Human ingenuity can beat stasis

This Perspective column was first published in today’s edition of Fund Strategy.

Although the claim that America has entered a “new normal” of low economic growth has become commonplace the argument is usually crude. A new paper* by Robert Gordon, a professor at Northwestern university in Chicago, is an important exception.

He puts forward a sophisticated case that contends that economic dynamism and innovation were weakening long before the onset of crisis in 2007. In his view there are several reasons why America at least looks destined to a future of permanent stagnation.

Gordon’s argument is in some respects reminiscent of that of Tyler Cowen that I examined in the cover story of 14 May 2012. But Gordon takes Cowen’s central contention that the “low hanging fruit” – easy technological gains – have already been picked and stretches it even further.

The main thrust of Gordon’s argument is that the epoch of modern economic growth that started in about 1750 has ended. Until the mid-eighteenth century economies were essentially static. Since then the western world has generally enjoyed high growth per head, rapid productivity growth and a structural transformation of its economy. In identifying growth as a feature of modernity he follows the path laid down by Simon Kuznets, one of the founders of national income accounting, from the 1930s onwards.

Until recently it was widely argued that such growth could continue indefinitely. But Gordon uses long-term studies of innovation to show that America is bumping against limits to the growth process.

For Gordon it is possible to divide modern American economic history into three industrial revolutions. The first ran from 1750-1830, the second, the most important, was from about 1870-1900, and the final one began in 1960.

This periodisation has two striking features. For a start the internet and mobile technology do not constitute a revolution in themselves. Gordon dates the current technological revolution back to about 1960s when computers began to be commercially used.

Perhaps even more striking is the contrast between the huge sweep of changes in the second industrial revolution and the relatively modest developments more recently. To illustrate this point Gordon asks readers to choose between two options.

Those who select Option A are restricted to electronic technology available till 2002, which would include a Windows 98 laptop accessing Amazon, but they can keep running water and indoor toilets. Option B means keeping Facebook, Twitter and the iPad but giving up running water and indoor toilets.

For those who choose Option B: “You have to haul the water into your dwelling and carry out the waste. Even at 3am on a rainy night, your only toilet option is a wet and muddy walk to the outhouse”.

Audiences given this imaginary choice invariably select Option A. They much prefer to forsake the iPad or Twitter than do without running water and indoor toilets. For Gordon this shows that the most recent technological developments are not as transformative as widely believed.

The slowdown in innovation coincides with a fall in economic growth. Gordon identifies downward steps in American GDP growth in 1964, 1972 and 1987. If anything the recent economic downturn has made the situation considerably worse.

He goes on to develop arguments to show why innovation has slowed down in recent decades. Gordon contends that one of the main reasons is that many innovations can only happen once:

“Speed of travel was increased from that of the horse to the jet plane in a century but could not happen again. The interior temperature that in 1870 alternated between freezing cold in the winter and stifling heat in the summer … could not happen again. The US was transformed from 75 percent rural to 80 percent urban, and that could not happen again.”

Gordon points to six “headwinds” which he says account for faltering innovation.

• The “demographic dividend” of women entering the labour force was a one-time only event.
• American educational attainment has hit a plateau.
• Rising inequality pushes down the median income.
• Globalisation combined with information technology means that cheap foreign labour can compete with American jobs.
• The impact of environmental problems such as global warming.
• The huge overhang of household and government debt.

There are several reasons to question Gordon’s gloomy prognosis. Although he is no doubt right that economic growth and innovation have slowed it would be wrong to see this trend as inevitable.

The most obvious limitation of Gordon’s analysis is that, by his own admission, it focuses entirely on America or less than 5% of the world’s population. To the extent he refers to the rest of the world it is the impact of cheap foreign labour on American jobs. But this ignores the enormous potential benefits of growth elsewhere.

Imagine, for instance, the rest of the world’s population reaching the economic and educational level of America. That would mean that people in such diverse countries as Bolivia, India and Nigeria could contribute fully to global innovation. Think what humanity would be capable of if so many brains could contribute fully to the world economy.

No doubt many greens would counter that environmental limits preclude such a development. But rather than see development as an environmental threat it would be better to see it as an opportunity to overcome natural limits. Innovation can itself solve many of the problems that humanity is up against.

Ultimately the challenge is finding the imagination to develop paths to better growth. To be fair to Gordon he gives several examples of past claims about the impossibility of future progress.

“In 1927, a year before the Jazz Singer, the head of Warner Brothers said, ‘Who the hell wants to hear actors talk?’ In 1943, Thomas Watson, then president of IBM, said, ‘I think there is a world market for maybe five computers.’ And in 1981, in the most famous of these ill-fated quotes, Bill Gates himself said in defense of the capacity of the first floppy disks, ‘640 kilobytes ought to be enough for anyone.’” [SEE NOTE ON THIS QUOTE BELOW].

The main thing holding us back is our reluctance to harness the power of our imagination.

* Is US Economic Growth Over? Faltering innovation confronts six headwinds. August 2012.

Additional note. My friend James Woudhuysen, an expert on innovation, tells me that there is no evidence for the Thomas Watson or Bill Gates quotes above. For example, he points to this article from USA Today.