There Is No Great Stagnation, Only Great Integration

There are a lot of ways to think about what's happened to the flattening of median American income growth. One of the most interesting is Cowen's stagnation hypothesis, which attributes the lack of wage growth to not generating enough job-creating innovation. I like some parts of that hypothesis -- although I prefer to look at changes to political systems and developments in the global economy -- but there have been other things going on as well. One of them is this:

I want to focus on the period ending around 2000. If you go from the early-1970s trough to the late-1990s peak, the U.S. added about 9 percentage points of its labor to the workforce in about 30 years. At current population levels, that's about 30 million people. Even if you go from 1970 peak to the 2000s average, it's about 15 million people or so. Often these would be members of disadvantaged groups, such as women and minorities, whose wage potential would be lower than that of white males that were already in the workforce, so we're adding a bunch of relatively low salaries to our statistics over that stretch.

Looked at that way, it's almost impressive that median wages have been flat. If there had actually been stagnation, median wages would have gone down as more people got added to the labor force at low wages.

Or, instead of looking at median individual wages, we could look at median household wages:

As you can see, until the 2000s we had pretty strong growth that was actually accelerating over time. This doesn't consider everything -- more two-worker households means greater expenses for child care, etc. -- but we generally think employment is good for its own sake. It yields psychological benefits, allows greater flexibility for satisfying preferences and tastes, etc. In terms of social justice, excluding fewer women and minorities from pursuing the good life is also a good thing.

If we're thinking about trends in the U.S. economy over the past few decades we might consider it good news that we've been able to integrate more people into the workforce and that household incomes have increased. That's not stagnation. That's improvement.

This only gets us up to the 2000s, and it doesn't tell us anything about the future, but it's a component of the U.S.'s postwar economic history that doesn't get talked about enough.

GOTD

Wow:



Via Uwe Reinhardt, who breaks it down:

Jobs in the tradable sector were added primarily in high-value services. They were lost in manufacturing, through outsourcing of the lower value-added components of the value chain to other countries.

The net effect has been that of the 27.3 million jobs created in the American economy from 1990 to 2008, only 662,000 new jobs were added by the tradable sector. That is only 2.3 percent of total job creation in the economy.

I assume that's gross, not net. This is in line with my view of (no) Great Stagnation, and see also this post from Will Wilkinson. Here's another worrying bit from Reinhardt:

Thus it is not surprising that ... close to 98 percent of the 27.3 million new jobs in the American economy in the last two decades were created in the nontradable sectors, led by government and health care in first and second place.

These two sectors alone accounted for 40 percent of the total job growth over the last two decades. They were followed by retailing and construction, both of which grew on the back of heavy debt financing and a real-estate bubble.

The American people look to the president and Congress to create jobs — or, more precisely, to create the economic conditions in which job growth occurs.

At the same time, the American people now look to the president and Congress to rein in government spending in general and health-care spending in particular, at a time when a sizable deleveraging by consumers and business has sharply put the brakes also on retailing and construction.

So how can these desiderata –- creating jobs and, at the same time, cutting back on government and health care spending –- add up to a rosy future jobs picture? Can any government actually deliver on these conflicting goals?

I'm slowly being persuaded by Karl Smith's argument that a construction boom is looming, and Ryan Avent's general optimism about the economy. I still believe that trade is a large net plus for the US. But the US economy has been shifting over the past two decades, and it will continue to do so. I expect GDP growth to rebound from its current doldrums, but not necessarily in an especially egalitarian way. These shifts and changes lead to political shifts too, and we've been witnessing those as well. It may be awhile before we find the new equilibrium -- I suspect it involves a shift to more social democracy -- and in the meantime we may be in for some more pain.

Follow-Up on TGS Graphs

Daniel Davies and Alex Tabarrok objected to the graphs of GDP I included in this post on The Great Stagnation. Specifically, they didn't like the fact that the hypothetical lines I drew reflect constant linear growth rather than constant percentage growth. I.e., I didn't compound the growth when i drew those lines. They're right that the latter is a better measure of trend (it's what is used in almost all statistical analyses), so here's a new graph that takes that into consideration.

