We’re in a Low-Growth World. Is This Really the Economic Problem?


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We’re in a low-growth world. We are being told that we need more growth. So say traditional and establishment economists who are published in mainstream media. But is growth really the answer?

“This [slow growth] trend helps explain why incomes have risen so slowly since the turn of the century, especially for those who are not top earners,” declares Neil Irwin in an article in The New York Times (NYT).

GDP GROWTH THEORY

GDP (Gross Domestic Product) growth forces employers to hire more workers. Competition for labor among producers creates upward pressure on wages. As a result, people make more money. People who make more money demand more goods. Demand for more goods raises production more. This is still good theory and very simple economics. But there is much more to the story.

AN EXERCISE IN LINE DRAWING

The NYT article declares: “This slow growth is not some new phenomenon, but rather the way it has been for 15 years and counting. In the United States, per-person gross domestic product rose by an average of 2.2 percent a year from 1947 through 2000 — but starting in 2001 has averaged only 0.9 percent.”

Neil Irwin uses GDP per person. While this is a fine adjustment to make, we are going to use the more familiar GDP numbers without this adjustment. Either way, the relationships are the same.

In the 1980’s and 1990’s, GDP growth rates averaged 3.4 percent and 3.7 percent respectively — not exactly slouchy. Since 2001, average growth has been 1.7 percent — slouchy! It appears at first that Neil Irwin may be correct. But something more important took place about 20 years earlier. Productivity started growing faster than wages.

PRODUCTIVITY THEORY

As productivity increases, the demand for the labor to make each unit of output falls. Productivity lowers demand for labor and reduces or reverses pressure upon wages. As the labor participation rate falls, the pressure on wages heads toward a vanishing point, almost regardless of other economic forces.

PRODUCTIVITY AND WAGES BECOME DISCONNECTED

This is exactly what we have seen. Productivity has increased remarkably fast. Wages have not. The ability to supply things went way up while the ability to buy things for cash went way down. Take a look at this well-known chart from the House of Debt blog.

Productivity and household income separated just about the time of the ‘Reagan revolution.’ Productivity rose faster, while income remained little more than steady. This separation of factors came about in the new era of deregulation, consolidation and tax cuts. The wealthiest people gained more, while the labor force struggled for very small gains.

Two things would have prevented these tough economic times. First, wages should have kept up with productivity. Second, massive tax cuts should not have been given to the richest people.

SOURCES OF GROWTH IN THE 1980’s AND 1990’s

At the same time, The federal government binged on massive deficit spending and credit was expanded. Government infused the economy with trillions of dollars and there was more credit available, spurring growth. Despite these infusions, GDP growth of 3.4 percent in the 1980’s was slower than in the prior decades — including the 1970’s when average growth was 3.7 percent. Things seemed to improve in the late 1990’s, with average GDP growth recovering.

THE COMPUTER REVOLUTION

When the ‘computer revolution’ made the economy boom, it appeared to some that a brief slowdown in the economy was over. In reality, the computer boom was the anomaly, and the slow times would return. The computer revolution quickly matured, a wave of consolidation followed, and the trend of increasing disparity from the preceding years quickly returned. Government debt exhausted its usefulness while credit became too big to extend anymore.

TAX CUTS AND IDLE MONEY

Despite the exhaustion of Reagan policies, two more monumental tax cuts occurred, first in 2001 then in 2003. These tax cuts mostly benefited the richest people and created a pot with trillions of dollars of ‘idle money’ lying around. Supposedly, this money was to be used for investments in production that would trickle down to the masses.

TAX CUTS AND BUBBLES

In reality, the tax cuts brought additional harm upon the economy not only in the United States, but around the world. The excessive investment money was used to inflate asset bubbles in one industry or commodity after another, bouncing around causing havoc and unpredictability throughout the economy. The money was used to consolidate deregulated industries [PDF], reducing competition and allowing for entities that were “too big to fail.” After a brief period of surplus, federal deficits returned with vengeance.

Many of these activities were included in GDP figures, inflating growth rates by including transactions that were little more than large sums of money moving around regardless of increasing production or demand. In fact, only about 12 percent of the United States economy is “productive labor” as the father of economics Adam Smith would say.

Incredibly, those who received the tax cuts also benefited by investing in treasury notes, profiting off of the very government debt that the tax cuts created.

THE PULLED CARPET TRICK

The tax cuts that were supposed to save the economy did the opposite. Debt was growing everywhere. Then, suddenly, stock market plummeted and those who were creating the debt decided it was time to pull back on the excessive lending. The 2008 crash was the result.

Two things would have prevented these tough economic times. First, wages should have kept up with productivity. Second, massive tax cuts should not have been given to the richest people. But few of the highly-paid media “economists” were very worried. For example, Neil Irwin is still of the view that “growth” is the answer… But first, a note on Say’s Law.

NOTE ON SAY’S LAW

In his NYT article, Neil Irwin mentions the old economic hypothesisSay’s Law.”

“Say’s Law” is the notion that supply creates its own demand. Say’s Law is built upon the premise that income equals expenditures. When an investor builds something, they have to pay. The people who they pay then have money to buy the stuff. This stimulates the economy.

In a nutshell, Say’s Law assumes that producers have magic powers to always know exactly what people want and that they build precisely that. If we build it they will come! Say’s Law also assumes that costs of building the stuff are always magically distributed to those who would buy the stuff. Neither of these assumptions are true — both can and do fail often. The lower the growth, the more these expectations fail.

But Say’s Law will continue being refined and advertised because people with big money want to keep or add to their personal piles; and they have the media resources, the think-tanks, and the paid “economists” to popularize it.

GROWTH IS NOT THE ANSWER

Despite the average 3.5 growth rates of the 1980’s and 1990’s, spending power fell. As the numbers tell us now, the economy would require sustained or average growth rates over four percent — as we saw between 1997 and 2000. Given productivity increases and diminishing wage returns following these gains, such growth rates would be virtually impossible to sustain.

WHAT WILL ACTUALLY HELP

Neil Irwin points out the idea of an ‘inverted’ Say’s Law: “Lack of demand creates lack of supply,” as described by Larry Summers. Neil Irwin notes that the “case [for the inverted rule] has become stronger in the last three years.”

However, he concludes the NYT article in confusion: “there’s a lot we don’t know about the economic future. What we do know is that if something doesn’t change from the recent trend, the 21st century will be a gloomy one.”

To clear up the confusion, consider increasing the tax rates on rich people and increasing the wages of workers to close the 35 year productivity-wage gap. We could also break up some of these giant conglomerates and restore real competition.

Featured picture background credit.