|'The Great Stagnation'|
by Tyler Cowen
Cowen argues that since the 18th century, American growth has been
driven by exploiting a number of easy technological or social
developments, his "low-hanging fruit," starting with vast amounts of
nearly free land, cheap immigrant labor, moving into the post-Civil War
innovations -- railroads, electricity, cars, chemistry, radio, the
computer -- and into a period that saw a fundamental expansion of
educational opportunities. In essence, Cowen is arguing the case of
technological determinism: that innovation drives economic growth. And
when that innovation slows, as he argues it has since 1973, various
metrics of growth slow as well. Cowen does not dismiss the role of the
various "causes" of the financial crisis, but he adds a sort of
fundamental context: Americans took on more risk and overleveraged
themselves because they were overly optimistic about future gains, which
simply did not materialize. Eventually, that optimism hit a wall of
This argument is not new, which Cowen himself admits. Cowen does a nice job weaving together this story. The very fact that it has stirred up so much discussion, particularly in economic (and political) blogs, suggests how resistant the profession has traditionally been to that great externality, technology, which can't be easily fitted into the prevalent quantitative models of mainstream economics (one exception was Joseph Schumpeter, who practiced economics in a period less dominated by mathematics). Anyone who knows the history of Silicon Valley, or the financing mechanisms that fueled it, knows the arguments about maturity that have been made over the past decade or so. Even before Oracle's Larry Ellison announced that software had grown mature, it was clear that the great leaps of performance gains produced by the semiconductor -- embodied in Moore's Law -- would eventually fall, producing lower growth and consolidation; and there are undoubtedly other effects of maturity that arise from greater complexity and size. As Cowen acknowledges, for all the excitement over Internet-based social media companies, from Google to Facebook to Twitter, they have not produced, at this time, the transformative effect on growth or job creation. To be fair, they may at some point, or rather, some new innovation may emerge that produces the kind of "low-hanging fruit" that reignites economic growth.
Much of Cowen's very broad-brush treatment of stagnation does jive with felt realities. Hype and self-promotion have always accompanied technological innovation when they break into public consciousness. But the hype has grown louder and more strident as the economic gains diminished; that is one psychological interpretation of the dot-com bubble, which may also apply to social media even without a full-blown bubble. The cries of revolution or "that everything has now changed," occur more quickly over developments that lack, as the movie folks say, legs, or that fail to produce any real economic gain. Besides, changes in behavior are not only difficult to judge over time but don't necessarily produce tangible economic gain. As Cowen admits, such changes, like the Internet, can for a time, like Schumpeter's creative destruction, cannibalize jobs by eliminating intermediaries. Indeed, it would be odd if technological innovation didn't mirror the peaks and valleys of other complex social phenomenon, including the markets. Whether these are fixed like Kondratieff Cycles -- Cowen's scheme doesn't suggest that -- or are periods shaped by as-yet-unknown inputs remains a mystery. Cowen's argument does imply, however, that the great dream of the tech utopians, that we have reached a level of self-consciousness about how innovation occurs to escape fallow periods, is as misguided and full of hubris as the notion that we have tamed market cycles.
Cowen's choice of 1973 as a turning point confirms the already prevalent sense of that decade's centrality in shaping current conditions. Cowen again is mostly thinking technology. But so much occurred in the '70s, with stagflation and oil crises, that set up the decades that follow: Productivity began to lag, and inequality began to grow (Cowen published an excerpt from the book on inequality on Marginal Revolution), the industrial economy swung to services, Wall Street was "reformed," deregulation and financial innovation took hold, shareholder democracy and modern M&A took off, the liberalism of the New Deal began to retreat, and a full-blown consumer economy emerged. The '70s saw the marriage of the modern entrepreneur and technologist, most clearly in the figure of Steve Jobs, and the beginning of the glorification of the entrepreneur, of IPOs and of Silicon Valley. Corporate change generally began to occur more dramatically. Competitiveness emerged as both a diagnosis and as a panacea for lagging growth; and the free-market school began to actively shape policy. Indeed, one could argue that every one of these trends attempted to, in one way or the other, lighten the load on American companies: to make them swifter, more nimble, more innovative, faster growing. The stock market, which was also changing fundamentally in those years, became the daily metric of American economic health, particularly after American workers were forced into the markets to fund their retirements. Rapidly advancing short-termism, which was tightly linked to the perturbations of the stock market, is a rational response to eroding long-term fundamentals.
