Last year, Foreign Affairs focused its March/April issue on Surviving Slow Growth. “The first decade of the twenty-first century was a time of unprecedented economic growth,” said the issue’s introductory article. “The rich world got richer, and the developing world raced ahead: by 2007, the emerging-market growth rate had hit 8.7 percent… Then came the fall… growth has ground to a halt almost everywhere, and economists, investors, and ordinary citizens are starting to confront a grim new reality: the world is stuck in the slow lane and nobody seems to know what to do about it.”
Economic growth has two main components, productivity growth and the growth of the labor force. Fewer workers is one of the key reasons for our stagnant economic growth. The labor force is still growing in some developing countries like India, Nigeria and the Philippines, but it’s already shrinking in China, Japan and Germany. In the US, the labor force is growing very slowly.
Over the coming decades, the labor force is expected to shrink in most parts of the world as fertility rates continue to decline. The 2016 US fertility rate was the lowest it’s ever been. Increasing productivity is thus more crucial than ever to promote economic growth. But, in the US and other advanced economies, productivity growth has significantly slowed down over the past few decades.
McKinsey offers three possible explanations for this productivity growth decline: the increasing difficulty of measuring productivity in the digital economy; the shortage of demand and investment opportunities, and the impact of technological innovation on the economy. Let’s take a close look at each.
The Difficulty of Measuring Productivity
GDP is a relic of a time dominated by manufacturing, where the production of physical goods was easier to measure. But it’s a less reliable measure of services, where there is much more variation in quality and value. This is a particular concern in our digital economy. How do you measure the value of the explosive amounts of free goods available over the Internet, including Wikipedia articles, Facebook social interactions, Linux open source software and You Tube videos? Since all these services are free, they are excluded from GDP. Furthermore, many new services we used to pay for are now also free, including long-distance calls, newspaper articles, maps and recorded music.
GDP measures the total amount spent on goods and services. If the price is zero, you could have an enormous explosion in services, information and whatever else, but their contribution to GDP will still be zero. Traditional metrics have not been adequate for the information economy because so much of the digital economy has been free.
Moreover, GDP does not reflect important economic activity beyond production, such as income, consumption and living standards. A few years ago, a Commission on the Measurement of Economic Performance and Social Progress, - led by Nobel-prize winning economists Joseph Stiglitz and Amartya Sen, - was convened to look at the limits of GDP as an indicator of economic performance and social progress.
“What we measure affects what we do; and if our measurements are flawed, decisions may be distorted…” it noted in its September, 2009 report. “So too, we often draw inferences about what are good policies by looking at what policies have promoted economic growth; but if our metrics of performance are flawed, so too may be the inferences that we draw.”
The Commission recommended measuring economic activity beyond GDP, looking at income and consumption rather than production because they more closely reflect how well off people are. To better track living standards, it called for tracking household income and consumption in addition to aggregated measure of the economy, as well as measuring not just the averages, but also the distribution of income, consumption and wealth. It also called for factoring in measurements of sustainability to help reflect the evolution of the economy into the future.
However, McKinsey notes that “While it seems reasonable to assume that our ability to correctly measure productivity changes has been limited, what is less clear is the extent to which measurement has contributed to the recent productivity growth slowdown in the United States.”
The Shortage of Demand and Investment
Other economists attribute the weak productivity growth to secular stagnation, - a prolonged era of slow demand and investments. In his article in the Foreign Affairs issue, Harvard economics professor Larry Summers wrote: “As surprising as the recent financial crisis and recession were, the behavior of the world’s industrialized economies and financial markets during the recovery has been even more so.” Back in 2009, almost no one would have predicted that we would still be in a period of slow economic growth, but “nearly seven years into the U.S. recovery, markets are not expecting normal conditions to return anytime soon.”
Secular stagnation, said Summers, is the reason behind this unusual situation. “The economies of the industrial world, in this view, suffer from an imbalance resulting from an increasing propensity to save and a decreasing propensity to invest. The result is that excessive saving acts as a drag on demand, reducing growth and inflation, and the imbalance between savings and investment pulls down real interest rates.” McKinsey adds that “Gross domestic investment as a share of GDP dropped in 2009 to its lowest level since 1950 and, although it has recovered somewhat, remains below historical norms.”
The Impact of Technological Innovation: An Innovation Slowdown or the Solow Paradox 2.0
Has the ideas machine broken down?, asked The Economist in a January, 2012 article that examined the growing concerns that we may be in a long-term period of slow innovation despite our rapidly advancing technologies. “With the pace of technological change making heads spin, we tend to think of our age as the most innovative ever,” said The Economist. But, “The idea that innovation and new technology have stopped driving growth is getting increasing attention… We have smartphones and supercomputers, big data and nanotechnologies, gene therapy and stem-cell transplants.” But, perhaps these don’t quite compare with modern sanitation, cars, planes, the telephone, radio and antibiotics. These innovations, first developed in the late 19th and early 20th century, have long been transforming the lives of billions.
Northwestern University economist Robert Gordon is one of the leaders of the innovation pessimism camp. Gordon believes that the rapid growth and rising-per-capita incomes we experienced from 1870 to 1970 was a unique episode in human history. Innovation is now stalled and there may well be little productivity and economic growth for the rest of this century.
An alternative, more hopeful explanation, - is that it takes a while, - years, sometimes decades, - for the benefits of major new technologies to become widespread across the economy and thus lead to significant productivity growth.
US labor productivity grew at only 1.5% between 1973 and 1995. This period of slow productivity coincided with the rapid growth in the use of computers in business, giving rise to the Solow productivity paradox, in reference to Nobel Prize MIT economist Robert Solow's 1987 quip: “You can see the computer age everywhere but in the productivity statistics.” But, starting in the mid 1990s, US labor productivity surged to over 2.5%, as the Internet helped to spread productivity-enhancing innovations across companies and industries.
Perhaps our current productivity puzzle is a kind of Solow Paradox 2.0. We’re in the early deployment stages of major recent innovations, e.g., IoT, data science, AI, robotics. Leading edge companies are already benefiting from these advances, but most companies are still in the early learning stages. Translating technological advances into productivity gains requires major transformations in business processes, organization and culture, - and these take time.
These various explanations are not mutually exclusive, and each may play a role in helping us understand the productivity puzzle. “So far, though, economists have failed to reach consensus on the causes of the productivity growth slowdown or indeed the relative significance of the various arguments,” notes McKinsey. “Far from mere academic interest, establishing the source of the slowdown is important for both the public and private sectors. Without understanding the forces behind slowing productivity growth, companies cannot set realistic expectations about future growth and policy makers cannot apply the correct policy tools to nudge economic growth into higher gear.”
The labor availability in the US is not due to fertility rates. It's due to people who were out of the workforce too long due to the recession. They don't come back.
B-schools insist on management-based innovation, as opposed to engineer-based innovation. Innovation is now continuous, rather than discontinuous. Continuous innovation does not contribute any economic wealth. We lost economic wealth due to globalism, and have yet to replace it. Cash does not replace lost economic wealth.
The volatility economy has superseded the production economy. Money can be made from a failing production economy.
Posted by: David Locke | July 24, 2017 at 03:22 PM