece, Ireland, and Iceland–substantially outperform Germany during the boom years, which is to be expected (blue bars).  For example, Greece had productivity growth averaging 2.4% per year from 1997 to 2007, compared to only 1% per year for Germany.

What is more surprising is that  Greece, Ireland, and Iceland continue to outperform Germany, even when we factor in  the 5 years of the bust, including forecasts through 2012 (the red bar).  For  example, average real GDP growth in Iceland is projected to be 2.7% annually over the 1997-2012 time period, almost double the 1.4% growth rate of Germany.

What can we make of these disparities? After all, we economists have been trained to believe that productivity growth is an essential measure of the health of an economy. Here are four possible explanations:

  1. OECD forecasters have drunk too many bottles of wine, leading to overoptimistic forecasts
  2. Five years post-bust is too short: The basket-case countries will be suffering for many years.
  3. Boom-and-bust beats slow-and-steady in the long-run.
  4. The usual way of measuring Gross Domestic Product overestimates  both debt-fueled growth (Iceland, Greece) and growth fueled by supply chains (Ireland).

As anyone who has been reading me for a while knows, I lean towards #4.  I think there’s a first-order problem with the way we measure GDP growth, because trade–including flows of knowledge capital–is being incorrectly counted, or not counted at all.*   That’s a big gotcha, since bad macro data have and will distort decision-making by policymakers,corporate leaders, and investors.  

*I will recap the full set of statistical issues in a post soon. If anyone wants to be on my “alternative system of global economic statistics” mailing list, just drop me a note.

A Massive Writedown of U.S. Knowledge Capital

In his column this morning, Paul Krugman gets it half-right:

America’s economy isn’t a stalled car, nor is it an invalid who will soon return to health if he gets a bit more rest. Our problems are longer-term than either metaphor implies….The idea that the economic engine is going to catch or the patient rise from his sickbed any day now encourages policy makers to settle for sloppy, short-term measures when the economy really needs well-designed, sustained support.

So far, so good.  But then Krugman goes off the rails:

The root of our current troubles lies in the debt American families ran up during the Bush-era housing bubble…What we’ve been dealing with ever since is a painful process of “deleveraging”: highly indebted Americans not only can’t spend the way they used to, they’re having to pay down the debts they ran up in the bubble years.

No, no, no. The build-up of debt was a symptom of  the real underlying problem:  A massive write-down of U.S. knowledge capital over the past 10-15 years, combined with anti-innovation policies on the part of the government.

U.S. prosperity has always depended far more on our accumulated store of knowledge capital than on our physical investments. Knowledge capital includes accumulated education, research and development, and business-knowhow–all the intangibles that underly a modern economy.

The value of knowledge capital depends, in part, on how rare it is. The more companies or countries that possess the same knowledge (say, about how to make a commercial airliner), the less valuable that knowledge is.  This is just Economics 101, applied to intangibles.

Over the past 10-15 years, the strengthening of information flows into developing countries meant that knowledge capital was being distributed much more quickly around the world.  As a result, the normal process of knowledge capital depreciation greatly accelerated in the U.S. and Europe–beneath the radar screen, because no statistical agency constructs a set of knowledge capital accounts.

What we should have been doing is boosting our investment in knowledge capital creation–education, R&D, business innovation.   Instead, we borrowed to support consumption.  Instead, we got Republican and Democratics administrations that  were more concerned with punishing innovative industries and ladling on additional security and economic regulations.

We still have some major knowledge capital advantages–in communications, in the biosciences, in the rapidly growing area of digital education–that we can build on for the future.   But this is the moment where we should be focusing on rebuilding our knowledge capital base rather than supporting debt-led consumption.

Added 12/15: Tyler Cowen agrees that knowledge capital may be depreciating more rapidly, but disagrees on the cause.

I agree with the conclusion but I am not sure that globalization was the mechanism.  I sometimes think of an imaginary economy with two sectors: music and bathtubs.  I believe that my bathtub is over thirty years old, yet for me it works fine and I have no desire to buy a new one.  When it comes to music, most people want to listen to what is new and hot, not Bach’s B Minor Mass.

Growth Upgrade for 2010

From a Bloomberg article by Rich Miller:

Pimco, which manages the world’s biggest bond fund, raised its forecast for growth next year in response to the stimulus, [Mohamed El-Erian, chief executive officer of Pacific Investment Management Co] said. It now sees the economy growing 3 percent to 3.5 percent in the fourth quarter of next year from the same period of this year. That compares with its previous estimate for 2 percent to 2.5 percent growth and the 2.2 percent gain forecast for this year by the International Monetary Fund.

Time for hiring to pick up as well.

Does regulatory backlash explain the midterm elections?

On the front page of the NYT this morning

Mr. Obama, having just cut a painful deal with Republicans intended to stimulate the economy, can ill afford to be seen as simultaneously throttling the fragile recovery by imposing a sheaf of expensive new environmental regulations that critics say will cost jobs.

The delays represent a marked departure from the first two years of the Obama presidency, when the E.P.A. moved quickly to reverse one Bush environmental policy after another. Administration officials now face the question of whether in their zeal to undo the Bush agenda they reached too far and provoked an unmanageable political backlash.

Finally! The light dawns. As I showed in my recent PPI policy memo, the regulatory burden actually rose under George Bush, with most but not all of the increase concentrated in homeland security. The Obama Administration then ladled another hefty layer of regulation on top of the Bush regulatory burden. Let me reproduce a chart from the memo.

The problem is that adding more regulations in a period of weak economic and job growth is precisely the wrong thing to do, and people know it in their hearts. If Obama really wants to support jobs and innovation now, he can’t be regulating willy-nilly.

That suggests the correct middle ground is pro-growth, pro-fairness, and sane regulation.

Wrong Diagnosis

An unsigned editorial in today’s NYT diagnosed the economy’s problem’s thusly:

The economy’s central problem is not lack of money to hire workers or make loans or rates that are too high. It is lack of hiring and lack of lending, despite cash cushions at many corporations and big banks and rates that are already very low.

Hmmm….that’s like saying the problem with the poor is that they don’t have enough money.

I’d say the economy’s central problem is a lack of innovation (with the exception of  the communication sector), combined with an increasingly oppressive regulatory structure.  Both of these combine to lower the expected rate of return from domestic investments, both for big and small businesses.

To solve these problems, we have to go beyond  monetary and fiscal policy, which have served their purpose of blunting the downturn. We have to develop regulatory policies that protect the vulnerable, while still leaving the room and incentives for innovation and growth.  We need to use the capabilities provided by our information society to better focus the regulatory apparatus, and turn it from a hammer, which it is today,  into a fine-edged scalpel.



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