Why The Great Stagnation Thesis is the Most Subversive Libertarian Argument of Our Age

|Peter Boettke|

Tyler Cowen caused quite a stir with his e-book, The Great Stagnation.  In properly assessing his work it is important to state explicitly what his argument actually is.  Median real income has stagnated since 1980, and the reason is that the rate of technological advance has slowed.  Moreover, the technological advances that have taken place with such rapidity in recent history have improved well-being, but not in ways that are easily measured in real income statistics.

Critics of Cowen more often than not miss the mark when they focus on the wild improvements in our real income due to quality improvements (e.g., cars that routinely go over 100,000 miles) and lower real prices (e.g., the amount of time required to acquire the inferior version of yesterday’s similar commodities).  Cowen does not deny this.  Nor does Cowen deny that millions of people were made better off with the collapse of communism, the relative freeing of the economies in China and India, and the integration into the global economy of the peoples of Africa and Latin America.  Readers of The Great Stagnation should be continually reminded that they are reading the author of In Praise of Commercial Culture and Creative Destruction.  Cowen is a cultural optimist, a champion of the free trade in ideas, goods, services and all artifacts of mankind.  But he is also an economic realist in the age of economic illusion.

What do I mean by the economics of illusion?  Government policies since WWII have created an illusion that irresponsible fiscal policy, the manipulation of money and credit, and expansion of the regulation of the economy is consistent with rising standards of living.  This was made possible because of the “low hanging” technological fruit that Cowen identifies as being plucked in the 19th and early 20th centuries in the US, and in spite of the government policies pursued.  An accumulated economic surplus was created by the age of innovation, which the age of economic illusion spent down.  We are now coming to the end of that accumulated surplus and thus the full weight of government inefficiencies are starting to be felt throughout the economy.  Our politicians promised too much, our government spends too much in an apparent chase after the promises made, and our population has come to accustomed to both government guarantees and government largess.

Adam Smith long ago argued that the power of self-interest expressed in the market was so strong that it could overcome hundreds of impertinent restrictions that government puts in the way.  But there is some tipping point at which that ability to overcome will be thwarted, and the power of the market will be overcome by the tyranny of politics.  Milton Friedman used that language to talk about the 1970s, we would do well to resurrect that language to talk about today.

Cowen’s work is a subversive track in radical libertarianism because he identifies that government growth (both measured in terms of scale and scope) was possible only because of the rate of technological improvements made in the late 19th and early 20th century.  We realized the gains from trade (Smithian growth) and we realized the gains from innovation (Schumpeterian growth), and we fought off (in the West as least) totalitarian government (Stupidity).  As long as Smithian growth and Schumpeterian growth outpace Stupidity, tomorrow’s trough will still be higher than today’s peak.  It will appear that we can afford more Stupidity than we can actually can because the power of self-interest expressed through the market off-sets that negative consequences. But IF and WHEN Stupidity is allowed to outpace the Smithian gains from trade and the Schumpeterian gains from innovation, then we will first stagnate and then enter a period of economic backwardness unless we curtail Stupidity, explore new trading opportunities, or discover new and better technologies.

In Cowen’s narrative, the rate of discovery had slowed, all the new trading opportunities had been exploited, and yet government continued to grow both in terms of scale and scope.  And when he examines the 3 sectors in the US economy – government services, education and health care – he finds little improvement since 1980 in the production and distribution of the services.  In fact, there is evidence that performance has gotten worse over time, especially as government’s role in health care and education has continued.

The Great Stagnation is a condemnation of government growth over the 20th century.  It was made possible only by the amazing technological progress of the late 19th and early 20th century.  But as the rate of technological innovation slowed, the costs of government growth became more evident. The problem, however, is that so many have gotten used to the economics of illusion that they cannot stand the reality staring them in the face.