This graph shows the actual GDP per capita growth (circles) for the US, OECD, and entire world. The lines that begin in 1974 reflect what GDP per capita would look like if it had continued to grow at the 1960-1973 rate*. Note that a "Great Stagnation" hypothesis would expect significantly weaker growth post-1973, not the same amount and certainly not more. So the fact that the US was above the trend line until the early 2000s provides fairly strong evidence that if we're in a Great Stagnation it's more recent than Cowen argues, and doesn't correlate with stagnating median incomes all that well. In fact, the US does better than either the OECD or the globe, if "better" is defined as "closest to 1960-1973 trend", although the OECD trend line is quite a bit steeper**.

Anyway, just wanted to make sure I didn't leave the impression that my main point (about distribution) relies on faulty extrapolation.

*Specifically, I regressed a year counter on the log of GDP per capita (constant dollars, via WDI) from 1960-1973. The coefficient estimate represents the average growth in GDP per capita per year during that period. I then took that coefficient estimate and added it to 1973's GDP per capita to get 1974's predicted point, added the same constant to the predicted 1974 to get the predicted 1975, and so on.

**Of course the US is a big part of both OECD and world economies; if you removed the US from those groups the US would likely look still better in comparison. Although in the OECD's case, they added some countries during the series (e.g. Mexico, Slovakia) with lower per capita GDP than more established industrialized countries.

There Is No Great Stagnation, Only Great Redistribution

Tyler Cowen's The Great Stagnation has gotten a lot of attention for both its form and content. (I.e., there's more than a little irony in the fact that a book alleging that technological progress has markedly slowed was the first notable electronic-only book, although it has since been released in pulp-and-glue as well.) In the video above he presents his main thesis at TEDxEast. For those unaware, the argument runs basically like this: 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.

Cowen's argument has bothered me on a number of levels. First, I think he understates the real, and monetary, value of the internet and improved communications technology for standards of living. Second, I think he makes a mistake by looking almost entirely at the U.S., and almost entirely at median income. I want to focus on the second of these, placing it in the context of the first.

I'm really late to this party... Cowen's book has been covered by everyone in the blogosphere and almost everyone in the corporate press, so I'm sure someone has written more or less exactly what I'm about to write, but I've haven't seen it in quite this form before. So to see why I think Cowen's thesis is wrong, or at least incomplete, let's start with some global data.



This graph shows global real gdp per capita from 1960-2009 (blue line). I've highlighted 1973's income level -- $1,148 -- to show what the world looked like around the time that Cowen thinks the Great Stagnation started in the US. In the following 35 years, per-person income increased by nearly 800%. If the pre-1973 trend had continued (red line), that number would be more than halved. If growth post-1973 had stagnated, we'd be below the red line. But that didn't happen, as we can see from this series. First, global growth in the 1970s was faster than in the 1960s. And while that trend wasn't consistent through the 1980s and 1990s (dark green line), global GDP growth in the 2000s was the fastest during the period. In fact, by the end of the decade we'd caught back up to where we'd be if the 1970s trend had been consistent, before the financial crisis knocked us back a bit. But the story here is of pretty rapid growth on a global scale that actually accelerated in the most recent decade. No Great Stagnation, on a global level at least.

Cowen agrees that global growth has been strong as other countries adopt the innovations the U.S. has already exploited. This "catch-up" growth may be fine for developing countries, which have a lot of low-hanging fruit, but he wants to focus on those at the edge of the technology frontier, especially the US. So let's look at what's happened to US growth over the same period.



The green line represents approximately where US incomes would be if we had stayed at the pre-1973 rate of growth. Average incomes would be less than half what they are now. If the economy had stagnated, as Cowen claims, average incomes would be below the green line. Instead, the rate of US growth actually increased over that period, at a more rapid pace even than the increase in global growth depicted in the first graph. This doesn't look like stagnation at all, much less a Great Stagnation. So what is Cowen going on about?



