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December 8, 2013
David Warsh, Proprietor


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Remember the Headwinds

The news finally seemed better than expected.  The US economy added 200,000 jobs in November, for the second month in a row. The unemployment rate dipped to 7 percent, down from its peak of 10 percent, in October 2009.

Mohamed El-Erian, the investment manager who in 2009 coined the useful term “the new normal” to describe the period of high unemployment, slow growth, and government debt problems that he expected to last from three to five years, shifted gears last week in his annual review as chief executive of the giant Pimcofirm.

“The ‘new normal’ allowed time for the corporate sector to heal, for the housing sector to heal, and that’s positive. That’s how you come out of [it]’” El-Erian told interviewers. What’s next, for those with money in the markets?  He expects three to five years of “stable disequilibrium” – a less catchy way of saying, “We don’t know.”

Alas, for the vast majority of Americans, the outlook may be a good deal more certain than that.

The idea that the 2007-08 financial crisis would be followed by years of sluggish growth has been around for a while. In early 2009, Carmen Reinhart and Kenneth Rogoff, both of Harvard University, were the first to warn, based mainly on the patterns of the past, that deep financial crises typically seemed to take five to seven years before growth returned to a normal rate.

Then in 2012, Robert G. Gordon, of Northwestern University, a long-time member of the National Bureau of Economic Research Business Cycle Dating Committee, ventured a shocking prediction: that while real disposable-income growth would continue to grow for the US as a whole, albeit more slowly than the century before, with outsize gains continuing to flow to superstars of various sorts, the bottom 99 percent of the population could expect to see income growth virtually disappear for a generation or more.

In a widely discussed paper, Is US Economic Growth Over? Faltering Innovation Confronts the Six Headwinds, Gordon estimated that, owing to a combination of six economic “headwinds,” per capita disposable income growth for 99 percent of Americans would average 0.2 percent a year for the next 25 to 40 years, as opposed to the 2 percent per year increase that was normal from 1891 to 2007.

That put in the shade talk about the possibility of a “lost decade,” to be remedied by the application of more governmental “stimulus.” Recently former White House chief economist Lawrence Summers has speculated about the possibility of “secular stagnation,” meaning a long-term future in which, for one reason or another, borrowing at low rates of interest would be insufficient to sustain growth.

President Obama last week sought to shift attention to the minimum wage and called income inequality and decreased mobility a “fundamental threat” to American prosperity.  His long, complicated speech, delivered to a friendly audience at the Center for American Progress, was clearly a rehearsal of next month’s State of the Union address.

Four of Gordon’s six headwinds facing the US economy are the stuff of standard national income accounting. They derive directly from the definitions that relate the standard of living to productivity; they boil down therefore to simple arithmetic.

They include:

demographic trends (Baby Boom retirements alone will drag down hours per capita for a quarter of a century, at least until 2034);

educational stagnation (between 1890 and 1970, the high school movement and the GI Bill added nearly a year of educational attainment per decade to the national average, but there’s been little gain since then, thanks to rising drop-out rates and higher ed cost inflation);

surging inequality (between 1993 and 2008, real income increased 1.3 percent a year for the population as a whole; but barely half a percent annually for the bottom 99 percent);

looming debt (stabilization of the debt-to-GDP ratio, especially at lower growth rates, implies higher taxes and lower benefits for the bottom 99 percent, reducing the growth of disposable income).

Subtracting arithmetic calculations of the drag on historic growth of two percent implied by each of the headwinds, Gordon arrived at an estimate of 0.8 percent as the prospect for disposable-income growth in the foreseeable future.  He added two other, more diffuse considerations, globalization and energy/climate concerns, as headwinds whose effects are not easily quantified. Recently, he began talking about medical care as yet another burden on US growth,  compared to European nations, which that spend as little as half as much. My hunch is that the storm-damaged banking system also belongs on the list. But none of these figure in his calculations.

The single biggest factor in Gordon’s pessimism is also the most controversial:  the penalty to future growth he expects will be imposed by the general “innovation slowdown” that he perceives to have begun around 1970. A slowdown in the contribution of technology to productivity these last fifty years?  How can that possibly be?

The comparison is with the century before. Gordon, an expert in the economics of technological change, counts five major innovation clusters that, when linked together, produced the consistent income gains of the years between 1891 and 2007 – electricity; motor vehicles; running water and sewers; advances in information-communication-entertainment technologies; and changes in working conditions produced by heating and air conditioning.

This juxtaposition of the effects of a Second Industrial Revolution that is now disappearing into history with what is today pretty clearly a Third Industrial Revolution, built on the computer, the satellite and the Internet, is a fascinating topic. For instance, will innovation over the next forty years keep up with the pace of advance of the last forty? What will robots, driverless cars, 3-D printing, and molecular medicine do for the 99 percent?  What about the economic response to climate change?

Technological forecasting is, however, a distraction from the cold, hard, arithmetic of Gordon’s “headwinds” accounting.  After calculations he describes as conservative, he subtracts another 0.6 percent for the innovation slowdown from the accustomed century-long 2.0 percent growth rate – his 0.8 forecast minus 0.6 percent leaves only 0.2 percent annual growth of real disposable income.  That would be an order of magnitude less than that experienced by generations of Americans (the 99 percent, that is), at least since 1891.

Last week Gordon was in New York, talking to the Group of Thirty about the reaction in the year since his “End of Growth?” paper appeared.  He promises a new version soon. It takes time to re-focus the narrative. So if you are interested in the elections of 2014, 2016, and beyond, Obama’s speech on income mobility was the real news last week.

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One Comment

  1. Adam_Smith wrote:

    “… Lawrence Summers has speculated about the possibility of ‘secular stagnation,’ meaning a long-term future in which, for one reason or another, borrowing at low rates of interest would be insufficient to sustain growth.”

    Not only is it insufficient but increases in household debt, inhibiting demand, becomes part of the problem. Meanwhile excess liquidity flows into bubble creating speculation. I personally find it hard to understand why smart professional economists have been so slow to understand this dynamic. It could be because debt as stimulus has been so accepted for so long that an old habit of thought has become hard to break.

    Monday, December 9, 2013 at 2:29 pm | Permalink

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  1. Links for 12-09-2013 | The Penn Ave Post on Monday, December 9, 2013 at 8:14 am

    […] at 4:16 on December 9, 2013 by Mark Thoma Remember the Headwinds – Economic Principals Austan Goolsbee: Pre-K Education Is a Long-Term Winner – WSJ.com […]

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