Saturday, March 05, 2011

The Great Stagnation, and Innovation as Savior

Can a new cycle of technological innovation save the U.S. from stagnation?



Longtime contributor Michael Goodfellow recently shared his summary and critique of Tyler Cowen's ebook on how innovation can save the U.S. economy.


The book made a brief splash a few weeks ago: The Great Stagnation: How America Ate All The Low-Hanging Fruit of Modern History, Got Sick, and Will (Eventually) Feel Better.


The topic of innovation needs careful analysis because all too often Americans place what amounts to quasi-religious faith in technology without bothering to understand its limitations and uncertainties.


Most important is this question: will it scale up to serve hundreds of millions of people, and become faster, cheaper and better with every product cycle? If not, then it is doomed to remain "interesting" rather than useful in the real world.


Here is Michael's commentary:

Here's the gist of The Great Stagnation:


- The "low hanging fruit" is the transition from agrarian/rural to industrial/urban. The U.S. went through that transition from 1880 to 1970 and had the same high growth rates that China is enjoying now. It's a one-time event though. Going from a population with no education to one with 80% high school and 25% college has huge gains. Going from one with 80% high school to 100% has fewer gains (and we haven't even managed that -- graduation rates peaked decades ago.)


Same thing with technology -- adding electricity, telephones, radio, movies, TV, cars, planes, etc. to the economy has huge gains. Adding the internet and some biotech since 1970 does not.


- He thinks technological progress is slowing and becoming more difficult. It takes more training before you can make a contribution, the age of first contribution is increasing (eating up those young-and-daring years of a scientists career) and patents per researcher is falling.


- Our politics and social network were greased by those ever-increasing productivity gains. Now that those have slowed, we're fighting over a more slowly growing pie, making our politics more acrimonious and gridlocked.


- We overpromised on things like pensions because of an expectation of growth rates which have not materialized. He has a graph showing that if pre-1973 growth rates had continued, the average income would be $90,000 in the U.S. today, instead of in the $50,000 range.


- The financial crisis happened, and happened world-wide, because we were overconfident, due to that pre-1970s expectation of growth. The previous housing bubble in the 1980s popped, we'd had the Savings and Loan crisis as a result, but without any real damage to the economy. So people didn't take the current run-up seriously. He thinks housing was affected not because of any decisions by the Fed, but because it was the weakest link, depending on the most marginal borrowers. As the economy runs out of easy growth and things get tight, the marginal borrowers are the people affected first.


- Modern growth rates are depressed by the kinds of things that are growing. Instead of more factories, we are spending more on education, health care and government. These contribute to GDP, but only because we count costs, not benefits. Education spending per pupil has doubled since 1970 with no increase in test scores. Spending on health care shows no correlation with life expectancy around the world. Government is mostly transfer payments, which have no effect on productivity.


- Eventually, new technology will come along and increase growth rates again. He feels we're at a temporary plateau, not the end of the line. And he calls for increased social status for scientists, so that more people will go into science in the U.S.


That's the basics, and you can finish the book in an hour. I didn't really feel it was worth $4, but oh well.


As for my reaction:


- The improvements in computers since 1970 have been nothing sort of miraculous -- improvements by factors of 1000, exceeding any other technology ever. And this has had an effect on the economy. I don't think you can have "just in time" manufacturing, or a world-wide supply chain without computers. You also need the cheap communications that microprocessors made possible. So all of globalization and outsourcing is enabled by computers.


The same is true for automation. Without processors, you couldn't have factory robots, but you also couldn't have ATMs, supermarket checkout scanners, phone system menus and other labor-saving changes. The pressure on the low end of job skills and drop in factory employment is all due to technology, and has been a huge change since 1970.


Without computers and software, you couldn't have the existing world financial system, which moves amazing amounts of money around every day. For good or bad, that's enabled by computers.


The internet is just starting to chew through existing industries, from newspapers to publishing to music and movies and TV. Amazon and eBay are changing retail, greatly increasing productivity. I have no idea how that ends up, but it's clearly a big change under way. Something like the "Minecraft" game, where a single person writes a piece of software and makes $15 million dollars in six months, just wasn't possible before. He didn't even need a publisher or ad agency or retail outlet. He just wrote the thing and sold it himself on the internet. Even a 1960s famous author, rock star or movie star would have needed to give 95% or more to the publisher/studio.


Biotech has already changed U.S. agriculture, with some huge percentage of crops already being genetically modified. I think it's mostly for pesticide resistance, but it is increasing yields and dropping costs. I think changes in livestock are just starting. Biotech is also starting to affect drug production.


- He's ignoring the changes in society and a lot of history. He doesn't seem to buy the standard argument that the Great Depression and WWII increased the size of government, which eventually led to more regulation and stagnation.


He feels that since organizations of all kinds grew in size (including the new giant industrial corporations like GM), and government grew everywhere, that this is an effect of a global change, like improvements in communications and record keeping, not a social change in just the U.S.. I kind of doubt that, since the growth in governments was so abrupt, and really seems to be a reaction to events, not just "grow because we can."


