Wednesday, 19 March 2014

THE GREAT STAGNATION AND WHY IT'S WRONG


In the same vein as my previous blog-posts on Pr. Kimball's ideas (i.e. writing about authors I respect but disagree with), I would like to talk about Pr. Tyler Cowen's ideas, notably about his Great Stagnation thesis.


I will be concentrating on 'The Great Stagnation' rather than Pr. Cowen's more recent work 'Average is Over' for two reasons. First, because I actually read 'The Great Stagnation'. 

And, second, because I think 'Average is Over' is mostly right: If we do nothing, our future will probably look something like what Pr. Cowen is describing i.e. a world with a tiny wealthy elite and most of the rest scrambling for scraps. After all, this is already our world right now and it was our world for most of Humanity's history... My only criticism would be that this has nothing to do with technology per se and everything to do with how we organise ourselves...

But, if 'Average is Over' is simply projecting existing trends a bit further into the future, 'The Great Stagnation' is an attempt to explain how we got there in the first place and it is thus far more interesting.

It is also wrong.


Pr. Cowen actually displays the following graph in his book and proposes to explain the drop in median income growth with a nice story about technology.



Let's summarise his thesis. From one of the reviewer: "Since 1973 or thereabouts, there has been a slowdown in median American income growth, and that trend has increased in the past decade. That slowdown is mostly attributable to a decline in technological innovation. We've reaped the gains of past innovations -- cars, planes, electricity, plumbing -- but haven't made many new ones. We tweak the old innovations to our advantage -- we've made cars safer and added GPS -- but those are marginal improvements, not fundamental advances. The exception is the internet and communications more generally, but while those improve quality of life they do little to improve typical incomes".

Pr. Cowen calls those past innovations and advantages (such as 'free' land for the USA, moving from an uneducated workforce to a better educated one across the western world and cheap oil) as "low hanging fruits" and describe them as yielding out-sized returns.

This description may seem superficially correct. After all, Bernanke agrees too. More has changed between 1905 and 1960 than between 1960 and 2015.

Or has it?

For example, electricity was first discovered in high Antiquity but a usual starting point when discussing this discovery is  Benjamin Franklin's experiment with kite and lightening - That's in 1752. Alessandro Volta invented the voltaic pile in 1800.

Most would say that electricity became viable for technological use with Faraday and his dynamo. That was 1831. Thomas Edison and Joseph Swan each invented the incandescent filament light bulb around 1878.

Yet some parts of the rural USA had to wait till the 1960s to be electrified...

I would imagine that Tyler Cowen would include electricity as a 'low hanging fruit' and yet, it took the USA between a 100 to 200 years from its discovery to its fully realised exploitation.

The same could be said about almost any other 'low hanging fruit' Tyler Cowen mentions.

Free land? It took ages and ages for the Europeans to invade and kill their way across the American continent, let alone properly exploit its vastness.

Education? In the USA, the first tax-supported public school was in Dedham, Massachusetts in 1644. According to Wikipedia, by the 1870s, all states had free elementary schools. By 1900, 34 states had compulsory schooling laws, up to 14 years old for 30 of them...

Etc, etc.

In reality, those 'over-sized returns' Tyler Cowen mentions were not hanging particularly low as far as our ancestors were concerned and thus their benefits were spread out over time. 

Indeed, I was taught that technological leaders (first, the UK then the USA) rarely grow faster than 2% for any amount of time. By definition, as Tyler Cowen points out, catch-up growth is unavailable to them. And the data confirms what my professors told me:



There are variations around the trend-line but no explosive 'boom' followed by a massive slow-down. You'll notice that's basically the same GDP per capita line as in Pr. Cowen's own graph...

The reality is that, whatever we may feel about the modern world, its comparison with the 1910s and with the future-that-never-was...



or with the 1960s and its paleofuture...




... Progress never stopped.

Or, as we will see, it stopped... but only in two very specific areas. For the GDP-per-capita line isn't the only line in Pr. Cowen.

And that income growth line certainly stopped. And, because Pr. Cowen assumes that income is linked intrinsically to productivity, he looks for a story about productivity and technology.

But the link between productivity gains and income growth ISN'T a law of Nature. It is dependent on the institutional set-up!

Indeed, looking at the same graph, Pr. Cowen decides that the story is in the stunted income growth line and goes looking for a Supply-side explanation. He more or less seems to ignore the GDP line.

Me, I look at the near perfectly smooth GDP-per-capita line and its gap with the income growth line and the only explanations that can fit this divergence are institutional/Demand-side explanations.

We aren't poorer than in the 1970s. Our GDP per capita, however flawed its calculations, tells us that our capacity for output has kept on rising.

What has NOT kept on rising is our income. That's a political/institutional 'choice'. To go looking for a supply side explanation in this case seems just perverse.

Now, I will concede that there is an interesting graph that has done the rounds on econo-blogs before (I have used it myself) and that is more supportive of Tyler Cowen's hypothesis.




If you look at the productivity for durables, there's been no Great Stagnation whatsoever. We've kept on getting better at producing durable goods at the same speed we've always been getting better at.

The same cannot be said about the non-durables. This is what I meant about progress having stopped in two areas: We stopped being able to distribute productivity gains to the majority of people (that's the stunted median income growth line in Cowen's graph) and, arguably, we've stopped getting better at delivering non-durables.

But the significance of this TFP slow-down in non-durable goods is actually unclear. It certainly does not mean that technological progress is slowing down. It doesn't even mean that growth or output capacity is slowing down.

So, in conclusion, while that non-durable TFP growth certainly look like something worth investigating, it doesn't change my basic point: Pr. Cowen is wrong about his Great Stagnation hypothesis in 2 particulars: Technological innovation did not decline (GDP per capita graph) and the slowdown in median income growth is a consequence of our institutional set-up, not of stagnating productivity.





Now, I don't pretend I will be teaching Pr. Cowen anything he doesn't know. I suspect that, apart from my own story telling about his 'low hanging fruits' not being particularly low, nothing I said above is exactly an original criticism of his thesis so he must be fully aware of it.

But I would really want him to explain why he thinks that I, and all the others who see these graphs the way I do, are wrong. I am a regular reader on Marginal Revolution (link on the side) and I haven't seen any further explanations. Maybe this blog-post will tempt him out of his cautious reserve?