What are the implications of declining productivity growth in high-income countries?

The graph shown above indicates that productivity growth rates in high-income countries have declined. That decline seems evident even if we disregard the low productivity growth in the years immediately following the global financial crisis. (Selection of high-income countries for inclusion in the graph was based largely on aggregate GDP.)

The productivity indicator used in the graph - multifactor productivity (MFP) – is that part of GDP growth that cannot be explained by changes in labour and capital inputs. It reflects the influence of technological progress and production efficiency.

The most obvious implication of a decline in MFP growth rates is a lower rate of growth in per capita incomes. Declines in MFP growth are sometimes offset by more rapid growth of employment, through higher immigration, or more rapid growth of capital stock, through higher investment levels. However, such offsetting factors are not sustainable over the longer term.

In most instances, and in the longer term, it seems reasonable to expect a ½ percent lower rate of growth in MPF to be reflected in a ½ percent lower rate of growth in average incomes. Over 10 years, a decline in average income growth from, say, 2 percent per annum to 1.5 percent per annum would amount to the difference between a 22 percent and 16 percent increase in income.

That is not negligible, but it doesn’t cause me a great deal of angst. As noted previously on this blog (in a post written when I was more sceptical about the number of countries experiencing a decline in productivity growth) the slow-down in measured productivity growth in the U.S. and some other countries may be attributable, in part, to difficulty in measuring the outputs of the information and communications technologies (ICT) industries. When consumers can download more stuff that they do not have to pay for, the quality of their lives improves, even though that isn’t reflected in average income and consumption measurements.

It is also likely that some part of the decline in measured productivity growth may be attributable to environmental and social regulation. I am sceptical about the merits of much of that regulation, but I acknowledge that some of it provides benefits to humans that should be offset against associated income losses.

However, there is an implication of declining productivity growth that governments and their dependents should be thinking more seriously about. That is the potential for revenue growth to decline. Unless the revenue to GDP ratio is raised, a lower rate of growth of MFP is likely to translate to lower growth of government revenue. (Note that the same difficulty in measuring the outputs of the ITC industries for productivity estimation also applies to measuring income, sales and value added for tax purposes.)

Lower revenue growth has interesting implications in the context of expected ongoing increases in government spending. As previously discussed on this blog, under existing programs, substantial increases in government spending seem likely to occur as the proportion of elderly people in the populations of many countries continues to rise.

So, why not raise the revenue to GDP ratio by changing the tax mix in favour of more efficient taxes that have less adverse effects on economic incentives? The political obstacles to tax reforms have not always been insuperable, but revenue-raising reform proposals are less likely to be supported than revenue-neutral proposals.

Another option is to raise the revenue to GDP ratio by raising tax rates. That is also likely to encounter political obstacles but, more importantly, the adverse effects on incentives seem likely to further reduce productivity growth. The marginal excess burden of taxes tends to rise as the tax rate is increased (see discussion here).

Yet another option is to let public debt continue to rise and hope debt servicing doesn’t become too much of a problem. We may actually see some problems emerging with that strategy over the next few years with increased public debt incurred in response to COVID-19. Perhaps central banks will succumb to government urging to over-stimulate economies to allow the “inflation tax” to reduce debt to GDP ratios. However, that would make ongoing debt accumulation a more costly strategy because it would result in high interest rates and thus higher costs of debt servicing over the longer term.

We haven’t considered debt default, but you have to be desperate to consider that!

My point is that governments and their dependents do not have any easy options available to adjust to an ongoing decline in productivity growth.

Economists advising governments will likely suggest that the best way forward is adoption of a package of reforms (including tax reforms) to raise productivity growth, combined with action to prune government spending. What governments will do, however, will depend to a large extent on the relative political power of different interest groups. In most countries, that seems to me likely to point more toward spending cuts than toward productivity-increasing reforms.

So, it seems reasonable to speculate that declining growth in productivity will be ongoing and result in cuts in government spending in policy areas where political resistance is likely to be weakest. Which policy areas are likely to be most affected?

What are innovation commons?

“An innovation commons is a system of rules for cooperation to facilitate pooling of information in order to maximize the likelihood of opportunity discovery”. That is how Jason Potts defines innovation commons in his book of that name.

