We are no longer the nation that we were coming out of World War II, which built a visible public (and private) infrastructure while still diverting a large part of our GDP to Cold War defense. We did it then by maintaining a savings rate out of household income of 10 percent. Today, as I’ve noted, that rate is in low single digits.
THE LARGER ISSUE
Our infrastructure deficiencies are part of a larger problem confronting the United States—the amount of our resources we set aside for contingencies. There are some inventories that sit unused for years—the Strategic Petroleum Reserves, for one. Some resources we produce stand idle for protracted periods and may in fact never be used: vaccine stockpiles for epidemics that never happen and dykes along rivers that never reach flood levels. By far our largest standby asset is, of course, our military.
Such assets serve as guarantees against, for example, foreign invasion, flu epidemics, tsunamis, and hurricanes, none of which are predictable and may never happen. They nonetheless require the building up of buffers of idle resources that are not otherwise engaged in the production of consumable goods and services. They are employed only if and when a crisis emerges. Such buffers address contingencies that range from uncertain but repetitive to rare and unpredictable. The former are insurable because they offer a reasonably steady rate of return to insurers. The latter are not.
Individual fires cannot be predicted, but they happen often enough for almost all cities to create and fund fire departments, whose cost is tantamount to insurance premiums. Health emergencies are not predictable but are also sufficiently repetitive to create health insurance, hospitals, and ambulances. The buffer may encompass expensive building materials (for example, special steels) whose earthquake flexibility is needed for only a minute or two every half century, or lightning rods that could be struck every month, or every decade.
The most visible insurables are life and property. I suspect that the higher the standard of living, the larger the share of GDP that originates in private insurance. Long-term uncertain risks have indeterminate probability distributions and are hence not insurable. Only risks on which actuaries can put a numerical probability are insurable. Risks that are highly variable imply too unstable a rate of return.
The choice of funding buffers is one of the most important decisions that societies must make, whether by conscious policy or by default. If policy makers, private and public, choose to buffer their populations against every conceivable risk, the nation’s current standards of living would, of necessity, decline. Funding such “investments” requires an increase in savings and, accordingly, a decline in immediate consumption. Resources can be put to active use or on contingency standby status, but not both at the same time. Buffers are a dormant investment that may lie idle and seemingly unproductive for most of their lives. But they are included in our total real fixed assets (and real net worth) statistics. It is no accident that earthquake protection of the extent employed in Japan, for example, has not been chosen by less prosperous countries at similar risk of a serious earthquake. Those countries have either explicitly or implicitly chosen not to divert current consumption to fund such an eventuality. Haiti, a very poor country, has not yet fully recovered from its 2010 earthquake. It had neither built a protective infrastructure like Japan’s nor has it had resources to recover on its own. Buffers are largely a luxury of rich nations. Only rich nations have the resources to protect their populations against events with extremely low probabilities of occurrence.
How much of its ongoing output should a society wish to devote to fending off once-in-fifty or one-hundred-year crises? How is such a decision reached, and by whom? While the decisions of what risks to take remain predominantly with private decision makers,2 the responses to low-probability events such as the Japanese earthquake and tsunami of 2011 have been largely government scripted. Although formal data are not available to gauge the depth and quality of our standby buffers, the aging and deterioration of our fixed capital stock, both public and private, is ample evidence that a subclass of those assets, standby buffers, is also in a state of decline.
FOURTEEN
THE BOTTOM LINE
When I was first contemplating the substance of this book, I was fully aware that a basic assumption of classical and neoclassical economics—that people behave in their rational long-term self-interest—was not wholly accurate. Moreover, the crisis of 2008 had impelled me to reassess my earlier conclusion that our animal spirits were essentially random and hence impervious to economic modeling. I was amazed, however, during the early months of this venture at just how many supposedly random variables were explained by statistically highly significant regression equations. Many, if not most, economic choices, the data show, are demonstrably stable over the long run for as far back as I can measure. My list is long, though doubtless, incomplete.
MODEL BUILDING
Producing a fully detailed model is beyond the scope of this book. But such a model would include a number of variables reflecting those verities of human nature that reveal long-term economic stabilities. Among them are time preference (and interest rates), equity premiums, corporate earnings–price yields, and, since the nineteenth century, the private savings rate. They reflect the outer limits to fear and euphoria that define the dynamics of the business cycle. For forecasting purposes they can be assumed to continue trendless in the future.
In addition, there are those stabilities that are not inbred, such as the sum of social benefits and gross domestic savings as a percent of GDP. Other forecast stabilities include the size of the workforce—those potentially in the workforce have already been born—and average hours worked.
Owing to the vagaries of human nature, forecasting will always be somewhat of a coin toss. But I believe if we appropriately integrate some of the aspects of animal spirits’ systematic behavior, constrained by market forces reflecting the imperatives of double-entry bookkeeping identities, we should importantly improve our forecasting accuracy. Euphoria will always periodically produce extended bull markets that feed off herd behavior, followed by rapid fear-induced deflation of the consequent bubbles.
