The 4% Solution: Unleashing the Economic Growth America Needs, ed Brendan Miniter with foreword by George W. Bush.
Why has the United States economy stopped growing? Aversion to risk is unprecedented. Despite a record low 30-year mortgage rate of 3.5%, Americans rent rather than buy. Corporations have stuffed nearly US$2 trillion in cash under the mattress rather than invest in their own businesses. Venture capital shuns manufacturing, and the short-lived stars of the tech world in social media have disappointed investors.
Firms on the threshold of expansion, with 500 to 1,000 workers, suffered the worst job losses of any cohort during between the first quarter of 2007 and the first quarter of 2011 with an 11% drop in total employment.
How intractable America’s economic problems have become is illustrated in the George W. Bush Institute’s new collection of essays on restoring growth. A diverse collection of authors agrees that it is necessary as well as possible to restore a high growth rate (the 4% target is arbitrary but as good as any), but that is like the mice agreeing that the cat should wear a bell.
The extreme dispersion of recommendations gauges the intractability of the problem.
Two of the most prominent offerings in the Bush Institute volume, for example, propose diametrically opposed monetary policies. David Malpass, a former Ronald Reagan administration Treasury official, argues for sound money and a strong dollar, while Nobel Laureate Vernon Smith proposes a massive currency devaluation like Thailand’s during the 1997 Asia crisis. Malpass believes that monetary policy is essential to the solution, while Smith contends that neither monetary nor fiscal stimulus will help, and the solution lies in currency depreciation.
As it happens, Thailand’s currency devaluation (by more than half at the worst of the 1997 crisis) compelled the country to sell its bankrupt banking system to foreigners and attracted fresh capital after the Thai assets went on fire sale. The only investor to whom a devalued America could sell its banking system is China. Even if America wanted to sell (unlikely) and China wanted to buy (even less likely), a major devaluation would disrupt the world economy and destroy confidence in American assets abroad as well as at home.
Prof Smith got his Nobel for a simplified economic model that leaves out expectations, among other things. But expectations are the nub of today’s problem. Investors are drowning in capital but terrified to commit it. To layer on yet another dimension of risk (namely devaluation) would make matters worse, and that is why I share Malpass’ views about sound money.
Smith’s pessimism about monetary and fiscal policy, though, should not be dismissed out of hand. It is possible that the air pocket in investment and the economic stall reflect a longer-term trend rather than a cyclical pause.Capital goods orders never regained their 1999 peak during the presidency of George W. Bush, and have fallen considerably farther on Barack Obama’s watch.
Non-defense capital goods orders (excluding Aircraft), nominal and deflated by capital goods producer price index (PPI)
Did the housing bubble sequester the nation’s capital during the mid-2000s? And was a return to normalcy aborted by an anti-business administration committed to massive new entitlements funded by the largest tax increase (for health care) in American history? Or are Americans enervated? Have the 30-year-old baby boomers who entered the Reagan years full of ambition and afloat in home equity become today’s 60-year-old scaredy-cats, traumatized by the $6 trillion loss in household wealth of the past four years?
In 1980, home equity had risen by 60% in real terms over the preceding decade; in 2012, by contrast, homeowners had lost 40% of their equity in the preceding decade.
Are Americans disciplined enough to compete with the cadres pouring out of Asian cram schools? Is a surge in Asian immigration (to 400,000 in 2010, against only 350,000 Hispanics) the best economic news we have had of late?
I don’t believe it. I agree with the authors of the Bush Institute volume that the entrepreneurial engine can be jump-started. But economics is more like medicine than rocket science. You won’t find out if the medicine works until you try it, and even then the doctors will disagree.
If Mitt Romney is elected president in November, we will know soon enough whether our problems stem from adverse policies, or long-term paralysis. I am convinced that an administration that fosters entrepreneurship rather than derides it (as in Obama’s now infamous “You didn’t build that!” gaffe) will elicit a revival of animal spirits. It’s like Pascal’s wager; we might as well bet on Romney because if he’s wrong we’re dead anyway.
Can we achieve a long-term growth rate of 4%, as the Bush Institute’s executive director James Glassman and most of the book’s contributors believe? That is a big number; at 4% growth, the economy triples every 28 years, and will grow 20-fold over the 78-year life of the average American. Numbers do not capture such transformations; life looks and feels different as old technologies give way to new. Market expectations in the sense that economists use the word hardly apply; we are speaking, rather of our long-term imagination.