Hopefully, that brings to mind hobbyists meeting in coffee shops, somewhere on the internet, or at backyard barbecues where they are tasting home brews and exchanging information about recipes. If so, you are on the track toward an understanding of innovation commons. If you have heard stories of successful entrepreneurs who obtained their most valuable ideas by interacting in similar ways, you might sense that innovative commons can be very important.

It might surprise you to learn that until recently few economists understandood the importance of innovation commons. Of course, those with an interest in technology would have read at some stage that Steve Jobs was once a member of the Homebrew Computer Club, and know of similar stories about other entrepreneurs who started as hobbyists or enthusiasts exchanging information freely with people with similar interests. However, it is one thing to know such stories and something quite different to realize that your professional understanding of the innovation process needs an overhaul.

Economists have thought of innovation in several different ways that view a single organization or individual as a prime mover. Innovative firms allocate resources to research and development, which leads to the launching of new products or adoption of cost-reducing technologies. Joseph Schumpeter’s bold entrepreneurs play the central role in innovation, leading to a dynamic process of creative destruction. Israel Kirzner’s innovative entrepreneurs are alert to profit opportunities. Edmund Phelps’ grassroots innovators are struck by new ideas, and then become investigators, experimenters and managers of innovation.

You might think that economists should be excused for overlooking the importance of innovative commons because they are a relatively new phenomenon. Jason Potts makes the point that common-pool innovation has existed since the beginning of market capitalism. He cites discussion of the Republic of Letters by Joel Mokyr, an economic historian. The Republic of Letters set up norms and incentives that supported a market place of ideas among the educated elite in Europe in the latter part of the 17^th and early part of the 18^th centuries (for a brief summary see my review of The Culture of Growth). In The Enlighted Economy, Mokyr makes a strong case that in Britain during the 18^th century the ‘legitimization of systematic experiment carried over to the realm of technology’. He suggests that the proliferation of provincial ‘philosophical’ societies discussing practical and technical issues often served as clearing houses for useful knowledge between natural philosophers, engineers and entrepreneurs (p 48).

Recent examples of areas of technology where innovation commons are important include blockchain, civilian drone technology, AI and gene editing.

Jason Potts’ own innovative contribution has been to develop an economic framework to explore the collaborative processes through which information comes to be available in a form that a potential entrepreneur can discern as a profit opportunity, if sufficiently alert. The framework Jason has developed contributes to understanding of the knowledge, coordination and governance problems associated with innovation commons. In developing that framework, he draws heavily on insights of Friedrich Hayek about the importance of distributed knowledge, and insights of Elinor Ostrom about governance of commons.

Innovation involves a knowledge problem because relevant information is distributed so that each person with relevant expertise can only know part of the picture, and there is great uncertainty about how that information might be useful. Innovation commons enable individuals with expertise to cooperate to pool information and discover opportunities. The formation of such commons is ad hoc and rules for governance develop spontaneously to promote cooperation.

Innovation commons tend to be temporary. Once they have created information about entrepreneurial opportunities, that valuable resource is likely to be exploited by some member who can effectively capitalize on it. At that point the conventional model of entrepreneurship comes into its own, and the commons collapses to some other institutional or organizational form.

Much of the book is taken up by discussion of rules of innovation commons, institutions such as industry organisations and a critique of conventional approaches to innovation policy (public investment in innovation and building infrastructure for innovation).

There is also an interesting discussion of ways to combat an increasing tendency for enemies of innovation to prevent it, thus contributing to a slowdown in productivity growth, particularly at the technology frontier. The enemies of innovation present themselves as having concerns with safety, sustainability, tradition, fairness, justice etc. even when their intention is to avoid the losses they are likely to incur from disruption of existing technology.

Who will engage those enemies? This is a collective action problem: the costs are borne individually, but the benefits are an industry-specific public good that accrue to all who follow.

In some instances, the first mover can capture sufficient benefits to make it worthwhile to engage the enemies of innovation. Uber may have done that with its ride-sharing technology.

Jason suggests that governments may also help. One role he suggests is promoting collective learning to demystify a new technology. He mentions public broadcasting in that context, but public broadcasters seem to have been more comfortable helping the enemies of innovation. At a more ambitious level, he suggests that governments should work toward “a social contract, culture and institutional system that are tolerant of innovation and prepared to engage with its enemies”. Good luck with that!

