Tyler Cowen & The Great Stagnation: Part 2

America’s Hottest Economist: Tyler Cowen & The Great Stagnation: Part 2

My article yesterday endorsed the thrust of Tyler Cowen’s book, The Great Stagnation, that the US economy has hit a wall, while arguing that this was not because of the exhaustion of “low-hanging fruit” but rather because the marketplace and the workforce have changed and management hasn’t. The great engine of US industrial growth for much of the 20^th Century—the hierarchical bureaucracy of traditional management—no longer fits the economic context of today. The future of the 21^st Century organization lies with those who know how manage in a radically different way that generates continuous innovation and delights their customers.

GDP overstates our economic well-being

Despite the flaws in the “low hanging fruit” theory, Cowen’s book does have some useful and striking insights. In particular, chapter 2 of the The Great Stagnation sheds light on an important puzzle: why do the economic indicators continue to show steady growth of the US economy, at a time when median incomes have been stagnant for a number of decades, jobs are hard to come by and everything seems to be more expensive?

If productivity is going up, we are doing more, getting more, with less, then things can’t be all that bad. Right?

The book helps explain why the GDP overstates our economic well-being in several domains

Government, health and education

One reason why the apparent growth of the GDP overstates our well-being is that a significant part of the growth of the economy is occurring in expenditures in government and on health and education, without corresponding increases in benefits.

This is because, in measuring the GDP, expenditures in these areas are valued at cost. In these measurements, it is assumed that the quality, importance and efficacy of government, education and health stay constant as their size increases.

For instance, the massive increase in defense expenditures, including developing weapons systems that are unlikely to be ever completed, let alone deployed or used, count as “benefits” valued at cost for the US economy, even though any benefits are restricted to the few firms and people involved building the weapons systems.

In education, we are spending more than twice what we spent forty years ago, but without any obvious gains in terms of educational outcome. Again, the benefits of these increased costs are valued at cost.

Similarly, health expenditures in the US are much greater than any other developed country, although health outcomes for the population as a whole are much worse than any other developed nation. But the increased expenditure counts as a benefit. The health benefits, if any, are mainly experienced by the old: everyone is paying a lot more, but the benefits are narrowly shared. Getting some correlation between health expenditures and health benefits would require much more innovation. Instead the current fee-for-service model virtually guarantees that health costs will expand, regardless of benefits.

The “benefits” of the private sector

Cowen also suggests in passing that the real benefits from the growth of the financial sector is of “dubious value”. It’s not obvious that the financial sector is growing the real economic pie. As Gerald Epstein, an economist at the University of Massachusetts has said:

“These types of things don’t add to the pie. They redistribute it—often from taxpayers to banks and other financial institutions.”

Cowen is in sync with Lord Adair Turner, the chairman of Britain’s top financial watchdog, the Financial Services Authority, who has described much of what happens on Wall Street and in other financial centers as “socially useless activity”:

Many people in the City and on Wall Street are the financial equivalent of slumlords or toll collectors in pin-striped suits. If they retired to their beach houses en masse, the rest of the economy would be fine, or perhaps even healthier.

What about the Internet?

Cowen argues that the Internet is a major public good, but its biggest benefits are distributed in proportion to our cognitive abilities to use them. We don’t benefit from it automatically as we did from a paved road or a flush toilet.

David Brooks summarizes:

“As Cowen notes in his book, the automobile industry produced millions of jobs, but Facebook employs about 2,000, Twitter 300 and eBay about 17,000. It takes only 14,000 employees to make and sell iPods, but that device also eliminates jobs for those people who make and distribute CDs, potentially leading to net job losses. In other words, as Cowen makes clear, many of this era’s technological breakthroughs produce enormous happiness gains, but surprisingly little additional economic activity.”

As a result, Cowen argues that the benefits of the Internet don’t show up in the productivity numbers. We assume that technological progress will result in big and predictable stream of revenue growth across most of the whole economy.

The Internet does generate sizable revenue streams

This way of looking at the world misses the meaning of the Internet. Google has a market capitalization of $170 billion with 26,000 employees. Its very sizable revenue stream affects not just the 26,000 employees who work there but also all the businesses that use its advertising services.

Similarly it’s misleading to judge the economic impact of Apple simply as a maker of iPods that employs only 14,000 people. The engine behind Apple’s phenomenal growth in the last decade (a company now with 46,000 employees and a market capitalization of $312 billion) is the Internet-based iTunes platform which offers cheap and easy access to music for everyone and which serves as the foundation for the App store, thus making the iPhone, the mobile phone that people “have to have”. By building these platforms, Apple enables tens of thousands of businesses to participate in its success.

In fact, the successful Internet companies generate very sizable revenue streams. For instance, Salesforce.com (with 5,000 employees and market cap: $20 billion) and Amazon (with 38,000 employees and market capitalization of $34 billion) are not tiny startups.

The idea that the Internet isn’t generating much in the way of revenue is at odds with the facts.

Politics makes things worse

The Great Stagnation is more surefooted when it comes to the politics of coping with the slowdown.

The Democratic Party seeks to expand government spending even when the middle class feels squeezed, the public sector doesn’t always perform well, and we have no good plan for paying for forthcoming entitlement spending. To the extent Republicans have a platform, it consists of unrealistic claims about how tax cuts will raise revenue and stimulate economic growth. The Republicans, when they hold power, are often a bigger fiscal disaster than the Democrats…

For the last forty years, most American have been expecting more than their government is capable of delivering. That mistake is at the root of why our government is functioning poorly. Instead of admitting its limitations or trying to manage our expectations, government starts lying to us about what is possible…

Tax cuts without spending cuts simply do not work, and yet politicians are driven to market them. Repeatedly. We are conducting fiscal policies that are unsustainable when combined with a growth slowdown. The tax cut proponents must make increasingly implausible claims about the potential benefits of tax cuts. e.g, “the tax cuts pay for themselves”…

The political debate proceeds in terms of tax cuts versus redistribution, and the two sides can no longer hear each other…

We throw subsidies to lobbyists, tax breaks for corporations, excess job security for K-12 teachers, or high reimbursement rates from Medicare for medical device makers, to name a few examples among thousands…

The Left defends the status quo while the Right is playing the role played by the Black Panters in the 1960s.

This is all wonderful stuff. And Cowen is right to conclude that Government will remain broken until we have some breakthroughs that will generate a lot of revenue and jobs.

As Part 1 of this article explained yesterday, fortunately those breakthroughs have already been made.

Just as the labor market is increasingly divided into a group that can keep up with technical work and those who can’t, so the industrial landscape is increasingly divided into a group of firms that can keep up with the new demands of radical management to delight their customers and those that can’t.

Those that delight their customers like Apple, Amazon, and Salesforce.com are experiencing exponential growth. Compare these to traditional stalwarts like GE, Wal-Mart and Cisco, which struggle even to hold their share price constant. The difference is stark. A whole different world is opening up in front of our eyes, if we dare to see it.

Read part 3 of this article: A core reading list for economists who want to understand the future.