The Levelling

by Michael O'sullivan

  Not only is the current business cycle very long by historical standards, but it is peculiarly marked by an unprecedented amount of monetary and fiscal stimulus internationally, in return for relatively low growth, meager investment, and slowing productivity, to the extent that nearly six years through this “expansion,” academics spoke of “lower for longer” and “secular stagflation.”6 The notion of lower growth for longer periods has, at least in the United States, been pushed to the sidelines by President Trump. His arrival in the White House provoked a rise in sentiment (animal spirits) among small businesses on the prospects that the broad regulatory environment would be more lax and that corporate tax cuts would provide a stimulus to companies and households.

  Supporters of President Trump will point to the impact of his early policies on GDP, but in my view such policies are classically short-term. They do not create new growth but, rather, borrow it from the future. This is done at the expense of creating longer-term risks: rising government debt, a historically large fiscal deficit (which means there is no money left to cushion a recession), deteriorating trade relations, and underinvestment in people. This approach has echoes of the classic real estate development model: buy an asset, take on a lot of debt, boost the short-term value and rental stream of the asset, and try to sell it off. That’s fine for real estate, but it’s not quite as easily applied in the case of countries, especially the United States. The outcome will depend on the ability or inability of the United States and other countries to generate organic economic growth. It is not yet clear that trend growth is picking up meaningfully around the world; in fact, an examination of its component parts suggests the opposite.

  No Growth No More

  One of the better, more coherent explanations for the troubling lack of organic economic growth comes from Professor Robert Gordon. Gordon’s central thesis is that many of the innovations we prize today do not generate increases in productivity, and those that do are less impactful on economic growth than previous waves of innovation (in transportation and urbanization, for instance). Social media are an example. Gordon asks whether people would rather do without older innovations, such as indoor toilets and running water, or their Facebook accounts. His view is that social media offer greater opportunities for interaction and for consumption (on the job and during leisure hours) but don’t necessarily boost productivity in the sense of replacing humans with machines. Artificial intelligence may do this, but it is yet too early to tell. He also argues that constraints on growth are coming from consumer, corporate, and government indebtedness, less economically friendly demographics, and the risks posed by climate change. In one paper he eerily states, “There was virtually no growth before 1750, and thus there is no guarantee that growth will continue indefinitely”! Rather, he suggests that the rapid progress made over the past 250 years could well turn out to be a unique episode in human history, and he concludes by predicting a growth level in consumption of only 0.5 percent for decades to come.7

  Gordon’s theory is increasingly plausible in the light of many of the fault lines that now beset markets and economies. Consider “disruption” as a glamorous theme that revolves around the ability of new technologies—or rather, in many cases, technologically enabled processes—to render existing business models obsolete or to enable very significant cost reductions in organizations and supply chains. There are many examples. Blockchain is perhaps the most fashionable, and it is expected to result in cost reductions for financial services companies, for example. Following closely behind is the “rent economy” described very well in Klaus Schwab’s The Fourth Industrial Revolution. Schwab is the founder of the World Economic Forum (WEF), the host of what is more commonly known as Davos, and he highlights such facts as that Uber, the world’s biggest taxi company, doesn’t own any cars and that Airbnb, the world’s largest “hotel” chain, doesn’t own any hotels. In the Airbnb- and Uber-led economy, capital investment is low, incumbent businesses suffer reduced profitability, and cost optimization is pushed to individual producers and consumers.

  Of course, this plays havoc with the economic world as viewed by the traditional economist. Business cycle expansions are supposed to be led by growing investment, stickier wages, and robust corporate profitability, but most of these factors have been absent from the global economy for much of the recovery that began in 2009. In addition, disruptors help increase income and wealth inequality, and the benefits of radical disruption go to venture capitalists and a relatively small number of shareholders, while at the same time the pricing model of the likes of Uber keeps their workers’ incomes at a low level (with zero social benefits). Investment in workers in the Uber economy is low, so skills do not improve and productivity remains low.

  Another aspect of productivity that is worth considering, especially given the increase in the number of academics and corporate scientists in recent years, is that research is either producing fewer new productive ideas or more ideas whose incremental impact is low compared to such earlier innovations as Excel spreadsheets and the computer semiconductor chip. Nicholas Bloom and his colleagues at Stanford University undertook analysis across industries, products, and firms to show that research effort is rising substantially even though research productivity is declining sharply. Citing Moore’s Law (based on the observation of Gordon Moore, the cofounder of Intel Corporation, that the number of transistors on a computer chip doubles every year), they hold that “the number of researchers required today to achieve the famous doubling every two years of the density of computer chips is more than 18 times larger than the number required in the early 1970s.”8 They confirm that similar results occur across a range of industries and countries—from semiconductors to soft commodities like wheat, cotton, and soybeans to pharmaceuticals (they examine mortality rates)—and conclude that either research is increasingly less productive (in the sense that more researchers are required to produce innovations) or new, impactful ideas are hard to find. This should be a worry, because in developed economies, where people are turning against immigration, productivity is what will drive growth.