These models should embody equations that, when possible, measure and forecast systematic human behavior and corporate culture. Regrettably, we have too few relevant historical observations that yield confident insights into the way financial markets behave, though we know a great deal more than we did before the 2008 crisis.
But we are far removed from the halcyon days of the 1960s, when there was great optimism that econometric models offered new capabilities to accurately judge the future. Having been mugged too often by reality, we forecasters appropriately express less confidence about our abilities to look beyond our immediate horizons. We will forever need to reach beyond our equations to apply economic judgment. Fortunately, most of our intuitive insights, when subject to the discipline of a syllogism, apparently do conform to reality.
We may never approach the fantasy success of either the Oracle of Delphi or Nostradamus, but we can surely improve on the discouraging performance of the past five years.
INTROSPECTION
This journey of analysis has finally come to rest in a place I could never have contemplated when I first began to recalibrate my economic views in light of what the crisis of 2008 was telling us about ourselves. America started out in the glorious aftermath of an early post–World War II era when we took the lead in setting up a new international financial system based on the U.S. dollar as well as an International Monetary Fund, World Bank, and GATT.1 As I noted in Chapter 11, it was not until the 1960s that we turned our national benevolence to the less well off within our own borders and set in motion an inexorable rise in social benefits to persons. Since its inception with Social Security in 1935, the social benefits program had barely demonstrated much momentum until Medicare was enacted in 1965 and benefits embarked on their unrelenting rise from 4.7 percent of GDP to nearly 15 percent of GDP by 2012. As I noted in Chapter 9, had we kept s
ocial benefits’ share of GDP to a still large 4.7 percent, as best I can judge, little of the fiscal chaos we are now experiencing would have found its way to the front burner of public policy. Especially disturbing is the fact that the retirement of the baby-boomer generation, the recipient of a large share of the benefits, has just begun.
But we have sadly learned that social benefits, never contemplated in a significant role of government before the Depression of the 1930s, have developed a whole infrastructure of political constituencies in support of every new entitlement. Trust funds for social benefits were crafted to mirror fully funded private pension plans. Contributions to trust funds plus interest and, since 1984, taxes on benefits, however, have fallen far short of full funding of benefits, according to the funds’ official actuaries. But even the federal government’s efforts to finance all of these programs on at least a pay-as-you-go basis have also fallen short, to a point where a fifth of federal government outlays (especially benefits) have to be borrowed in financial markets. The source of those funds is almost wholly private domestic savings and whatever savings we can borrow from abroad.
Postwar current account surpluses reflected the unmatched generosity of America. Exports of abundant grains2 from America’s heartland and industrial materials and capital goods were shipped from our shores in 1947 and 1948. But starting in 1982, the surplus ran out and we began instead to have to borrow from foreign businesses, individuals, and governments to supplement our diminishing flow of domestic savings. Those borrowings have created a net American debt to the rest of the world valued currently at nearly $5 trillion. As our government budget deficits rose, gross domestic savings fell pari passu. The cause of our diminished flow of gross domestic savings, as I document in Chapter 9, is demonstrably government social benefits to persons.
Gross private domestic savings as a share of GDP have been remarkably stable reaching back to 1870 (see Exhibit 9.5). It remains the primary source of funding of American gross domestic investment—the source of productivity growth and standards of living. Personal consumption expenditures, by definition, add nothing to our capital stock and hence nothing to our future standards of living.
Yet social benefits, almost all of which are consumed, as I demonstrate in Chapter 9, have been a virtual dollar-for-dollar diversion of private savings flows from private fixed capital investment to personal consumption expenditures. As CBO data demonstrate, owing in part to the continued rise in income inequality, the highest quintile of income earners accounted for 94 percent of individual income tax liabilities in 2009, up from 64 percent in 1981.3 That quintile has been a major source of funding for the rise in benefits. The average savings rate of the top quintile is approximately 10 percent to 15 percent of income,4 but I calculate that the marginal savings rate of this group is triple that, as I document in Chapter 9. Household savings as a percent of disposable personal income have declined from approximately 10 percent in the mid-1970s to less than half of that in 2013.5 The unexpected outcome of the switch from savings funding investment to financing consumption has been the significant decline in the growth rate of GDP and the erosion of household middle incomes.
American business, however, is doing well. Cash flow has risen significantly, not because the economy is robustly expanding (it has not) but because business costs are under control, with competitively and technologically suppressed hourly wage costs of production workers rising less than 2 percent annually during the past couple of years, and even less in real terms (see Box 14.1). This weakness reflects, in part, the remarkable decline in private sector union participation. The evidence confirms that collective bargaining does increase union wage premiums. Public unions have also come under stress as diminished tax revenues increasingly press on state and local employee earnings.