Ah, the picture looks a bit different if you compare mean GDP/capita to median GDP/capita. Before 1973 the two tracked each other very closely. Post-1973, mean GDP/capita (the white circles) kept growing at roughly the pre-1973 trend rate, while median GDP/capita (black diamonds) stagnated. But the economy overall did not. Just median incomes. That indicates, to me, that Cowen's preferred causal mechanism -- a stagnation due to slowdown in innovation -- is missing what's actually happened. There's been enough growth, it just hasn't gone to the median earner. The result has been higher inequality.

Why has that happened? Theories abound. Some political scientists have recently made the case that rising inequality is a result of wealthy groups hijacking politics for their own economic benefit. In other words, the distribution of growth is zero-sum, and it's been redistributed towards the wealthy in the form of tax cuts, decline in union membership, erosion of the welfare state, and deregulation. I think there's something to that, but I think it's too focused on developments specific to the US. To get the whole picture, I think we need to situate the US in a global context.

It's difficult to find reliable estimates of global median income in a time series (in fact I couldn't... pointers welcome), but indications are that inequality is increasing within many countries, and across them as well. This is also not consistent with Cowen's argument, since the movement towards the technology frontier in the US was associated with rising median income, not rising inequality. If that's the process that rapidly-growing economies like China and India are in, then we should see less inequality, not more. And if the Great Stagnation is something that afflict the US specifically, we might expect the gap between the US and the rest of the world to narrow, not widen.

So I think a more nuanced theory is needed. Specifically, we need to be able to explain two things: stagnating median, but not mean, incomes; global, not just local, trends. So what do we know about the major ways in which the global economy has changed over the past 40 years? I think three things are most relevant:

1. The global economy has become more integrated. This is partially due to politics, as more countries opened their economies to trade and investment. Average tariff rates have fallen dramatically during the GATT/WTO tenure. Capital accounts have been opened by many countries. Additionally, technological improvements have lowered transaction costs. International trade and investment have increased dramatically as a result. The consequence of this movement is a larger (global) market with more middle- and high-income consumers, and increased competition in production. This leads to point #2.

2. The US's post-WWII advantage was conducive to broad-based growth. The US share of global manufacturing was nearly 50% immediately after the war. The other industrialized economies were mostly decimated by the war, and many countries had not yet industrialized. For an American worker during this period, a high marginal product (relative to a foreign worker) did not require large amounts of human capital. Relatively low-skilled workers could mix with (non-human) capital in fairly lucrative ways. In a sense, the median American worker was able to collect rents from the rest of the world from 1945-1973, because the de-industrialization in Europe and pre-industrialization in much of the rest of the world operated as barriers to competition. By the early 1970s those advantages had waned, and trade agreements made it difficult for the US to protect domestic workers. The increased competition from workers in Europe and the Asian NICs (which shifted to export-biased development in the 1960s-70s) led to the US's share of global manufacturing output to fall to 20-25% by 1973, where it has stayed more or less ever since. This hit high-wage/less-skilled workers in tradable industries the hardest, since those were the workers that would face international competition directly. It isn't surprising that incomes would stagnate as those "rents", born of circumstance, are competed away.

3. These same processes benefit high-skilled workers with lots of human capital, as did the technological improvements, particularly in information technology and communications. The rise of the rest has increased the market into which they can sell their labor (demand curve shifts right), but the high skills required to compete with them provide a continuing barrier to entry (supply curve sticks). Compensation for those high-skill workers (and innovators) goes up, but is stuck for everyone else. We get a weak version of "superstar economics", where the highly-skilled are able exploit lower transaction costs to sell into an ever-enlarging global market, while the lower-skilled face increased competition. It's a two-track economy.

Cowen dismisses globalization-rooted theories of the Great Stagnation (around minute 12 in the video above), but (to my knowledge) he hasn't dealt with the sort of mechanisms I'm discussing in any kind of detail. Somewhat bizarrely, Cowen also claims that modern innovations (the internet, satellite-based telephones) have not contributed to GDP very much. But then how to explain how GDP growth, and total worker productivity, have increased post-1973 at the same rate as pre-1973? Median incomes have stagnated because those innovations, unlike previous innovations in manufacturing, do not require the mobilization of huge numbers of workers to increase output. A few computer programmers or financiers can create generate output on their own.