  Why Russia Didn’t Win?

  That productivity is central to the advancement of nations was made clear to me nearly twenty years ago. When I lived in the United States, I once shared an office with a colleague who spent much of his career researching the Russian economy. At that time Russian economic history had little to offer save to act as a case study in economic collapse and crisis management. However, in the 1950s and even in the 1960s America was worried that Russia could surpass it economically. Infrastructure and defense spending combined with substantial agricultural output meant that during those decades Russia registered decent economic growth rates.

  However, Russia soon ran into a wall called productivity. Central economic management and lack of flexible labor and capital markets meant that innovation was severely curtailed, and new technologies (at least outside the military and the space industry) and processes were not permitted to flourish. With limited productivity gains, a near absence of competitive funding through capital markets, and scant external trade, Russia’s economy stagnated.

  The economic decline of Russia is an illustration of the fact that productivity is central to economic advancement and, in some respects, to social advancement. In a very broad sense, economies will grow when labor and investment are applied in clever and productive ways to generate more output with existing resources or even new output (innovation). Economists refer to this as “total factor productivity.” Productivity is an essential factor in enabling emerging economies to move from early phases of growth (agriculture and manufacturing, for example) to higher-end ones (such as services and technology). It is also the principal way in which developed economies and societies can sustain high levels of economic growth.

  In this context it is a concern that in the five years from 2012 to 2017 productivity growth in both the developed and developing countries dropped to historically low levels (one long-run data s
ource puts today’s level of productivity growth in the United States at the lowest since 1880, and much the same is true for Europe).9 In more detail, in the United States, total factor productivity averaged 1 percent from 1996 to 2006, then slipped to 0.5 percent from 2007 to 2012, and has languished at close to zero since then.10 Long-term, or perhaps “structural,” productivity is more important because it speaks to the capability of a country and its people to boost output. Factors like the quality of governance/political systems and educational attainment are the important drivers. In this respect, with institutions such as the US Federal Reserve and State Department under attack from politicians, and with public education receiving less spending (at the same time as educational attainment rates are falling in the United States), there should be cause for concern.

  In addition, the drop in productivity has led to some head scratching, especially in the context of a world that is apparently advancing technologically. One charitable view is that productivity is generally hard to measure and that its effects come with a lag—thus the impact of new approaches to and uses of technology such as social media, 3D printing, and robotics have not been reflected yet in the productivity numbers—and that even the way productivity is calculated needs to change to reflect these new approaches (e.g., to better incorporate the online economy).11 We might also argue that in order to really boost productivity, we need even more robots!

  Yet one might think that in the aftermath of the global financial crisis, with unemployment levels so high, that businesses would already have worked hard to change and streamline processes to boost productivity. But this is not immediately clear in the data, and it suggests that new labor market practices may in fact be affecting productivity.

  The UK economy is a good example here, as there has been a collapse in productivity in recent years. This has been associated with new trends in the labor market such as the zero-hours contract (a labor contract where the employer is not obliged to provide any minimum working hours and where, equally, workers have no obligation to accept the hours offered) and the very large number of people who establish themselves as entrepreneurs or as “registered companies,” actions that may cause them to lose some of the productivity benefits of organizational infrastructure and learning. The drop in productivity in the United Kingdom has coincided with an apparent absence of wage inflation, even as unemployment falls. One interesting piece of research from the Bank of England’s chief economist, Andy Haldane, suggests that the UK labor market today resembles that of the pre–Industrial Revolution seventeenth century (we are not so far away from the Levellers after all).12 Many workers then had two or three different jobs, technology was not well advanced, and bargaining power was weak.

  A more clear-cut reason why productivity is low is that since the global financial crisis, investment has been tepid by historical standards. There are several reasons: low economic growth implies relatively fewer investment opportunities, but it has not deterred companies from more financialized growth. That is, low interest rates have enticed executives at many corporations to focus more on financial engineering (management consultants might call it “financial productivity”) in which debt is issued cheaply in order to fund share buybacks and dividend payouts. Higher share buybacks make earnings per share look better, which means greater executive pay.

  More broadly, over the last ten years on average, confidence among business leaders has not been high, which has probably led to deferment of investment. We must also bear in mind that many parts of the world economy have experienced investment booms of gigantic proportions (China is the key example), and the later phases of those booms have been less productive in their economic impact. State-owned enterprises, the engines of the early part of China’s boom, are now the repository of its toxic consequences: unprofitable businesses, overleveraged construction and property projects, and managerial hubris.