But even our still vibrant corporate sector seems hardly likely to continue thriving unless the pall of uncertainty is lifted and a far greater proportion of its abundant cash flow is invested in capital outlays. This is especially important because, with government outlays constrained by deficits, the only significant source of self-generating spending is private business that, with large unused cash flows, has resources to expand (see Box 14.2). American innovation continues to edge out global competition, but the diminishing rates of GDP and multifactor productivity gains—the latter our measure of the extent to which innovation contributes to a higher growth rate—are worrisome.
BOX 14.1: THE MISMATCH
The increasing shortfall of adequate skills to match the ever-rising needs of our workforce has led in recent years to a shift in the composition of capital investment toward labor-saving equipment. That has pressed many semiskilled workers’ wages lower as robots take over routine though still complex tasks. Pressure on highly skilled workers’ wages has been less, especially given the limited quotas for competitive high-skilled immigrants.
With, as I noted in Chapter 8, an apparently inbred upper limit to human IQ, are we destined to have an ever smaller share of our workforce staff our ever more sophisticated high-tech equipment and software? Even taking into account population growth, do we ever reach the point when all we have left is a small handful of especially talented people who can create and operate the newer technologies?
Technology rarely moves at the same pace as the educational capabilities of a workforce. While there is an upside limit to the average intellectual capabilities of a population, there is no upper limit to the complexity of technology. This implies an ever greater need of automation where robots’ simulated intellectual capabilities must begin to have the capacity (taught by human beings) that we have yet to imagine.
The gap between job openings and new hires in an increasing number of occupations raises the specter that, at our best, we may not have the capability to educate and train students up to the level increasingly required by technology to staff our ever more complex capital stock. The median attainment of our students just prior to World War II was a high school diploma. That level of education at the time, with its emphasis on practical shop skills, matched the qualifications, by 1950s standards, for a reasonably skilled job in a steel mill or auto-assembly plant. The mass of our labor force then was still dominated by high school graduates and less. On-the-job training filled what education holes still existed. These were the middle income jobs of that era.
But the skill level required of today’s highly computerized technologies cannot be adequately staffed with today’s median skills. Moreover, much of what absorbed labor a half century ago has been displaced by robots and more advanced forms of labor-saving technologies. It is in this context that the seeming failure of our primary and secondary school systems (K to 12) in recent years raises concerns about levels of future productivity growth.
BOX 14.2: THE MULTIPLIER
It is always difficult to envision the source of recovery or decline in economic activity when such a large proportion of that activity is endogenous, that is, determined solely by responses to the initiatives of others. The reason for the current suppressed economic environment is that inflowing orders are themselves reflecting incoming orders of others. How does an economy exit self-reinforcing stagnation? Fortunately, not all order placements are in response to other players in the economy. For example, a company with a new invention decides to build a new plant to manufacture widgets for which there is yet a market. The activity of building the new plant increases the stream of endogenous orders that are set off by the initiative of the new investment. That process, duplicated many times over, will enlarge the flow of endogenous orders that will carry the total economy to higher levels. This is the famous economic multiplier at work.
LOOKING BACK
The most problematic trend that has emerged from this crisis is the doctrine of “too big to fail” (TBTF). As I explain in Chapter 5, the role of finance is to allocate the savings of a society toward funding the most promising cutting-edge investments. TBTF aborts that process and economic growth and is rapidly spawning an America
n crony capitalism. I have come to a point of despair where, if we continue to make banks wards of the state through TBTF policies, I see no alternative to forcing banks to slim down to below a certain size threshold where, if they fail, they will no longer pose a threat to the stability of American finance.
LOOKING AHEAD
I have purposely refrained from the type of long-term forecast that I made six years ago for the year 2030 in The Age of Turbulence because it required, then and now, an assumption that there would be no “governmental restrictions against competition in domestic markets” (page 467). I cannot make such an assumption currently yet cannot think of a credible alternative assumption.
Integrating evidence of how people responded during the recent years of extreme economic stress has furthered economists’ understanding of financial and economic relationships during periods that almost all of us have rarely, if at all, experienced. We have learned a great deal about tail risk and risk aversion generally. Bubbles seem more understandable, as does the fragility of markets. The exercise is scarcely complete, but I believe economists now have gained access to a vast array of data that no generation has had before. Those newly available data have allowed me to answer the question that I put to myself in Chapter 1: “We humans appear a truly homogenous species. But at root, what are we?” The answer, I now tentatively conclude, at least from an economist’s perspective, is that we are driven by a whole array of propensities—most prominent, fear, euphoria, and herd behavior—but, ultimately, our intuitions are broadly subject to reasoned confirmation.
That reason persuades me and most economists to conclude that modern industrial capitalism, despite earlier excess enthusiasm of what it could accomplish, has been the most effective form of economic organization ever devised, a fact attested to by the remarkable gains in material well-being and life expectancy that it has produced since its emergence during the eighteenth-century Enlightenment.
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