The Who-What-Where-Why-How of Economic Growth
In all the recent debates over deficits, debt, unemployment, entitlements, bond markets, the euro, housing, etc., the absolutely central factor has too often been ignored. A new book, however, deals with nothing but this central factor -- economic growth. If we're going to improve the economic discussion, and the economy itself, The 4% Solution: Unleashing the Economic Growth America Needs is likely to serve as a good foundation.
The book contains chapters by five Nobel economists, including the modern dean of economic growth Robert Lucas, Ed Prescott on marginal tax rates, and Myron Scholes on true innovation; also Bob Litan on "home run" start-up firms, Nick Schulz on intangible assets, David Malpass on monetary policy, and others on entrepreneurs, immigration, debt, and budgets.
I've only skimmed many of the chapters, but one thing that jumped out is an important point about the links, and distinctions, between supply and demand. When economic growth has been discussed these last few years, the cause/cure usually cited is a drop in aggregate demand and the "stimulus" measures needed to boost it. It's of course true that the housing bust and banking troubles caused lots of deleveraging and that government spending and interest rate cuts may help tide over certain consumers and businesses during temporary tough times. Despite substantial Keynesian fiscal and monetary "stimulus," however -- wild deficit spending, four years of zero-interest-rates, and a tripling of the Fed's balance sheet -- businesses, consumers, and the economy-at-large have not responded as hoped. Even if you believe in the efficacy of short term Keynesian growth policies, you ignore at great forecasting peril the array of countervailing anti-growth policies.
Here is how I put it in a Forbes online column last December:
the real problem with demand is supply. Consumption is partly based on current income and needs, sure, but more importantly it is a function of the expected future. Milton Friedman’s version of this idea was the permanent income hypothesis. More generally, we might ask, what are the prospects for prosperity?
We live in a complex, uncertain world. But it’s not unreasonable to believe, even after the Great Recession, that America and the globe still have prodigious potential to create new wealth. It’s also not unreasonable to believe that Washington has severely impaired America’s innovative capacity and our ability to grow.
If you think ObamaCare reinforces and expands many of the worst features of our overpriced, government-heavy health system, then you worry we might not get the productivity revolution we need in one of the largest sectors of our economy. If you think Dodd-Frank and other post-crisis ideas will discourage true financial innovation while preserving “too big to fail,” then you worry more financial disruptions are in store. If you think tax rates on capital and entrepreneurship are going up, then you might downgrade your estimates of the amount of investment and dynamism -- and thus good jobs -- America will enjoy.
A downgrade of expected long term growth impairs growth today.
In the new book, Lucas makes a similar argument:
imagine that households and businesses were somehow convinced that the United States would soon move toward a European-level welfare state, financed by a European tax structure. These beliefs would naturally be translated into beliefs that labor costs would soon increase and returns on investment decrease. Beliefs of a future GDP reduction of 30% would be brought forward into the present even before these beliefs could be realized (or refuted).
This is just hypothetical, of course, but it is a hypothesis that is entirely consistent with the way that we know economies work, everyone basing current decisions on expectations about future returns. What I have called recovery growth has happened after previous U.S. recessions and depressions and is certainly a worthy and attainable objective for economic policy today, but it would be foolish to take it as a foregone conclusion.
In the next chapter, Ed Prescott reinforces the point:
what people expect policies to be in the future determines what happens now. Bad policies can and often do depress the economy even before they are implemented. Peoples actions now depend on what they think policy will be -- not what it was.
. . .
The disturbing fact is that, as of the beginning of 2012, the economy has not even partially recovered from the this recession. When it will recover is a political question and not an economic question. Only if the Americans making personal economic decisions knew what future policy would be could economists predict when recovery would occur.
This is one reason long term growth policies are often more important, even in the short term, than most short term "growth" policies.
This post can also be found on Maximum Entropy.