In 1934, when today’s 78-year-olds were born, the first computer was three years away, penicillin first was being tested, and a primitive television station was broadcasting in New York. The world of 2012 was remote, but remotely imaginable. The US economy measured by real GDP is seventeen times larger than it was in 1934 and grew at an average rate of 3.7% over the period.
But it is a different world, in which children no longer die of scarlet fever or polio, and families flung across the world Skype together.
What would the economy look like in three generations of sustained growth? Only one of the original components of the Dow Jones Industrial Average (GE) remains in the index. In 1934, whole industries – computers, pharmaceuticals, aircraft, communications – were waiting to be born.
What do we imagine today? Glassman is an optimist; his book Dow 36,000 appeared in 1999, at the peak of the stock bubble occasioned by the conceit that cyberspace would change our lives in some fundamental way. No such thing happened; the last blush of this idea was the social media debacle earlier this year.
The Internet has made it easier to shop, flirt, leer, and gossip; it was the late Apple chief executive Steve Jobs’ genius to recognize that the vast majority of computers did nothing more than surf the web and exchange brief messages, so that a tablet would do better than a laptop. But the tablet and smartphone have come and matured as innovations without making a dent on the broader economy.
Nobel Laureate Myron Scholes (whose work on option pricing with Fisher Black and Robert Merton helps measure the cost of uncertainty) titled his contribution to the Bush Institute volume, “Not all growth is good,” by which he means the housing bubble as well as scattershot government stimulus spending. Prof. Scholes was an early victim of the mortgage-backed securities bubble, as a partner in Long-Term Capital Management, which blew up on levered mortgages in 1998. One would like to know what he thinks of the Internet bubble of the 1990s.
Annual growth of working-age population
Source: UN World Population Prospects, Medium Variant
We are right in the middle of the fastest decline in the growth rate of working-age population (from about 1.5% a year in 1995 to less than 0.5% a year) as the Baby Boomers retire. Population growth contributes to growth; the greater the supply of workers, the faster the economy can grow.
That cuts both ways, though. Between 1790 and 1950, faster GDP growth led to faster working-age population growth, as economic opportunity attracted immigrants. Since 1950, though, working-age population growth has led GDP growth, and explains about a quarter of the variation in the GDP growth rate.
Lagged effect of 5-year percentage growth of working age population on 5-year growth rate of real GDP, 1950 to 2011
Source: US Census; BEA; Macrostrategy LLC Calculations
Part of the solution, as Charles Blahous and Jason Fichtner argue in a chapter on Social Security reform, lies in giving workers an incentive to extend their working careers. Americans live healthier and longer lives than they did when Social Security set the retirement age at 65, and the decline in the labor force can be offset by later retirement, in theory. But it will be a challenge to get this done in practice.
American households of 2 or fewer vs. 3 or more
Source: Census Bureau
America used to be a nation of large families, and an economy driven by homebuilding and consumer durables. Now households of two or fewer comprise 60% of all households, and one-person households 30% of all households. That explains the housing bubble.
In 1973, the United States had 36 million housing units with three or more bedrooms, not many more than the number of two-parent families with children – which means that the supply of family homes was roughly in line with the number of families. By 2005, the number of housing units with three or more bedrooms had doubled to 72 million, though America had the same number of two-parent families with children.
We seem to envision a world of hipsters and oldsters living in tiny apartments communicating through Facebook, the one new thing to grab the tech market’s attention during the past couple of years, only to disappoint again. Where is the television, the computer, the antibiotics, the rockets that brought us from 1934 to 1982? Gene sequencing, targeted cancer drugs, and nanotechnology?
The risk is that we are becoming the wrong sort of people with the wrong sort of desires with the wrong mix of technology. Much as I favor the free market over statism, it’s possible for the free market to choose the wrong things. If the trend continues, Vernon Smith will be right at some point: the US economy will cease to respond to monetary and fiscal tools, although for different reasons than he seems to believe.
Of course, Americans might never find out how bad things are unless they elect Mitt Romney and adopt Reagan-style incentives for investment. Another four years of the current trend, and the medicine may no longer work.
The 4% Solution: Unleashing the Economic Growth America Needs, edited by Brendan Miniter with foreword by George W Bush. Crown Books, New York 2012. ISBN-10: 0307986144. Price US$26.00; 368 pages.