On January 20, Donald Trump’s new team of economic advisers will take up their posts in Washington. With them will come a new set of theories about what makes an economy grow — and a new set of political battles over questions whose answers are based more on quasi-religious beliefs than on real understanding. We’ll hear a lot about the new administration’s “pro-growth policies.” What we won’t hear is an admission that economists, and the politicians they advise, don’t know much about how to make the economy grow faster for any sustained period of time.
Yes, it’s easy enough to juice the economy temporarily. A big tax cut or a shot of deficit spending will do the job nicely. But the effectiveness of such policy moves is likely to be measured in months rather than years. Over the longer run, the rate at which the economy expands depends mainly on the growth of productivity — the efficiency with which the economy makes use of resources such as labor, capital, energy, and raw materials. When politicians assert that their policies are “pro-growth,” they are claiming that those policies will raise the rate at which productivity improves from year to year.
Economists have been spinning theories about how to improve productivity growth for decades, if not centuries. Before the industrial revolution, this was largely an agricultural problem; farmers increased the yield from each acre of land by breeding better plant varieties and consolidating small fields into big ones, but also by offering contracts to tenants and sharecroppers that gave them incentives to increase their output. In 1776, in his famous book The Wealth of Nations, Adam Smith pointed out that specialization and economies of scale can increase productivity too. If each worker in a pin factory performs only some of the tasks required to produce a pin rather than making entire pins by himself, Smith showed, the workers will collectively turn out many more pins with each hour of labor.
Adding more advanced machinery to factories boosted growth — until it didn’t
Once machines came into wider use, the secret to productivity growth was thought to be giving workers more equipment to help them produce more in each hour of work. This is what economists refer to as increasing the capital-labor ratio. That perspective changed in the 1950s, as computers and new data-crunching techniques, along with better economic data, revealed that much of the improvement in workers’ productivity came not from more capital investment, but from new technologies and new methods of work. In other words, simply adding to the stock of factory equipment matters less than developing equipment that is more flexible, more precise, or more energy-efficient.
With new ways to make steel, freeze orange juice, and load cargo ships, the post-war period brought technological progress in spades. New factories replaced plants built in the 1920s or even earlier, and lower long-distance telephone rates for businesses allowed headquarters to communicate with branch offices by phone instead of telex. In 1950, according to the work of Robert Barro and Jong-Wha Lee, the average working-age adult in the United States had 8.5 years of schooling; a quarter-century later, the average was nearly 12 years, creating a labor force capable of handling far more complicated work.
The quarter-century between 1948 and 1973 was the most remarkable period of economic growth in human history. The world economy expanded at an annual rate of nearly 5 percent; in countries as far-flung as Italy and Japan, West Germany and South Korea output doubled and then doubled again. The United States, wealthier to begin with, didn’t do badly either: The nation’s income, adjusted for inflation, increased about 1.7 times during those years.
Higher productivity was reflected in workers’ paychecks, enabling millions of people to buy homes, cars, and washing machines. The fact that so many people were getting so much better off so quickly seemed to confirm that the experts had cracked the economy’s secret code.
Productivity dropped in the ’70s, and has never fully come back
Then, at the end of 1973, the trend came to an abrupt end: Economic growth around the world collapsed. A sharp rise in oil prices was the immediate trigger, but when the oil crisis ended, robust growth failed to return. Nothing seemed to fix the problem. From 1973 to 1979, income per worker across 28 wealthy economies grew at an average annual rate of 1.7 percent — less than half the growth rate between 1960 and 1973.
Great Britain fared by far the worst among the world’s major economies, with income per person rising a scant 1.3 percent per year. As Keith Joseph, a leader of Great Britain’s Conservative Party and economic adviser to an anti-establishment politician named Margaret Thatcher, admitted as his country wallowed through a double-dip recession in 1974, “Growth is welcome, but we just do not know how to accelerate its pace.”