There's another aspect to this that I think Cowen has missed. Increased inequality and a move to a superstarish economy should create more of an incentive for innovation, not less. And while Cowen complains that scientists are no longer heralded by society as they once were, innovators most definitely are. We make movies about them and their social networks, and then give awards to the movies. We make them the richest people in the world. And, contra Cowen, we have seen a lot of innovation in the past 35 years. Cowen focuses on innovations in two major areas that led to the pre-Stagnation growth: transportation and energy. He may be correct that innovation in transportation has declined, although the rise in high-speed rail (outside the US) might be one counterpoint), but part of that is because innovations in communication and information technology has made transportation less necessary. In terms of energy, there have been more breakthroughs in new energy sources from 1980-now than there was from 1945-1973.

There's more I could discuss, but this is long enough. So in short: I do not see a world economy that has stagnated overall. I don't even see a US economy (pre-2008) that has stagnated. I see a redistribution from a certain class of American workers to workers with similar skills in other countries, and to workers with very high skills in the US that can market those skills to a global economy. This doesn't have to be a bad thing, if the government can respond by encouraging innovation by high-skilled workers, and even encourage a lot of compensation for them, but provide for the rest with a fairly robust safety net. And, in fact, the major political cleavages of the present focus on precisely these issues. The political battles aren't about stagnation, but about distribution.

UPDATE: A few folks thought the graphs above are misleading, and they've got a point. So rather than just draw some lines in Powerpoint, I did a more reasonable comparison here. It doesn't change the substantive conclusion of this post, but it was worth doing.

Finance, Trade, and Growth Through History

New NBER paper:

Historical Evidence on the Finance-Trade-Growth Nexus
Michael D. Bordo, Peter L. Rousseau
NBER Working Paper No. 17024
Issued in May 2011

We study linkages between financial development, international trade, and long-run growth using data since 1880 for seventeen now-developed “Atlantic” economies and a set of cross-country and dynamic panel data models. We find that finance and trade reinforced each other before 1930, but that these effects did not persist after the Second World War. Financial development has positive effects on growth throughout the sample period, while trade affects growth strongly and independently after 1945. We attribute the rising importance of trade in explaining growth to major post-World War II changes in tariffs and quantity restrictions associated with the GATT, the establishment of the European Common Market, and the gradual elimination of capital controls after 1973. The findings are robust to the use of ‘deep’ fundamentals such as legal origin and indicators of the political environment as instruments for financial development and trade. Financial development, however, is more closely linked to these fundamentals than trade.

When all the debate over whether financial innovation added any value to society was going on, and folks like Volcker were saying that there was no evidence that it did, I always wondered what the evidence was. I've always thought that countries with deep, liquid financial markets had better economic performance than those that did not. I've always thought that financial innovation helped to create deep, liquid financial markets. Not sure this paper will settle that question, but it's worth a look.

Chart of the Day

We are rightly concerned about the economic doldrums in the U.S. and Europe, but we shouldn't forget that elsewhere progress marches on. Via the Economist, which adds:

MUCH has been written about the rise of the BRICs and Asia’s impressive economic performance. But an analysis by The Economist finds that over the ten years to 2010, six of the world’s ten fastest-growing economies were in sub-Saharan Africa. On IMF forecasts Africa will grab seven of the top ten places over the next five years (our ranking excludes countries with a population of less than 10m as well as Iraq and Afghanistan, which could both rebound strongly in the years ahead). Over the past decade the simple unweighted average of countries’ growth rates was virtually identical in Africa and Asia. Over the next five years Africa is likely to take the lead. In other words, the average African economy will outpace its Asian counterpart.

Rosling on the Beeb

We've featured Hans Rosling and his cool data visualizations on this blog multiple times. Now he's got his own BBC show, "The Joy of Stats", which airs on December 7th on BBC4. Unfortunately, it does not appear that it will be shown outside the UK, but here is the preview:



(ht: The Economist Daily Charts blog)