Jason also suggests that innovative commons can play a role in creating a large pool of participatory stakeholders, each with a vested interest in developing the technology and its institutional (regulatory) framework. Examples include open-source software and technologies that have emerged from hackerspaces, such as 3D printing and cryptocurrencies.

Are innovative commons likely to result in a fundamental change in society?

Jason Potts’ answer:

“The innovation commons—including the adaptive behaviors and the institutions that compose it—are … a natural part of an open, evolving, market economy. They are not prima facie evidence of an emerging turn to a new type of more cooperative economic society.”

That is probably right! Nevertheless, as previously discussed here, it is possible to conceive of circumstances in which new technologies that are evolving in innovation commons - blockchain technology and decentralized collaborative organizations – could result in some quite fundamental changes in society.

Is cultural change responsible for a long term decline in productivity growth?

The story of cultural change that Edmund Phelps tells in Mass Flourishing has a happy beginning and a sad ending.

Phelps’ cultural story of the advent of rapid economic growth in Britain and America in the 19^th century is much like that of Joel Mokyr and Deidre McCloskey (discussed here and here). The main difference is Phelps’ greater emphasis on grassroots innovation within firms.

Phelps makes a strong case that Joseph Schumpeter, famous for his theory of entrepreneurship, over-emphasized the importance of exogenous scientific discoveries (external to innovating firms) as a source of innovation. Phelps probably goes too far in downplaying scientific advances, but his story about the importance of grassroots innovation to the emerging modern economies seems highly plausible. He suggests:

“a modern economy turns people who are close to the economy, where they are apt to be struck by new commercial ideas, into the investigators and experimenters who manage the innovation process from development and, in many cases, adoption as well” (p 26).

Phelps describes a modern economy as “a vast imaginarium – a space for imagining new products and methods, imagining how they might be made, imagining how they might be used” (p 27).

A substantial part of the book is devoted to a discussion of socialism, as practiced in the Soviet Union, and corporatism, as practiced in Italy and Germany in the 1930s. The contemporary relevance of that discussion become relevant later in the book in his discussion of reasons for the decline in productivity growth that seems to have occurred in the U.S. since the 1960s.

Phelps’ focus on the U.S. economy as the main driver of technological progress seems appropriate. He notes that European countries experienced high productivity growth while playing the technological catch-up game, but their productivity growth has generally been lower than in the U.S. in recent decades. He attributes their lack of dynamism to ongoing corporatism over the decades since World War II. The classical corporatist model - involving state direction of industry and promotion of solidarity and social responsibility – has been augmented with codetermination of labour and capital (instead of owner-control) and stakeholderism (instead of a focus on income generation).

The author suggests that corporatism has also grown in the United States. Industries that have been subject to government policy interventions have been affected by a new populist type of corporatism as businesses have sought to use their political influence to mould government regulation to their advantage. The result is a “densely interconnected system of mutually beneficial relationships between private and public’, which tends “to redirect the economy’s innovation toward politicians”. He notes that supporters refer to that system as industry policy and detractors refer to it as corporate welfare. It should be referred to as rent-seeking.

The cultural change that Phelps sees as leading to a decline in economic dynamism is not fully reflected in changes in economic freedom indexes. He sees a deterioration in the “core functioning” of modern economies. This involves, among other things:

• Managerialism, short-termism and the rise of a “money culture” in business, with wealth-seeking turning people away from innovation.
• A rise in the litigiousness of American society - people who devote their time and energy to suing one another have less time and energy for innovation.
• Excessive patent protection resulting in an economy clogged with patents – “a creator of a new method might require as many lawyers as engineers to proceed”.
• More people aspiring to attain social station rather than to achieve something.
• Adolescent culture – less willingness to accept temporary austerity in the quest for achievement; less ability to concentrate intensely (unable to resist distractions of social media).
• A resurgence of traditional values putting more pressure on business to allow people to work from home etc.

Has this cultural change in U.S. business caused a decline in the long-term productivity growth rate? If so, what can be done about it?

In a series of posts written in 2015, I was sceptical that there had been a decline in long term productivity growth. I suggested that the slow-down in measured productivity growth in the U.S. and some other countries may be attributable, in part, to difficulty in measuring the outputs of the information and communications technologies (ICT) industries. I also noted research findings suggesting a technological diffusion problem, rather than a slow-down in technological advances, with productivity growth of global frontier firms remaining relatively robust.

