On the Future of Capitalism: The Great Stagnation?

Tyler Cowen has produced some interesting concepts in his book The Great Stagnation. He provides a rather explicit subtitle that indicates quite well where he is headed: How America Ate All the Low-Hanging Fruit of Modern History, Got Sick, and Will (Eventually) Feel Better. Cowen advances the notion that the US and other advanced economies have been facing slower growth over the past few decades because they have consumed the available benefits from a collection of unique circumstances and technological advances, while failing to develop sufficient new innovations to maintain the necessary economic expansion. This slowdown in growth is said to be the cause of changes in our economy that have focused energies in directions that have not been beneficial. A major change has been in the increasing precedence of what he refers to as "private goods" over "public goods."
"Contemporary innovation often takes the form of expanding positions of economic and political privilege, extracting resources from the government by lobbying, seeking the sometimes extreme protections of intellectual property laws, and producing goods that are exclusive or status related rather than universal, private rather than public; think twenty-five seasons of new, fall season Gucci handbags."

Cowen talks about a "slowdown in ideas production" and complains about too much innovation focused on "private goods" in the same breath, leaving the reader a bit confused. In any event, the lack of what might be termed "good innovation" is claimed to be the source of all our problems.

"The slowdown in ideas production mirrors the well-known rise in income inequality. Labor and capital are fairly plentiful in today’s global economy, and so their returns have been somewhat stagnant. Valuable new ideas have become quite scarce, and so the small number of people who hold the rights to new ideas—whether it be the useful Facebook or the more dubious forms of mortgage-backed securities—earned higher relative returns than in earlier periods. The ‘rise in income inequality’ and the ‘slowdown in ideas production’ are two ways of describing the same phenomenon, namely that current innovation is more geared to private goods than to public goods....That simple observation ties together the three major macroeconomic events of our time: growing income inequality, stagnant medium income, and....the financial crisis."

The historical picture Cowen presents is similar, in effect, to that provided by Brink Lindsey in his description of society evolving into a mode where it is driven by what he refers to as "frontier economics." We described and discussed Lindsey’s ideas in On the Future of Capitalism: Frontier Economics? Although the evolution and end point is essentially the same in the two authors’ presentations, the causes and implications are quite different.

Cowen provides a plot of median family income between 1947 and 2007. The curve turns over in the mid 1970s and begins to grow at a much smaller rate. He uses this behavior to pinpoint 1973 as the end of the "era of the low hanging fruit." He further states that medium income is "the best measure of how much we are producing new ideas that benefit most of the American population." The cause of lower income growth is then the great stagnation to which he refers. His claim is that this trend can be reversed by the next great wave of innovation which he expects to occur at any time now.

Instead of using Cowen’s chart, let’s look at an equivalent representation that plots income versus productivity over the same time period.

Income and productivity track each other until around 1975 when income begins to fall while productivity continues to climb. Is it really obvious that one can claim a deficit in innovation and a strong gain in productivity? Can this trend be changed by becoming more innovative again as Cowen claims?

Lindsey would look at this chart and claim that around 1973 is when we began to fulfill the needs required by the great mass markets of food, clothing, shelter and transportation, and the economy began to evolve in a different direction. He would say that saturation of these dominant areas led innovators to look for smaller, more specialized markets, where rapid turnaround and low up-front capitalization where important. Another way to say this is that we transitioned from an economy where the fundamental needs of the population had to be met, to one in which products had to be created and marketed that were not a fundamental need. This is a true inflection point in the evolution of the economy and in the evolution of capitalism. Lindsey does not go into detail about the feedback on income growth, but his general assessment seems intuitively more correct than that of Cowen.

There is another approach to discussing this inflection point in the economy. Robert Reich, in his book, Aftershock: The Next Economy and America’s Future, provides a similar graph to the one above—one that better illustrates what he thinks is occurring. Reich plots productivity versus average hourly compensation. Hourly compensation falls off even more quickly than median income. Around the mid-70s is the period when outsourcing of manufacturing to low-wage countries began to be significant, and it is also the time when increased automation in our factories began to eliminate human jobs.

Reich does not deny that off-shoring was important, but he points out that unemployment remained at a modest level up until the last few years, so the economy continued to create jobs, but they were lower paying jobs. Automation certainly played a significant role in this trend as manufacturing output continued to climb while manufacturing employment continued to fall. Reich also believes that the fall in wages that accompanied the continued creation of jobs was due more to socio-political factors than to purely economic issues.

Reich describes the years 1947-1975 as "The Great Prosperity." He describes the subsequent years as the time when Washington broke "the social contract." In his view it was a time when many social functions were privatized, unions were attacked, payroll and sales taxes where raised on the middle and lower classes while income tax was lowered for the upper income earners. In addition the government

"....increased the cost of public education, reduced job training, cut public transportation, and allowed bridges, ports, and highways to corrode. It shredded safety nets—reducing aid to jobless families with children, and restricting those eligible for unemployment insurance so much that by 2007 only 40 percent of the unemployed were covered."

Whether one fully agrees with Reich’s assessment or not, he is correct in pointing out that fundamental changes occurred in society and in the economy starting in the mid-70s. Reich’s book is discussed here for those who wish more information.

Cowen’s attempt to blame the ills of the economy on innovation stagnation seems a bit muddled. It is difficult to claim that there is a lack of innovation when one sees new products, and even new industries, come and go in the bat of an eye. Cowen has to resort to defining good innovation and not-good innovation—a rather artificial distinction. His assumption that there will be great new innovations that will redistribute wealth and great new jobs for all is presented as a matter of faith. A compelling example to look forward to might have helped the unconvinced.

The arguments of Lindsey and Reich that a fundamental transition has occurred seem more compelling. It is more intuitively correct to assume we are in a period of high innovation, but in an era when innovation leads to work savings and thus the elimination or downgrading of labor. Think of manufacturing and automation as an example. Think of computers and software doing rapidly the work that was once done slowly by legions of individuals. One person can produce software that can eliminate thousands of jobs.

This discussion leads inexorably to the overarching question of what is to be the role of government in its evolving partnership with capitalism? Cowen, whether he admits it or not, will need massive intervention by government, both in funding and in planning, if he is to see the type of innovation he is hoping for. Reich will certainly need government action to restore his social contract. Lindsey believes a hands-off approach must be taken by government for the economy to run efficiently. We will come back to this issue as we pursue further the possible futures we face.