This is where we stand in our current debt ceiling debate.  Government is too big, too bloated. Washington faces a spending problem, not a revenue problem.  But too many within the economy depend on the government transfers to live and to work.  Yet the economy is not growing at a rate that can afford the illusion.  Where are we to go from here?

Cowen’s work makes us think seriously about that question.  How can the economic realist confront the economics of illusion?  And Cowen has presented the basic dilemma in a way that the central message of economic realism is not only available for libertarians to see (if they would just look, or listen carefully to his podcast at EconTalk) but for anyone who is willing to read and think critically about our current political and economic situation.  The Great Stagnation signals the end of the economics of illusion and lets hope paves the way for a new age of economic realism.

Comments

[Ryan Murphy]

This is my way of looking at growth. Let's suppose that we're at wherever long-term growth level we can get through capital accumulation (c.f. Solow). Let's also suppose we have put in place the optimal policies for intellectual property, taxation, and everything else (or that private firms have entered such an equilibrium, whatever). What rate of GDP/cap growth do you think is plausible? I would say, with little justification besides "mere" intuition, that it would not be greater than 5%, because otherwise we would have incomprehensibly high levels of growth.

Look at the gap between the rate of growth over the last thirty year and that 5%. Maybe we had at one point certain capital accumulation or other "dynamic" effects. But beyond that, how much can any single reform get us to expand our level of growth? If you believe that our current normal rate of growth is 1% per cap, and that an optimal level of enforcement (or non-enforcement) of intellectual property would provide us with an addition 2% growth per cap, is it really plausible that failures of intellectual property are 40% of all inefficiencies? Keep in mind, as long as we are playing the utilitarian game, that it is not given that the optimal level is not more government (or "governance") in this area. *ANY* improvement in public policy must be looked at in this way; if you wish to ascribed 40% of inefficiency to intellectual property, there is less "room" for fiscal policy to matter (setting aside interactive effects, which would still need to add up to 5%).

I think many of the factors Cowen lists are worthwhile. They made it easier for us to have growth in the short-run without reaching all those long-run goal. But it makes it much more disconcerting that we will converge to Japan's growth behavior than anything else.

[Steve Miller]

The problem with TGS is that Tyler really is saying that Schumpeterian growth especially has slowed down. And it hasn't. I understand the libertarian interpretation of his argument. It would be ideologically convenient to say that growth in the size and scope of government has led to stagnation. The problem is it hasn't, because there is no stagnation. There's a counterfactual argument to be made that innovation would have been even greater without a government that consumes roughly a third of GDP. That's fine, but the word stagnation is completely misleading. Economic pessimism is wrong even when libertarian economists are preaching it.

[Roger Koppl]

If we are in the Great Stagnation, isn't the opportunity cost of interventionism correspondingly low?

[Jerry O'Driscoll]

As presented by Pete, Cowen's argument comes across as a rediscovery of Mises' concept of the surplus. We are now consuming our surplus.

Readers should be aware of David Henderson's trenchant review of Cowen in Regulation.

The question is what is normal. Has growth slowed, or were growth rates in the 1990s and early 2000s artificial and the product of monetary stimulus? Is the perceived slowdown cyclical or permanent?

[Jerry O'Driscoll]

@Roger,

Not if the stagnation is caused by he intervention.

[Roger Koppl]

Jerry: Right, but Tyler says the "low hanging fruit" has all been harvested. Although he does have some discussion of how intervention creates inefficiencies, he is *not* saying the stagnation is caused by the intervention.

[Richard Ebeling]

As long as the general "economic pie" of the society as a whole is growing at a certain rate faster than the government slice of the pie is increasing, then the market economy has been able absorb a significant amount of government intervention and welfare statism (taxing, spending, regulatory costs, transfers, etc.), and continue to provide rising standards of living, technological and application improvements, etc.

But a tipping point certainly can and perhaps has been reached, now, when the size of the government slice of the pie is increasing at a sufficiently high enough rate relative to the growth in the economic pie as a whole that the impact of the government slice slows down the growth in the economic pie.