The addition of a few more years of data seems to lend support to the view of the historical pessimists that there has been a long-term decline in U.S. productivity growth. And Phelps’s cultural change explanation does seem plausible.

Unfortunately, the remedies that Phelps offers are less plausible. He suggests that governments can act to restore dynamism if they become aware of its importance and gain some practical knowledge of how innovation is generated. He suggests:

“Nations will have to push back against the resurgence of traditional values that have been suffocating in recent decades and revive the modern values that stirred people to go boldly forth toward lives of richness”.

Edmund Phelps seems to be hoping that a reinvented corporatism, perhaps inspired by the starship Enterprise, will foster grassroots innovation and be less prone to rent-seeking than the industry policies it replaces. Good luck with that!

I prefer to put my faith in the potential for new technologies to disrupt and subvert populist corporatism.

Which of the western democracies will be able to cope with future growth in government health spending?

The chart shows that those OECD countries with the greatest burden of debt servicing a decade ago have subsequently had the lowest growth in government spending. It isn’t hard to understand how that might happen when we think about the consequences of accumulating debt in our personal lives. If we go heavily into debt, a higher proportion of our income must be devoted to servicing debt and less is available for other spending. Our creditors are likely to be reluctant to extend further credit if they become concerned about our ability to service existing debt.

At a national level, there are additional complications including the potential for governments to inflate away the real value of debt denominated in local currency and possible ‘bailouts’ by the IMF and ECU. Nevertheless, governments that become poor credit risks must pay a higher risk premium than is normal for government bonds, in order to obtain access to additional credit.

There is evidence that rising government debt to GDP ratios are associated with lower economic growth, which in turn, leads to lower growth in government revenue. That obviously has potential to further squeeze non-interest government spending. The results of a recent study published by the Dallas Fed (‘Rising Public Debt to GDP Can Harm Economic Growth’, by Alexander Chudik, Kamiar Mohaddes, M. Hashem Pesaran and Mehdi Raissi) suggest that over the longer term persistent accumulation in debt as a percentage of GDP at an annual rate of 3 percent is eventually associated with annual GDP growth outcomes that are 0.2 to 0.3 percentage points lower on average. To put that in perspective, the average growth rate of OECD countries has been about 1.5 percent per annum over the last decade. Causality could run both ways. Lower GDP growth can lead to higher debt levels, which, in turn, can lead to lower economic growth.

You might be wondering why I think the chart shown above has much relevance for western democracies other than Greece, Italy and Portugal, which had high government debt servicing burdens a decade ago. The relevance stems partly from the continued increase in government debt as a percentage of GDP in most OECD countries over the last decade. On average, net financial liabilities of those countries have risen by around 23 percentage points of GDP over the last decade to around 67% of GDP in 2018.

Those looking for reasons to be complacent can obtain some reassurance from low world interest rates. With interest rates paid by governments lower than the rate of economic growth in most OECD countries, debt servicing is not yet a widespread problem. At current interest rates, it would be possible for the debt to GDP ratio to decline in most OECD countries, even if governments pay interest on their debts by borrowing additional funds.

How likely is it that world interest rates will remain at low levels over the next few decades? In their recent OECD paper, The Long View: Scenarios for the World Economy to 2060, Yvan Guillemette and David Turner suggest that relatively low growth in investment is likely to keep downward pressure on world interest rates, even though population ageing is likely to reduce savings rates. Nevertheless, they note evidence that reversals of the relationship between world interest rates and economic growth rates have been “fairly common” in the past. They warn that a sustained rise in interest rates relative to growth “could eventually make large debt stocks costly to service and unsustainable”.  Their projections suggest that some decline in economic growth rates is likely to occur in most parts of the world over the next 40 years.

My concerns about the potential for debt stocks to become costly to service in many more OECD countries are related to the implications for government spending of the ongoing increase in the proportion of elderly people in the populations of these countries. The implications of demographic change have been much talked about over the last few years, but the magnitude of the likely impact on government spending doesn’t yet seem to be widely appreciated. The study by Guillemette and Turner projects an increase in annual public health and pension spending of about 5 percentage points of GDP for the median OECD country between 2018 and 2060. The bulk of that increase is for public health spending, which is projected to continue to be pushed up by technological change and government health policies, as well as demographic factors.