  There are two other ways by which we can tie lower productivity to the concept of the levelling. The first is the transition from globalization to multipolarity. Globalization was driven by Western companies investing abroad and leaving a trail of foreign direct investment that crisscrossed the world. This is reversing. Protectionism, security of intellectual property, and rising costs in emerging countries mean that large multinationals increasingly relocate investment to their home countries. In the United States, they are increasingly exhorted to do so by the president.

  In many cases, lower cross-border investment or forced relocation can prove to have a diminishing effect on productivity. The debate on corporate investment by US companies in Mexico highlighted this because the complexity of supply chains and differences in labor market dynamics would make it difficult economically and logistically to relocate manufacturing capacity to the United States. A further current constraint is that with the ratio of real wages to corporate profits the most stretched it has been in history—a sure sign that corporate America and its shareholders have been doing very well but labor has not (the wages-to-GDP ratio is close to record lows)—companies may face a productivity battle in that higher labor costs may be the only avenue through which productivity can be increased in a nondisruptive way.

  The second Leveller-like explanation for lower productivity lies in anomie and human development. Anomie—a sense of alienation, social disengagement, and disconnection—is the root of more radical political movements such as the Freedom Caucus and the Tea Party Caucus in the United States or the Rassemblement National and La France Insoumise in France.13 The work of one of the first sociologists, Émile Durkheim, is relevant here, and it is a surprise that he is not spoken of more widely. One of his primary research areas was into the factors that hold societies together, and he explored how societies integrate and form a collective consciousness. One line of inquiry he pursued was the way in which societies that are less well integrated—especially because of a less fraternal work environment—eventually make extreme political choices. This is something we now see across the United States, the United Kingdom, and Italy, for instance. In the workplace, anomie may derive from cost-cutting measures that are taken to make workplaces more productive, and in some cases anomie itself can provoke weaker productivity as workers become disruptive or disengaged. Two reasons for higher anomie and lower productivity are a lack of attention to ongoing worker training and generally poor levels of education. In areas of the US economy where productivity is at lower levels, education attainment levels are stagnant.14 For example, OECD data show that public spending on worker training in the United States, United Kingdom, Australia, Japan, and Spain is small when compared to the likes of Denmark and France.15

  Over the Hill

  Without sounding too glum, there are other long-term factors that stack up against higher-trend economic growth. An important one is demographics, which from the 1980s until approximately 2010 had a positive effect on growth but which may now act as a drag. Population aging is a particular concern, with the fraction of the US population aged sixty and older expected to rise by 39 percent from 2010 to 2050.16 Some governments have set up research bodies to better understand the impact of aging on their economies, with the National Research Council’s Committee on the Long-Run Macroeconomic Effects of the Aging U.S. Population being notable in the United States. Research findings in this area are stark, pointing to a fall of 1.2 percent in US GDP in the next decade as a result of demographic changes, with a subsequent drop of 0.6 percent expected in the following decade. An aging population is also associated with lower productivity. This demographic, together with lower fertility, also points to a structural drop in long-term interest rates and to a new normal of lower trend growth.17

  To sum up the economic fault lines ahead, there are, to put it politely, going to be significant challenges—high debt levels, demographic changes, and other economic traps—that stand in the path of future economic growth. Forecasts from the IMF and OECD bolster this assessment.18 Nor should we confuse the recent cyclical upswing in the business cycle w
ith the long-term trend in growth. In my view, cyclical up- and downswings are temporary; what really matters is long-term trend growth because this is a sign of the economic potential or ability of a country. Moreover, a positive movement in trend economic growth is what matters for wealth creation and our livelihoods.

  The trouble is, there is still a great gulf of expectations between where many policy makers and companies expect growth to be and a future where we may experience only very modest growth, as characterized by a world moving away from globalization. In the decade after the recession of the early 1990s, there was a long-lasting positive surprise to economic expectations in that factors like falling interest rates, beneficial demographic conditions, and the rise of emerging economies boosted growth. The danger now is that the world has to deal with a negative switch in expectations.

  Having listened to this long tale of lower growth, the economic handbrakes of demographics, and lower productivity, Minister Chidley is thoroughly depressed and wishes she had been made a minister for defense instead. Tackling low growth and its consequences will demand some ingenuity from her.

  She has two, perhaps three, options. First, worried that there seems to be very little public acceptance that the future could be less rosy than the past, she asks her mandarin for a quick fix, an economic magic pill. An infrastructure program like Boston’s Big Dig might fit the bill. A second option is economic nationalism. With the level of growth likely to be lower than it has in the past twenty years, she might take to megaphone politics, point to growing competing economies and tell her voters that she will take back the growth that is theirs. Third, and the difficult solution practically and politically, she might ask what drives national development and stability in the long term and set about creating a framework to implement those drivers.