In 1940, Colin Clark, in his book, "Conditions of Economic Progress," or in his 1961 IEA monograph, "Growthmanship," had warned that there were potential limits to taxation, beyond which growth would be affected and pressures would be placed on governments to resort to inflation to fund further increases in government spending.

In "Human Action," in 1949, Ludwig von Mises had emphasized that there is a limit to government spending and taxation, beyond which the "reserve fund" of savings and capital of the society is more or less fully absorbed by expanding government spending and welfare transfers, with economic growth threatened and the danger of "capital consumption" in the more extreme.

(Mises had explained this process of capital consumption due to taxation, government spending and borrowing in post-World War I Austria in a monograph in 1930. [The English summary is in Fritz Machlup's famous article on, 'The Consumption of Capital in Austria' published in 1935.])

A similar theme is in Milton Friedman, for example, in his 1984 book, "The Tyranny of the Status Quo," in which he warns of the negative consequences of a slower growing economy, inflationary dangers, etc., due to the "iron triangle" of interacting politicians, special interests, and bureaucrats in the political arena.

While Pete may be right that a leading theme in Tyler's book is bringing out the negative impact on income growth due to these factors, they are not new. Intelligent economists (such as the three I've mentioned; there are many more) have been warning of these types of tendencies for a very long time.

But the fundamental dilemma, to which Pete also refers, is that so many special interest groups and sectors of the economy have become dependent upon this government largess for all or a significant portion of their relative income shares, that stopping the growth in government spending via more taxation or borrowing, or trying to decrease government spending by just reducing or cutting government borrowing, threatens actual and expected standards of living of too many in the society. This is the basis for the social tensions and violence we are seeing in places such as Greece. (Or with the attempts to reduce the income position of government employees in Wisconsin.)

The question is, Can this dilemma be solved without a highly disruptive and destructive social crisis. Mancur Olson, in his "The Rise and Decline of Nations," was clearly pessimistic, believing that only a major social cataclysm is able to pry loose the spider's web of interlocking special interest groups and the institutional order in which they exist for any significant institutional reform and change in more free market direction.

Remember the Chinese curse: "May you live in interesting times."

Richard Ebeling

[Jerry O'Driscoll]

I'm not convinced innovation has slowed. More of it seems to be happening in other countries. As Richard suggests, that leaves the size and scope of government as the culprit.

Every report I've seen, including personal discussions, suggests that firms with a global reach are putting net, new investment overseas. There are too many negatives here, and too many positives elsewhere. So the US innovation slowdown is endogenous, not exogenous.

[Robert]

I thought David Henderson's review was quite good:

http://www.cato.org/pubs/regulation/regv34n2/regv34n2-9.pdf#page=4

[Steve Horwitz]

What Steve Miller said.

Pete's reading is about the best interpretation you can make out of Tyler's argument, but Steve's point is the one I've been making as well and I think it's correct and shows the limits of Tyler's argument.

[Rafe Champion]

Australia will provide a case study of the impact of new taxes, plus a surge of regulation, with a cardon tax and six new regulatory agencies to oversight the system, including maga billions devoted to picking winners in alternative energies to placate the New Communist Party (Greens) which as of July has the balance of power in the Upper House.
http://catallaxyfiles.com/2011/07/13/six-new-agencies-20-new-programs-the-labor-way/

We have come a way since the conservative administration lost office in 2007 leaving a healthy surplus which has been dissipated (plus a great deal more) in various stimulus packages. On top of that the labour unions have been re-empowered. Everything depends on the demand for coal and iron ore from Japan, if that falters we are in real trouble.

[Jonathan]

Doesn't the argument here weaken if mean (or total) not median income is considered?

[Jim]

I would add Tainter to Mr. Ebeling's excellent comment. And yes, Olson has long been a hero of mine.