The methodology used by Guillemette and Turner produces estimates of the increase in the revenue to GDP ratio needed to pay for projected government spending increases without any further increase in debt to GDP ratios. An increase in revenue as a percentage of GDP of 6.5 percentage points of GDP is projected to be required for the median OECD country over the period to 2060. A much larger increase is projected to be required in some countries. For example, the required increase in revenue for the U.S. is projected to be 10 percentage points of GDP.

I think the baseline scenario presented by Guillemette and Turner is too optimistic because their modelling takes no account of the disincentive effects of higher taxation on GDP growth. The possible magnitude of this excess burden of taxation is discussed in an Australian context in an article posted on this blog a few years ago.

Leaving that aside, it seems to me that ongoing increases in debt to GDP ratios - and hence substantial increases in government interest payments as a percentage of GDP - are a much more likely outcome in most OECD countries than tax increases in the years ahead. In those countries where debt servicing isn’t yet a problem, there seems likely to be much less political opposition to further increases in public debt than to tax increases. That suggests to me that over the next few decades most OECD countries are likely to increase their debt to GDP ratios until debt servicing does become a more widespread problem.

Guillemette and Turner present scenarios that would require smaller increases in government revenues than in the baseline (no-change) policy scenario, but those scenarios involve health policy and labour market reforms that have been difficult to achieve in the past. I don’t think we can expect voters to be any more supportive of reforms that could damage their short-term interests than they have been in the past. The best we can hope for is that when they see the writing on the wall, a sufficient proportion of voters in most countries will be supportive of political parties proposing economic reforms, rather than waiting until they are imposed by creditors (or institutions such as the ECB and IMF). In 2013 I wrote something here contrasting the responses of Sweden and Greece to fiscal crises, that illustrates the choices available.

The transition may be traumatic, but it seems likely that technological advances will provide options superior to government provision of many services in coming decades. What I have in mind particularly is the potential for blockchain to enhance opportunities to seek mutual benefit in voluntary cooperative enterprises, as previously discussed on this blog. That may create potential for functions to be transferred from the public sector to cooperative enterprises that can perform the functions more efficiently.

During the next few decades most of the western democracies seem likely to experience ongoing difficulty in coping with the additional government spending required to meet the health needs of the elderly.  The most likely outcome seems to me to be an increase in debt to GDP ratios that will result in more widespread debt servicing problems. It seems inevitable that debt servicing problems will lead to a lower rate of growth in government spending in many OECD countries, possibly accompanied by the transfer of some functions to voluntary cooperative enterprises.

That leaves the difficult question of identifying which of the western democracies are more likely to be able to implement those reforms through normal democratic processes in order to avoid having austerity imposed upon them by creditors and international agencies.

Is Steven Pinker too optimistic about the future of liberal democracy?

Steven Pinker’s aim in Enlightenment Now, The case for Reason, Science, Humanism and Progress, is “to restate the ideals of the Enlightenment in the language and concepts of the 21^st century” and to show that those ideals have worked to enhance human flourishing.

In response to one of Pinker’s earlier books I was prompted to consider whether Enlightenment humanism is the coherent world view that he claims it to be. In this book Pinker makes clear that he views “the ideals of the Enlightenment” to be synonymous with the open society and classical liberalism.  He argues that four themes tie the ideas of the Enlightenment together: an insistence on applying reason to understand our world; use of the methods of science; humanism, defined in terms of a focus on the happiness of individuals rather than the glory of tribes, races, nations or religions; and the hope for progress through political institutions that are conducive to human flourishing. Pinker regards liberal democracy as “an Enlightenment-inspired institution” and “a precious achievement”.

In my view Pinker succeeds admirably in showing that for the last two and a half centuries application of those Enlightenment ideals has enhanced individual human flourishing. Much of the book is devoted to evidence of the massive progress that has been made in the quality of life enjoyed by people on this planet over that period. I recommend this book and Max Roser’s Our World in Data web site (the source of much of Pinker’s data) to anyone who needs reminding that ‘the good old days’ were not so great.

Turning to the future, Pinker is more of a hopeful realist than an optimist. He recognises that “the darker sides of human nature – tribalism, authoritarianism and magical thinking – aided by the Second Law of Thermodynamics” have potential to push us back. In an early chapter he points out that in a world governed by entropy and evolution, the default state of humankind is characterized by disease, poverty and violence. A large and growing proportion of humanity have been able to escape from the default state through ongoing adherence to the norms and institutions fostered by the Enlightenment.

