The New Economic Growth: We Haven't Figured It Out
By Gregory Tassey
The American economy is stuck in a slow-growth gear characterized not just by inadequate job creation but also by stagnant real incomes, increasing income inequality and an eroding tax base that exacerbates the growing under funding of social programs. The response, at least by the "compassionate" portion of society, has been to support extended unemployment benefits, and promote a more progressive tax structure and a higher minimum wage. The problem is that such initiatives themselves are constrained in a slow-growth economy because the resulting inadequate tax base means they must be funded through either additional deficit spending or income redistribution -- the latter being more strongly resisted when personal incomes are not growing. These are not long-term solutions.
It wasn't always this way. For approximately three decades after World War II, the American economy dominated world markets and the United States experienced trade surpluses due to superior technology and skilled labor. During this period, workers' real incomes grew steadily.
But in the 1980s, foreign competition began to take not only moderate skilled jobs but also technology-based, higher-paying ones from the U.S. economy. Embracing globalization, U.S.-based corporations' share of GDP, after declining for several decades, began growing in the 1980s and their share has accelerated in the last decade. The flip side of corporate income's relative growth has been a declining share for American workers: inflation-adjusted weekly earnings in 2012 were only 5.3 percent higher than in 1980 -- basically unchanged in over three decades. Not coincidentally, the power of unions declined drastically beginning in the 1980s, as witnessed by the virtual disappearance of work stoppages.
These opposing trends are the result of U.S. companies increasing productivity in response to growing global competition and taking advantage of emerging markets where workers attained productivity levels that were higher relative to wages. This process of labor arbitrage has produced the stagnant real income growth and increasing income inequality within the U.S. economy.
The declining relative competitiveness of domestic American manufacturing has led to offshoring and less exports and more imports. The U.S. manufacturing trade balance, which became negative for the first time in 1975, has shown steadily increasing deficits for the past 38 years. In the last 10 years (2002-2012), the cumulative drain on GDP from these deficits was $5.6 trillion. Even the "advanced technology" portion of the manufacturing trade balance became negative in 2002 and has grown steadily, reaching a low of $100 billion in 2011. Deficits in high-tech trade are particularly shocking, as virtually all major technologies currently driving the world economy originated in the United States but are now, in many cases, produced largely outside the domestic economy.
Clearly, the negative economic trends described here transcend multiple business cycles. Thus, the underlying causes are not the result of the last recession, as many analysts seem to think. Sticking to an out-of-date long-term growth strategy has resulted from long held philosophies that new industries will somehow form on their own and that an appropriately skilled labor force will automatically appear to work in these industries -- basically all through the pull and push of the market mechanism. In the past, such transitions did in fact occur but only over extended periods of time, which in today's increasingly competitive global economy will not cut it.
As real incomes ceased to grow, the response was to maintain growth in consumption by taking on increasing amounts of debt. In the period prior to the Great Recession (2000-2008), total credit market debt increased 99 percent while GDP grew by less than half that rate (45 percent). One of the major manifestations of this debt-driven growth was a national savings rate that hovered around zero. In a national accounting sense, this meant that virtually all investment had to be financed by foreign capital. Not surprisingly, "fixed private investment" (hardware and software) had its lowest rate of growth in decades during the 2000s. Such investment is the primary vehicle for incorporating new technology and thereby enabling long-term productivity growth. However, after decades of growth, U.S. public debt held by foreigners is now declining. The party is coming to an end.
When the huge debt bubble popped, aggregate demand collapsed as consumers and government at all levels drastically reduced consumption in order to repair debt-burdened balance sheets. The traditional economic policy response to a drop in demand is to apply monetary and fiscal stimulus. This approach was implemented in historic proportions but has had modest impact at best.
Here is the fundamental problem. Monetary and fiscal policies are designed to stabilize the business cycle. That is, their job is to dampen swings in economic activity about a long-term growth track, but such policies do little to determine the growth track itself. Thus, they fail miserably as long-term growth strategies. In particular, they focus on short-term demand with little or no emphasis on investment, especially long-term investment in R&D and associated capital formation, which are essential for long-term productivity growth. Productivity growth is the only long-term solution to sustained job creation and higher incomes. Nevertheless, Keynesian economists have insisted that aggressively leveraging demand through deficit spending until renewed growth is achieved is the only policy tool needed to revive the economy.
Other economists and policy analysts will argue that the federal government does, in fact, have an investment policy. After all, it spends about $140 billion per year on R&D. However, the vast majority of these funds go to mission-oriented agencies. While this R&D does lead to commercialization of new technologies, there is no way this funding comes close to the optimal portfolio for promoting economic growth. And, while other countries have well established programs for supporting commercialization of new technologies, the U.S. is just beginning to experiment with similar strategies.
Over the next few years, the U.S. economy will get a boost from increasing supplies of domestically produced energy and consequently lower prices for a range of products and services. This will improve the cost structures of energy-intensive industries and industries using petrochemicals as feed stocks. However, while the cost advantage realized will help these subsectors for a period of time, it may also once again distract the nation from the need to restructure the economy. Cheap energy does not change the quality of domestically produced products that must compete in global markets.
The fact is, the United States accounts for only 5 percent of the world's consumers. Thus, as other industrialized nations continue to restructure and an increasing number of emerging economies "converge" on industrialized nations in the sense that productivity and income differentials shrink, the rest of the global economy will exert growing pressure on U.S. economic growth rates. Domestic demand stimulation does nothing to help solve this problem. Combined with low income growth, it will only ensure stagflation as excess liquidity and continued trade deficits eventually lead to a resumption of currency depreciation and hence rising prices for which weak domestic income growth cannot compensate.
Meanwhile, our competitors are increasingly attaining the capability not only to produce high value-added goods more cheaply but also to create them. This is truly a global phenomenon. A lot of attention is placed on Asia and other emerging economies. However, superior growth strategies work even in high-cost economies. For example, hourly compensation for the average manufacturing worker in Germany is about 25 percent higher than in the United States. Yet, Germany has produced consistent trade surpluses. The reason is simple: the Germans have a more holistic and aggressive investment strategy. Such a strategic approach is typical of much of Northern Europe.
The world is spending $1.4 trillion per year on research and development (R&D), which in turn is stimulating many times that amount in capital formation, manufacturing, commercialization activities, and hence employment -- high-paid employment. To support such a technology-based growth strategy, nations are increasing their workers' skills, automating production and service industries, and providing new technical infrastructures conducive to technological innovation and market share growth. Such trends mean serious growing competition and loss of market shares for the economies that do not aggressively raise their productivity on a long-term basis.
The bottom line is that in order to achieve higher rates of growth on a long-term basis, a major shift in U.S. economic growth philosophy is required. A few states are implementing new investment strategies such as "innovation clusters" and worker training programs, but the federal government has only recently gotten started and Congress shows no signs of adequately funding what initiatives have been put forward. If a broad and sustained investment-oriented growth strategy focusing on a range of advanced technologies and their commercialization is not implemented, the prospect of stagflation will surely be realized. If we could maybe have just one of the multiple trillion-dollar pulses of demand stimulation injected by the Fed and the Treasury since the Great Recession, a great start could be made.
- Greg Tassey is a Research Fellow at the Economic Policy Research Center, University of Washington and is formerly Senior Economist at the National Institute of Standards and Technology.
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