Nothing could have been more impolitic. Economists, not to mention politicians, hastened to come up with cures for the growth slump. The data showed clearly that productivity improvements had tailed off, not just in the United States, but around the world. Some experts blamed inflation for deterring business investment that could make the economy more productive; others argued that greater government spending would ramp up demand for goods and services, increasing productivity by allowing business to operate near full capacity. Still others, pointing out that the service sector was becoming more important in every country, suggested that service providers could not raise productivity as easily as manufacturers who could simply install new machines.
Pursuing chimerical theories about growth
The would-be solution with the greatest political appeal became known as supply-side economics. The theory, embraced by conservative leaders like Thatcher in Great Britain and Ronald Reagan in the United States, was that cutting taxes, eliminating regulation, and shrinking government would lead to massive new investments in factories and business equipment — which, in turn, would raise workers’ productivity. The results were disappointing: Supply-side policies brought slower productivity growth around the world than the high-tax, big-government policies that preceded them. Incomes everywhere rose far more slowly than before, and unemployment rates were far higher. The jobless rate in the United Kingdom averaged nearly 9 percent during Thatcher’s 11-year reign, and US unemployment exceeded 7.5 percent during the Reagan years. Only in the incomplete memories of their partisans were these times of unparalleled prosperity.
The failure of small-government medicine in the 1980s brought forth new big-government ideas for restoring the vibrant economic growth of earlier years. These computer-age theories held that intangibles like creativity and innovation lie at the heart of a vibrant economy. In this analysis, government plays a critical role in raising productivity by funding scientific research, improving education and training, and making sure that the patent system helps innovators earn profits without tying them up in a mass of infringement suits.
Trouble is, while there are anecdotes aplenty about how government aid has spurred development of cancer treatments or solar panels, there is little evidence that such programs have spurred productivity or raised wages across the entire economy. Improving the quality of the workforce is harder now that almost all young people in wealthy economies finish high school or complete apprenticeships. While worker education is important, raising the average length of schooling by a few months doesn’t do as much for productivity as turning elementary school dropouts into high school graduates did back in the 1950s.
Why has raising productivity growth proven such a tough challenge? The historian’s answer is that rapid productivity growth tends to arrive unannounced and depart unpredictably, due largely to the success of the private sector in putting innovations to economically valuable uses. But which innovations work is often evident only in retrospect.
From the 1950s into the 1980s, to take one example, many companies and government agencies used their new mainframe computers to generate more paper than they had before — possibly offsetting the productivity-enhancing aspects of new computational power. As late as 1987, Robert Solow, the famed MIT economist, could quip, “You can see the computer age everywhere but in the productivity statistics.” Then, in the late 1990s, productivity growth suddenly jumped in the United States and Canada possibly because businesses were reorganizing their operations around the internet. More recent innovations — smartphones, artificial intelligence, virtual reality — don’t seem to have done anything for the productivity growth rate so far. Tomorrow, they might — or might not.
Four decades of failure to boost the rate of economic growth in the wealthy economies argue not against any particular growth theory, but rather against hubris. Moving the economy onto a trajectory that raises living standards rapidly for a generation — the sort of trajectory that made average families feel prosperous in the 1960s and early 1970s — requires faster productivity growth. Government policy — keeping inflation relatively low, investing in infrastructure and education, supporting research — may help a bit, and it is conceivable that some government policies may be a hindrance. But the fact that productivity growth has slowed all over the world, not just in the United States, strongly suggests that the productivity slowdown is not the result of the Affordable Care Act, the US tax system, or anything else cooked up in Washington.
It would be wonderful indeed if productivity were to soar once again. Perhaps innovations as yet untapped will make that happen. But a productivity boom is not something Trump’s economic advisers, or anyone else’s, have the tools to bring about. Until and unless it arrives, we’re likely to be stuck with an ordinary economy.
Marc Levinson is an economist and historian. This essay draws on his new book, An Extraordinary Time: The End of the Postwar Boom and the Return of the Ordinary Economy.
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