As I see it, the prospects for further progress in human flourishing in the liberal democracies will be strongly influenced the effectiveness of this form of government in delivering economic policies conducive to ongoing productivity growth. Productivity growth will obviously be required if people continue to aspire to have higher disposable incomes, but it will also be required to generate the additional taxation revenue needed to prevent public debt spiralling out of control. That is because spending on social welfare programs – particularly health care and retirement benefits - is likely to rise as the proportion of elderly people rises. Resort to higher tax rates would be likely to have adverse effects on incentives to work, save and invest, and thus reduce productivity growth.

Pinker notes that with stronger safety nets in place, the poverty rate for elderly people in the United States has plunged since the 1960s and is now below that for younger people. However, generous safety nets have a down-side. People in the liberal democracies face traumatic adjustments in the years ahead if governments are unable to meet public expectations of ongoing funding of existing programs at current levels.

Pinker recognizes low productivity growth and “authoritarian populism” as potential threats to human progress but does not draw out the links between these threats. Most of the populists that he is concerned about do not strike me as being particularly authoritarian, in the sense of enforcing strict obedience to authority. Nevertheless, they are stasists, seeking to undermine the Enlightenment values that have enabled technological progress and international trade to contribute massively to human flourishing since the beginning of the industrial revolution. Pinker’s discussion of the recent causes of low productivity growth is adequate, as far as it goes, but he fails to emphasize the potential for additional damage to be done by populist politicians seeking to capitalise on fears of the disruptive impacts of globalisation and technological progress.  

Pinker makes the important observation:

“A challenge for our era is how to foster an intellectual and political culture that is driven by reason rather than tribalism”.

He is scathing in his description of current electoral politics:

“Here the rules of the game are fiendishly designed to bring out the most irrational in people”.

In support of this assertion Pinker cites: the rational ignorance of voters; the bundling of disparate issues to appeal to a coalition of voters with geographic, racial, and ethnic constituencies; and media that “cover elections like horse races, and analyse issues by pitting ideological hacks against each other in screaming matches”. He notes:

“All these features steer people away from reasoned analysis and towards perfervid self-expression”.

Pinker’s suggests that for public discourse to become more rational, issues should be depoliticized as much as possible. His discussion of the ways in which issues become politicised and proposals for depoliticization of issues was covered in my last post on the benefits of listening to opposing viewpoints. His discussion ends by noting that the discovery of political tribalism as an “insidious form of irrationality” is “still fresh and largely unknown”. He appeals to readers:

“However long it takes, we must not let the existence of cognitive and emotional biases or the spasms of irrationality in the political arena to discourage us from the
Enlightenment ideal of relentlessly pursuing reason and truth”.

Pinker may not sound particularly optimistic about the future of liberal democracy, but he may well be too optimistic. Unfortunately, in addition to the irrationality he discusses, we are also confronted by widespread failure to adhere to the norms of self-reliance and reciprocity that underpin liberal democracy. As explained by James Buchanan (see this post for the reference) failure of the liberal order is becoming increasingly likely as a higher proportion of the population becomes dependent on government and voters increasingly seek to use the political process to obtain benefits at the expense of others.  

We seem to be heading toward what might be described as a democratic tragedy. As noted in an earlier post, when interest groups view the coercive power of the state as a common pool resource to be used for the benefits of their members, the adverse impact of tax and regulation on incentives for productive activity is likely to result in outcomes that will be detrimental for everyone. The incentives facing individual interest groups in that situation are similar to those facing users of common pool resources in the absence of norms of restraint.

Perhaps, as more people come to recognize that liberal democracy is confronted by deep problems, efforts will be made to reform political institutions to produce better outcomes. It is not obvious how that can be achieved, but we should not allow ignorance to prevent us from seeking solutions.

In my view Seven Pinker is on the right track in urging people to be hopeful:

“We will never have a perfect world, and it would be dangerous to seek one. But there is no limit to the betterments we can attain if we continue to apply knowledge to enhance human flourishing”.

Is the cycle of political complacency beginning to turn in the United States?

The villain in Tyler Cowen’s latest book, The Complacent Class: The self-defeating quest for the American Dream, is “us”. Tyler is writing about America, but much of what he has written is relevant to other high-income countries. The problem, as Tyler sees it, “is that peace and high incomes tend to drain the restlessness out of people”. Many people have become complacent – “satisfied with the status quo”. Most people don’t like change much and “they now have the resources and the technology to manage their lives on this basis more and more, to the country’s long run collective detriment”.