I also believe Cowen tends to under-state regulation's cumulative effect on growth as well as cultural confidence (for lack of a different term).

Privatize education, health care, SS, and conform regulation to nurturing free markets. I suggest the cost of government would fall like a stone, while innovation and incomes would sky rocket.

The only industries which are not gently deflationary are those controlled or delivered by government. I agree with Cowen that those growth rates now threaten standards of living. But that observation does not include the other side of the coin; the benefit they would yield if they were not being mismanaged by government, along with the quiet desperation it would avoid.

As example, imagine the cultural, capital, and innovation implications in our society if after 20 years of 12% payroll contributions on SS, that most everyone was well on their way to becoming a millionaire even under insurance industry levels of regulation. Or consider the difference in energy and jobs if regulations had not controlled American oil exploration for the last 40 years, or scared a significant portion of manufacturing offshore due to Super fund insanity.

Growth compounds.

[steve]

Interesting... thank you for posting this!

Steve
Common Cents
http://www.commoncts.blogspot.com

[Paul Johnson]

"The uniform, constant and uninterrupted effort of every man to better his condition..." is not really the same thing as "the power of self-interest expressed in the market."

The latter puts the market at the center - it magically transmutes narrow self interest into the general welfare.

Smith puts people at the center - their drive, creativity, laudable and proper ambition - the desire to improve their prospects. When a young man sought his fortune in the 18th century it was likely to be by going venturing abroad - manifesting a spirit of adventure and daring. "Self-interest" implies a narrow grasping "me first" frame of mind. It's Smith's deep appreciation and respect for people that is the heart of his case for the market, not some mechanical transmuting power of the market.

[Jim Rose]

The input side of the stagnation issue has been addressed by Ben Jones in ‘The Burden of Knowledge and the Death of the Renaissance Man: Is Innovation Getting Harder?’

His paper investigates whether as knowledge accumulates as technology advances, successive generations of innovators may face an increasing educational burden.

Innovators can compensate through lengthening educational phases and narrowing expertise, but these responses come at the cost of reducing individual innovative capacities.

This has implications for the organization of innovative activity - a greater reliance on teamwork - and negative implications for growth.

Jones found that the age at first invention, specialisation, and teamwork increased over time in a large micro-data set of inventors. Upward trends in academic collaboration and lengthening doctorates can also be explained in this framework.

Jones’ theory provides an explanation for why productivity growth rates did not accelerate through the 20th century despite an enormous expansion in collective research effort and levels of education.

Remember Murray Rothbard’s lament that there were no treatise written in economics anymore in the preface to his 50 years ago.

The senior and more experienced readers of this blog might remember that the better of their professors seemed to be masters of the entire field of economics and could teach almost any subject.

These days, too many professors rely on textbooks with annual editions that come with the lecture notes, assignments and test-banks written for them by the publishing company.

Are there any polymaths left? Posner? Tullock? Neither studied economics!

[Ivan]

Sometimes i wish the government didn't create the internet so imbecile libertarians wouldn't write this tripe for all to see while ignoring the irony.

[Leonardo Baggiani]

The most stylised:
- if we consider that free market can allocate resources at their best, free market involves maximum (sustainable) growth.
- if an agent (the State) can allocate resources at his will (redistribute, incentivise a sector...), the resulting allocation is by definition sub-optimal, then growth must lower.

Demonstrated that innovation has not stopped and State has grown, as an Austrian-follower I have a clear idea of what has happened.
if innovation has actually stopped, then we are in the realm of real business cycle.

[McKinney]

Thanks Dr. Ebeling for another excellent post! Lots of economists have made Cowen’s point in the past, so I’m wondering why it has caused such a stir now.

If I remember the data correctly, the decline in median income began in 1973 and ended in about 1992. Median income rose throughout the 90’s then plateaued around 2000.

Could the problem be three consecutive tax increases beginning with Reagan, each of which was the largest in US history, finally having their effect?

