Tyler Cowen & The Great Stagnation

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

This week, Bloomberg Businessweek hails Tyler Cowen as “America’s hottest economist”. And David Brooks in the New York Times calls his book (The Great Stagnation: How America Ate All the Low-Hanging Fruit of Modern History, Got Sick, and Will(Eventually) Feel Better, “the most debated nonfiction book so far this year”. The book by Cowen, an economics professor at George Mason University, is, we are told, one that “must be responded to.”

The book is short, clear, well-written and very affordable at $3.99—all superb virtues in any book. It argues that the US economy has hit a wall. The Great Recession of 2008 was not a cyclical event. It reflects a deeper truth: we are not as rich as we thought. And things won’t get better, any time soon.

According to Cowen, we face a foreseeable future of continuing stagnation, because we have run out of the “low-hanging fruit” that have fueled economic growth for three centuries. Our economic predicament is structural, not cyclical.

Cowen’s book is a curious brew of hard economic truths and folkloric nonsense. Despite some striking insights, Cowen’s overall diagnosis is misguided and the solution to our predicament does not lie where he finds it.

Cowen’s nonsensical “low-hanging fruit” theory

Among the book’s folkloric nonsense is the idea that the economy is in trouble because we no longer have the three kinds of “low-hanging fruit” that have fueled economic growth for centuries: free land, technological breakthroughs, and smart kids waiting to be educated.

(a) “No more free land”: Free land had something to do with America’s wealth as an agricultural powerhouse in the 19^th Century but practically nothing to do with America’s emergence as the premier industrial power of the 20^th Century. I’m sorry. Free land was not a significant factor.

(b) “No more technological breakthroughs”: According to Cowen, the economy has already gotten most of the benefit out of previous technological breakthroughs. The big technological leaps are over: we are now squeezing out marginal gains. “Apart from the seemingly magical Internet, life in broad material terms isn’t so different from what it was in 1953.”

Hello? The world I lived in back in 1953 is a world that a young person of today can hardly conceive. In addition to not having an Internet, I had no computer, no word processor, no spreadsheet, no desktop publisher, no email, no texting, no mobile phone, no video camera, no Facebook, no Twitter, no YouTube, no mp3 player, no television, no microwave oven, no Cuisinart, no credit card, no bar codes, no self-check-in, to mention just a few of the everyday things that today’s young people take for granted. I had a telephone but a long distance telephone call was hugely expensive and complicated. I had a newspaper but it mainly focused on local news: I had little idea of what was going on in other parts of the world or what my real economic options were. And of course, Cowen mentions that little exception, “apart from the Internet”, which is like saying “apart from the wheel”, transportation hasn’t changed at all in ten thousand years.

To argue that in broad material terms that our situation in material terms back in 1953 “isn’t so different from today” is ridiculous. The real challenge for most organizations is not lack of technological opportunities but rather keeping up with accelerating technological change.

(c) “No more smart kids waiting to be educated”: Cowen notes that high-school enrolment in the US went from 6% in 1900 to 60% in 1960, as farm kids starting going to school. He writes “taking a smart motivated person out of an isolated environment and sending that person to high school will bring productivity gains.” Cowen has a curiously low opinion of today’s continuing flow of immigrants. Educating the rest of the population, he says, is going to be “a long tough slog with difficult obstacles along the way.”

What Cowen misses is that for the first two thirds of the 20^th Century the economy not only had jobs for people with an education, it also had jobs for the relatively uneducated.

In fact, as management theorist Gary Hamel has noted, “Management was originally invented to solve two problems: the first—getting semiskilled employees to perform repetitive activities competently, diligently, and efficiently; the second—coordinating those efforts in ways that enabled complex goods and services to be produced in large quantities. In a nutshell, the problems were efficiency and scale, and the solution was bureaucracy, with its hierarchical structure, cascading goals, precise role definitions, and elaborate rules and procedures.”[i]

The success of management resulted in America emerging as the premier industrial power, not principally because of a large educated workforce who magically self-organized so as to become highly productive, but rather because large US corporations discovered how to use large numbers of even semi-skilled people more productively. One of America’s major technological breakthroughs of the 20^th Century was management.

Frederick Taylor, Henry Ford and Alfred Sloan among others showed how to run big organizations by delivering mass production through managing the supply chain, parsing and manufacturing demand, controlling employees as human resources, and steadily increasing efficiency through economies of scale. As a result, the firms made large amounts of money for shareholders and provided good jobs for both the educated and the uneducated. It was a win-win-win solution.

Our problem today is the opposite: this way of managing doesn’t provide good jobs even for the educated, as recent college graduates have found to their shock as they enter the job market and shareholders of traditional firms are finding as they see their returns on the decline.

The real issue is figuring out why an economy that had strong growth and good jobs for everyone for much of the 20^th Century now has neither.