Tyler has not persuaded me that complacency is a problem of itself. It would be nice to be able to feel more complacent. (According to Tyler’s questionnaire - international version here - I am a striver: “You embrace newness, but you need to strive harder to break the mold”.) As I see it, complacency only becomes a problem when people are complacent about things that they have good reason to be alarmed about.

Tyler provides a fair amount of evidence that Americans have become more complacent. For example:

• ·         People now switch jobs less frequently.
• ·         Geographical mobility has declined.
• ·         There has been a decline in start-ups relative to total business activity.
• ·         There are fewer unicorns (miracle growth firms).
• ·         Market concentration has risen.
• ·         There is more pairing of like with like e.g. people are choosing marriage partners with similar education levels, and housing is more segregated by income and race.
• ·         Upward mobility in income and education has stopped rising.
• ·         People are now more inclined to stay at home and use delivery services.

That is all very interesting. It changes my perceptions about America. I have to get used to the idea that Americans are no longer as mobile and innovative as they were a couple of decades ago. But that does not necessarily mean that complacency is a problem. If peace and high incomes have made Americans more complacent, isn’t that a good thing? There is not much point in striving for more of anything once you are satisfied with what you have already. How is complacency leading to bad outcomes?

When Tyler looks in detail at some of these changing characteristics, he points to the failure of political decision-making to cope with interest groups seeking to protect themselves from change. How does complacency come into that? The NIMBY advocates who are using their political muscle to protect their interests against higher density building can hardly be described as complacent. The people at Donald Trump’s rallies who are supporting his policies to protect jobs - by reducing immigration and constraining import competition - do not seem complacent. The complacency must lie with the general public, who are not yet sufficiently outraged by the stasists to cast their votes for candidates who will constrain their political influence.

Tyler’s discussion of declining geographical mobility provides a good example of political market failure. He points to research showing potential for a substantial increase in GDP if more people were to move from low-productivity cities to high-productivity cities. Regulatory constraints prevent this from happening:

“Residents in Manhattan, San Francisco, and many other high-productivity locales just don’t want all of those new people moving in, and so they have passed overly strict building and land use regulations or in some cases they have limited infrastructure so that adding more residents just isn’t practical. Without good bus or subway connections, for instance, a lot of neighbourhoods just don’t work for people with jobs downtown”.

Tyler uses the terms ‘stasis’ and ‘dynamism’ quite frequently in this book, but I couldn’t find any reference to Virginia Postrel’s pathbreaking book on this topic, The Future and Its Enemies, published 18 years ago (my discussion here). I would have been satisfied with a footnote to explain how Tyler’s views build on, or differ from Virginia’s views. Similarly, it would have been nice to see a footnote discussing the affinity between Tyler’s views and Mancur Olson’s argument that stable societies tend to accumulate distributional coalitions that slow down their capacity to adopt new technologies and reallocate resources. See: The Rise and Decline of Nations.

Early in the book Tyler suggests that “the growing success of the forces for stasis” are linked to complacency. That argument has most force it the final chapters of the book where he discusses politics.

Tyler makes the point that much of the U.S. federal government budget is locked in to spending programs that are politically untouchable. Political change occurs at the margin and is the result of complex battles among interest groups, political manoeuvring and use of public relations campaigns. The Trump administration is unlikely to change this situation much. The pre-allocation of tax revenues will ultimately become unsustainable:

“At some point this country will face an immediate crisis, and there won’t quite be the resources, or more fundamentally the flexibility to handle it”.

Tyler presents a view about the tendency of governments to take on more responsibilities than they can cope with effectively that is similar to the view I expressed in Chapter 8 of Free to Flourish. I argued that there is a growing gap between the expectations that many people have of what democratic governments can deliver and what they are capable of delivering.

However, Tyler seems to present a more optimistic view of the ability of western democracies to reform themselves rather than to collapse and to be replaced by authoritarian regimes. That is just my impression. I find it hard to point to particular passages that support that view. The scenario that Tyler presents of a possible future that would be more dynamic does not feature less dysfunctional government, although smaller government may be implied.