In addition, Americans are buying less stuff and spending more on entertainment, education and healthcare, fields in which productivity increases are rare and small.

To respond to Dr. Ebeling’s comment about how change will come, I think history proves that it takes a crisis to destroy our illusions.

Meanwhile, libertarians could help a lot buy giving investing advice to people to help them weather the coming crisis. If libertarians prosper in spite of the crisis, people will pay attention.

[Steve Miller]

Yes, the government created (more like forced taxpayers to fund) the internet. And then it sat, unused by the vast majority of consumers for 15-20 years. It wasn't until bandwidth was effectively privatized in the early 90s that the internet became the medium we know today.

[Leonardo Baggiani]

The increase of debt is the consequence of the State's will to expand its interventism, and it's interentism that moves the economy into sub-optimal arrangement. We should not forget this, as the mere increase of someone's debt does not mean so much per se.

[Daniel J. D'Amico]

I support Pete's praise of Cowen's latest. For technological innovations to improve economic welfare the way standard macroeconomists intend, such developments must also carry real consumable returns and real employment effects. Cowen's argument is straightforward, relative to what has been invested across industries in recent decades (especially by government) such returns are very low and fast running out.

Again I agree with Pete, this theme represents a wonderfully subversive libertarian argument. Tyler used to be more of an optimist, but now he sees the world as "very messed up" and it's mostly the government's fault. I also consider The Great Stagnation to present a subversively Austrian argument. Tyler is, after all, focusing upon the heterogeneous nature of the capital structure.

Many have criticized the Austrian perspective because it implies that members of the economy continuously get fooled by low interest rates and government subsidy? Why not ignore the new money? Why not innovate new institutional arrangements to avoid these effects?

Tyler writes about how much fun and enjoyment we get from the internet, but we are not fundamentally restructuring our lives or improving our real living conditions - we are more just goofing off. I perceive this phenomena as the unconscious expression of rational expectations at work. As government continuously messes up the structure of production by failing to pick winners and confusing financial signals, people's willingness to hold wealth in traditional financial terms and traditional capital investments decreases. The economy is becoming more digital and more knowledge based in part because these forms of wealth are less subject to the unintended consequences of government meddling than the older more tangible sectors of the economy.

The cool thing about our new technological world is that the ability to hold alternative stocks of wealth in the form of social networks and social capital has become easier. The tragedy is that our regulatory, tax and monetary policies have labotomized the entrepreneurial spirit of our younger generations. There is almost no real opportunity to convert the stock of value held within online social networks into real consumable value or financial profit.

The under thirty crowd looks like a bunch of slackers to older generations. They spend so much time surfing the net and playing around on facebook instead of working hard and climbing the corporate ladder. Some think this is a problem with their work ethic or their culture. I say that's just crotchety old people talk. The younger generation would rather surf the net because this is precisely their best rational strategy given the messed up environment that our public policies have created.

I propose that it is more difficult today than ever before in American history to grow wealth and actualize entrepreneurial endeavors from a starting point of zero. If you have a significant body of savings and investments, you can protect it and you can find investment opportunities to grow it. But if you are young and motivated and want to invest in ideas that you believe will be profitable in the future - high risk and high taxes await with only marginal relative benefits. The super wealthy do not have access to a better internet than the rest of us. They do not listen to better music or get to see better movies. The internet makes for a far more culturally egalitarian society. The only real difference between being super rich and just getting by is access to luxury goods like flashy cars, houses, clothing etc.

The tax system is set up to support the traditional financial sector. If you want to protect your money the only real opportunity is to max out your 401k. Which will probably be subject to inflation and business cycles. There is almost no incentive for young people to save and invest in real entrepreneurial endeavors.

This is why we are and will continue to stagnate. It is a hard pill for older generations to swallow, but it is true. Social networking via the internet is an advancement in human cooperation and coordination, and younger people are better at it because they have grown up in tandem with these technologies. It is their abilities and their ideas which should and must shape the capital structures of our future world.