Two major macroeconomic developments

As Cowen misdiagnoses why the economy was so successful for much of the 20the Century, it’s not surprising that he also misses two major macroeconomic developments that help explain why the economy is seemingly permanently stalled in a succession of jobless recoveries.

Over the last couple of decades, there has been an epochal shift in the balance of power from seller to buyer. For the first two-thirds of the 20^th Century, oligopolies were in charge of the marketplace. These companies were successful by pushing products at customers, and manufacturing demand through advertising. But this situation changed.

Today customers have instant access to reliable information and have options: they can choose firms who delight them and avoid companies whose principal objective is taking money from our wallets and putting in their own. The result is a fundamental shift in power in the marketplace from the seller to the buyer: not only do customers not appreciate being treated as “demand” to be manufactured: now they can do something about it. If they are not delighted, they can and do go elsewhere.

The second is a fundamental shift in the workplace where the nature of work has shifted from semi-skilled to knowledge work. Meeting the business imperative of delighting customers can only be accomplished if the knowledge workers contribute their full talents and energy to contribute continuous innovation. Treating employees as “human resources” to be manipulated undermines the workforce commitment that is needed.

As a result, the 20^th Century management system—the goose that laid America’s golden egg—stopped delivering. The monumental study by Deloitte’s Center for the Edge shows that the rate of return on assets of US companies is one quarter of what it was in 1965; the life expectancy of firms in the Fortune 500 has fallen from around 75 years half a century ago to just 15 years today and is falling fast. Only one in five employees is fully engaged in his or her work. And a study by the Kauffman Foundation showed that firms older than five years produced almost no net new jobs in the period 1980 to 2005 (whereas firms younger than 5 years created around 40 million jobs in that period.)

The world changed but management didn’t

It was management, not Cowen’s low-hanging fruit, that created an economy with strong economic growth and good jobs. When the world changed, management also needed to change. The problem was: it didn’t.

By and large, the management of big firms pressed ahead with 20^th Century management without always realizing that pushing products and services at customers, treating customers as “demand” to be manufactured and treating staff as “human resources” as things to be manipulated, were practices that frustrated customers and dispirited employees. The harder management pursued these practices, the more counterproductive the practices became. In this setting, education, far being the automatic key to higher productivity, was a problem: the more educated the employees, the more dispirited this way of managing made them.

The new business imperative: delighting customers

As a result of these problems, a whole new way of managing is emerging, which reflects the new balance of power in the marketplace and revolves around delighting the customer. Delighting the customer has become a business imperative, not just because the customers are happier or because the people doing the work are energized or because it extends the life expectancy of a firm, generates jobs and fuels the growth of the economy. Delighting the customer does all those things, but the real driver of its inevitability is that it makes more money.

Yet delighting the customer poses challenges. It requires constant innovation, which is more difficult than pushing a product out the door. It requires collaboration across multiple disciplines to accomplish it. It requires a radically different kind of management.

Big corporations take the easy way out

When CEOs find difficulty in pursuing continuous innovation, investment bankers are quick to whisper in their ears and offer an easy way out:

“How do you know that your efforts at continuous innovation will pay off? Why go through all that hassle? Why not just buy your competitor and let half their people go. There’s little risk. Your stock price will go up. Your company will be much bigger and more powerful. And you personally will get a huge bonus.”

For the last two or three decades that’s what has been happening on a large scale. Many companies have taken the easy way out. And in the short run and from a narrow perspective, it seemed to work. The acquisitions were made. Some companies got bigger. Many jobs were lost. The CEOs got their oversized bonuses.

According to the official statistics, this way of managing makes the economy seemingly more productive, but it does so by cutting jobs and costs, not by innovating and creating real growth. The short term financial returns conceals the fact that these firms and the economy were starting down a long-term death spiral.

In due course, Wall Street started discovering the difference between growth by acquisition and organic growth through continuous innovation. As shown below, the consequences in terms of long-term share price are stark.

We know how to manage differently

As a result, discerning leaders are pursuing a radically different management, which entails five fundamental and interlocking shifts:

• The firm’s goal (a shift from making money for shareholders to delighting the customer through continuous innovation).
• The role of managers (a shift from controller of individuals to enabler of self-organizing teams).
• The mode of coordinating work (a shift from bureaucratic control to dynamic linking).
• The values practiced (a shift from economic value to the values that will grow the firm: radical transparency and continuous improvement).
• The communications (a shift from top-down command to adult-to-adult conversation).

“Delighting the customer” is an operational business objective, not some vague, abstract or subjective chimera. Measurement is central.

Individually, none of these shifts is new. What is new is doing them together as systemic change. When only one or two of these shifts is pursued without the others, the change tends to be unsustainable because any improvements are undermined by conflicts with the principles of traditional management.

The radically new way of managing is not just profitable. It’s hugely profitable.

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 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 2 of this article: Some hard truths from Tyler Cowen on the economics and politics of solving the great stagnation.

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

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