Although I'm not sure why, after reading the book I was left feeling hopeful that the cycle of political complacency has reached its peak and that, over the next few years, American politics might become less shrill and more focused on problem solving. Perhaps the actions of the Trump administration will further erode political complacency in ways that will lead to a public reaction favouring a more constrained role for government. So, democracy will probably survive in the U.S. I’m also reasonably confident that a fiscal crisis in Australia will eventually result in rule changes needed to make democracy sustainable in this country. I’m less complacent about the future of democracy in some of the countries of southern Europe. 

Postscript
Tyler Cowan has provided some grounds for optimism in a recent Cato article entitled "Between authoritarianism and human capital". An extract:

"So we’re going to see a kind of intellectual war, and possibly war in other, more violent forms too. That war, using that word in the broadest sense possible, will be between today’s amazing accumulated stock of human capital — and the emotional momentum behind authoritarianism, which is encouraged by the political fraying that stems from underlying fears of disruption.

Right now, I’d still put my money on the positive side of talent and human capital. But in recent times, I can’t say I’ve seen the odds moving in my favor."

Could Larry Summers be half-right about secular stagnation?

When I read ‘The age of secular stagnation’ by Lawrence H Summers (published in Foreign Affairs (March/April 2016) I was pleasantly surprised to find that I agreed with part of his analysis.

I agree that economic growth has been relatively weak in most developed countries in recent years because levels of investment have been low, despite high levels of saving and low real interest rates. That is not quite how Summers puts it; he talks about “excess savings”. He might have reasons for that, but it makes his argument seem convoluted.

I tend to agree with Summers when he writes:

“Absent many good new investment opportunities, savings have tended to flow into existing assets, causing asset price inflation”.

My agreement is qualified because I think the absence of investment opportunities is more about perception than reality. Why I think that will become clearer later.

The solution Summers offers to the problem of low investment is an expansionary fiscal policy pursued through public investment. Writing about the United States he argues:

“A time of low real interest rates, low materials prices, and high construction unemployment is the ideal moment for a large public investment program. It is tragic … that net government investment is lower than at any time in nearly six decades”.

It is obviously problematic to be proposing an expansion in public investment at a time when rising government debt has been imposing a significant burden on later generations. But there may be ways around such concerns. In its article, ‘Fighting the next recession’ The Economist (Feb. 20) gave some prominence to the New South Wales Government model of privatising assets such as ports to fund public investment. I had not previously thought of the efforts of the NSW government to raise some cash for infrastructure spending as a model that might have wider application.

However, there are limits to the extent that additional public sector investment is likely to stimulate further private investment. Additional public investment in most economic sectors competes with private investment. If governments confine their investments to sectors where public investment might have a comparative advantage, they will, before long, end up investing in projects that have no hope of yielding even a modest return on investment. Such misallocations seem more likely to add to secular stagnation than to help overcome it. Japan’s efforts to stimulate economic growth by building roads to nowhere may be a good example of such counterproductive public investment.

Before proposing solutions to the problem of secular under-investment it would be a good idea to try to understand why it is occurring. In his recent article, ‘U.S. secular stagnation?’ Steve Hanke pointed to Robert Higgs’ concept of “regime uncertainty” as a possible explanation of the long term downward trend in net private domestic business investment as a percentage of GDP since the beginning of the 1970s. An index of economic policy uncertainty developed by Scott Baker, Nicholas Bloom and Steven Davis suggests that economic policy uncertainty is currently very high - at similar levels to the 1930s, and much higher than in the 50s and 60s.

An increase in policy uncertainty is also consistent with the observation by Kevin Lane and Tom Rosewall (RBA Bulletin 2015) that the hurdle rates of return that firms use to evaluate investment projects has not declined along with declines in interest rates that have occurred since the 1980s. This implies that profitable investment opportunities are being foregone because of greater uncertainty about future after-tax returns and costs. OECD researchers suggest that policy uncertainty (concerning regulation, macro policy and taxation policy) is one factor causing the hurdle rate that companies apply to capital spending to be higher than that applied by financial investors (Business and Financial Outlook 2015, p 60).

My conclusion is that Larry Summers might be about half right in his observations about secular stagnation. Investment has been too low, but the long-run solution can't lie in increased public investment. Governments should be thinking about how they can make businesses feel confident that regulatory and tax burdens are not likely to be further increased over the lifetime of new investments.