In contrast, the electoral population who gets pandered to the most, are the middle aged and middle class. The shovel ready jobs our government tries to create are out of date and out of place with what society actually needs or wants. We don't need traditional forms of infrastructure like bridges or roads to build our economy, we need MacBooks and internet ready Starbucks. We don't need poorly designed American automobiles, we need more Craigslists and Bitcoins to replace our rusted out and failing social institutions.

The sad reality is that we live in a world where the people who assembled your Chevy Tahoe probably can't set the timer on a Tivo and for some ungodly reason they also have more influence on public policy. Our younger generations are the very people who have the forms of knowledge most useful for our technological future - an innate ability to use telecommunications devices and navigate cyber networks. Yet they are the most systematically disadvantaged by our public policies.

Our globalized markets have produced a world with unparalleled affordable access to the necessities of life, but our public policies have created an incentive environment that breeds contentment rather than an enterprising spirit. The youth would rather invest in culture and social networks over money and businesses precisely because culture cannot be sucked away by our federal government and its composite elder interest groups. Our economy and the entitled parasites it hosts cannot sustain as our younger generations unconsciously tap out.

[Steve Miller]

I wish Cox and Alm would update their book, because much like Steve Horwitz I believe that numbers over the past 10-15 years would show steady or even accelerating improvements in standards of living. It's not just the internet or iPads, it's the quality and quantity of all consumer goods out there, from over-the-counter medicine to housing to transportation to communication to food. The real prices of these things in labor hours (education and health care are large exceptions) continues to fall. It's precisely the younger generations Dan refers to who benefit the most, as they have the leisure time to enjoy their lattes, video games, and re-runs of Teen Mom.

[Peter Boettke]

Steve,

I like your emphasis on economic optimism. I guess you also find the argument for zero marginal product workers to be misplaced as well.

[Jerry O'Driscoll]

There is still a conundrum about median income. Something strange is going on when Apple reports record profits for selling discretionary i-things, while there is 9+% unemployment. Planes have been full for months, but people don't want to drive their cars to the local Walmart. These are distributional issues.

We have poverty with prosperity. This is a problem for everyone, and denying the phenomena is not the answer.

[Troy Camplin]

I have often argued that we are terribly impressed with ourselves because of what we have accomplished with the least complex level of reality: physics. This is another term for "low-hanging fruit." All of our mechanical and computer advances have had to do with manipulating physical processes. We have not made nearly the same advances in chemistry, far fewer in biology, and far, far fewer in levels of reality even more complex. Having made probably most of the technological advances on can make in macrophysics (there may still be a lot we can do in quantum physics), we will have to move away from simple science and technology to complexity science and technology. This will require a shift in understanding and world view as well as a shift in technological development and the economy. So, yes, we are in the Great Stagnation - -at least, until we move into complexity technology.

[darwinian roadkill]

Bring on the robots.

[Glen]

Roger: "If we are in the Great Stagnation, isn't the opportunity cost of interventionism correspondingly low?"

Not necessarily. Think of low-hanging fruit as innovations with very high net benefit. As a result, the "wedge" created by taxes and regulation usually won't be great enough to deter the innovation. High-hanging fruit, on the other hand, have low net benefit. As a result, the same tax/regulation wedge will be more likely to deter the innovation (and a higher tax/regulation wedge, even more so). Consequently, interventions will have a larger opportunity cost -- in terms of forgone innovations -- when the remaining innovation opportunities are low-hanging fruit.

BTW, anyone know how much of the median-wage stagnation is driven by the shift from wages to other forms of compensation? What does the graph of median total compensation look like?

[Troy Camplin]

Is there a positive correlation between long-term economic growth trends and increases in certain kinds of regulations, particularly those acting as barriers to entry, including certifications and licensing? I bet there is.