Obviously, there's a lot going on here. And Cowen's short book skims over any number of complexities. There is a chronic chicken and egg problem that remains, to me, insolvable, particularly when it involves the key relationship between finance and economic growth. Take Wall Street. It's true: The exploitation of low-hanging fruit that drove growth for many decades did occur with a relatively cozy, inbred Wall Street, not to say investor participation. Wall Street's "reform," driven by the rise of institutional investors, did, over the following decades, produce liquidity for a larger swath of corporations, well beyond the giants catered to by, say, J.P. Morgan Sr. in the late 19th century. The development of the junk bond, of the LBO, even of securitization, spread liquidity far wider and deeper than at any time in history; the side effects, of course, were greater change and risk, more short-termism and volatility. But how much of the great stagnation was caused by changes in finance -- the trading, the consolidation, the growth and the innovations -- and how much was it a reaction to slowing growth and productivity? The same could apply to bubbles that began to afflict the economy in the '90s and to the financial crisis. For all the certitude of pundits on the complicity of Wall Street in the bubble, there's not a lot of research on size, complexity and finance's relation with growth -- of Wall Street's "socially constructive" or "socially destructive" role -- to consult.
This is more than just an academic question. Understanding what's primary and what's secondary or tertiary is the only way to truly get at the root of these problems. The fact is all the technological innovations in the world don't matter much if funds are not available at the right price and at the optimal moment to develop and nurture their development. This relationship between finance and technology (or new company creation) has changed dramatically over the years, as each pole has followed its own evolutionary path; venture capital, for instance, in its modern form begins only after World War II and was amplified by a strengthening equity culture in the '60s and beyond. The financing of the middle market has been transformed by the presence of private equity and new financial instruments, both of which were fueled by new and deeper capital markets. The IPO market has waxed and waned; so too has the willingness of corporations to provide exits for entrepreneurs and investors in startups. Again, which is the chicken and which is the egg? What role does finance play in extracting the full potential from technological developments? And if that development is so central to growth, what's the optimal size and structure of finance?
Finance however is just one of a number of essential inputs. Technology must be funded adequately, but the creation of innovations is profoundly cultural as well, involving everything from schools that can train scientists and engineers in large numbers and encourage them to think creatively to a financial sector that can allocate capital efficiently to companies, large and small, that can grow in a fertile climate for growth. (America has long been blessed in its ability to attract talented foreigners, though there are reasons, both from rising post-Sept. 11 xenophobia and anti-immigration sentiments and accelerating growth in emerging markets, whether that will continue.) It's a complex mixture, a delicate balancing act between, again, creation and destruction, risk and reward, regulation and freedom. A culture that effectively rewards entrepreneurial drive, technological enterprise and supports basic science is a rare phenomenon, and one that can easily go awry, for a hundred different reasons; it is not necessarily an American inheritance. Cowen himself talks about how American respect for the scientific enterprise needs to rise. This is a long way from the traditional concerns of neoclassical economics.
Cowen believes that we need to accept a period of stagnation, which will eventually end, and to reorder our policies and perceptions for a different world. This adjustment will be difficult politically, which does not easily accept the stagnation he describes; it seems vaguely un-American. He does not seem to think we can do much proactively to create more low-hanging fruit more quickly; stagnation will end when it ends. His longer-run optimism is undoubtedly sensible, though getting there may be rocky. He believes sectors like healthcare and education, both of which are tortuously tangled mixtures of public and private, can be cleaned up and made much more productive. But technology remains a black box ruled by serendipity and driven by opaque inputs, including finance. Cowen has been accused of all kinds of sins by positing such grim realities: a failure of optimism, a loss of belief in all giving markets, an un-American gloom. But If Cowen's essay does anything, it will convince other economists to put some of their models aside and try to illuminate some of the mysteries of technology, finance and growth. - Robert Teitelman
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