- I've been getting more and more skeptical of education in general over the years. Most adults I run into seem to have basically a third grade education. They can read, if it's nothing complicated or subtle. They can write, if all you want is simple sentences and don't care about grammar or spelling. Forget about getting a coherent essay out of most people! And they can do basic arithmetic, although I'm not sure about long division.


The rest of their education, even for the college educated, is never used, so it's forgotten. None of the high school math or science or history is retained, from what I can tell.


So although going from uneducated 19th century to third-grade 20th century might be worth a lot, I'm not convinced that we've maxed out on education. I think the current school systems actually destroy the desire to learn for a high percentage of the population. They come out of school hating lectures, study and tests. They feel it's all been a complete waste. The average adult never reads for pleasure, and I assume, never reads anything non-fiction. Some percentage of the population is out there taking night classes, but I think the average person avoids classrooms for the rest of their lives.


I agree most health care spending is a waste, from the larger social point of view. Health care is divided into public health measures (clean water, food, vaccinations and other disease control measures), primary care (esp. prenatal and childbirth) and all other high-tech medicine. Public health is a huge bargain and separates the first and third worlds. Primary care is affordable and has big benefits. High tech care is mostly a waste of money. Unfortunately, that's where all the money goes, and what all the arguments are about.


Tyler also doesn't mention demographics, which I think are key. The U.S. had that huge boomer generation, and now they are retiring. That both increased the average age of Americans, and increasing the size and cost of government. Demographics (including low birthrates) are changing things in the U.S., Europe, Japan, and (soon) China. Immigrations in Europe and the U.S. is changing the culture. This is all relatively recent and I don't see how you can ignore it.


My bottom line is that technology is still moving quickly, and poised to move even quicker, and that is benefiting the tiny percentage of the world population prepared to use it. There are very reasonable scenarios where the world changes out of all recognition in the next 100 years.


China and India are in catch-up mode and growing fast as a result. But as soon as automation starts replacing all those entry level jobs (when cheap robots have decent eye-hand coordination), it's all going to stop. China is the last country that's going to get rich off manufacturing for export.


The stagnation isn't caused by a drop in productivity improvements. Instead, we have a mismatch between skills and jobs. We have far too many people in the U.S. who have no skills beyond hand-eye coordination and basic English. They are getting crushed between massive amounts of competition from poor countries and automation.


So although I buy some of his argument, overall, I think it misses the point. And I think optimism about the future is misplaced. Technology is improving faster than skills, widening the gap. There are going to be a lot of people left by the side of the road.


Thank you, Michael, for the excellent precis and the analysis. Here are my initial thoughts on the notion that technical innovations will "save" us from a vast re-ordering of an unsustainable system.


1. What we need even more desperately than some new techno-wonder is institutional innovation. The Ratchet Effect (costs and payrolls go up without friction but only decline with great force) has caused the cost of the largest institutions such as "healthcare" and the Pentagon to skyrocket with little visible performance improvements. Medicare/Medicaid and the Pentagon spending alone are dooming the nation's finances to implosion.


The machinery of governance is still operating in the 1940s, if not the 1840s. Technology has made incremental improvements (i.e. electronic voting machines, heh) where it has the potential to revolutionize the machinery of government.


What we have is a bloated network of fiefdoms and cartels, all of whom are hoping that some new technology will enable their continued siphoning of the nation's wealth and income stream.


2. As Michael has pointed out here before, any technology that will scale up in the next few years has already been in the lab and initial production for 10 years. In other words, the fabulous, world-saving lab innovations touted in breathless magazine and Web articles are more than 10 years away from real-world applications abd 20 years away from scaling up to useful levels of production.


Other "savior technologies" such as nuclear fusion and algae-based biofuels have been "five years away from production" for 20 years. That history suggests just how few technologies are truly scalable.


3. A tremendous quantity of critical technology is ignored because it is incremental and therefore boring/unsexy. Ten years ago I was involved in a microchip startup that designed small cheap processors that improved the power management of multiple-battery rechargable arrays, like the kind that power laptops and tablets. It went nowhere, despite some interest from the Pentagon.


As I have noted here many times before, inefficient power management in "standby" or "sleep" modes for TVs, computers, printers, etc.--hundreds of millions of devices--consume all the electricity generated by 140 power plants. That's a lot of power wasted for no payoff at all.


The market fails in instances such as this. The manufacturers have no incentive to spend 50 cents more on an effective power management chip, and the consumer isn't going to insist, either. So the Central State has to impose regulations for incremental technological solutions like this. Without regulations, it will never happen, and we have 140 power plants spewing CO2 etc. into the air and burning valuable fuel for nothing.


Our economy is chockful of these kinds of inefficiencies--some can be addressed with regulation, other by market forces. One size does not fit all.


In other cases, the consumer doesn't care right now because energy is still too cheap. When oil is $300/barrel, then small turbo-diesel cars of the type sold in Europe that get 50 miles per gallon of fuel may yet be demanded by consumers, as will small electrical vehicles charged by distributed (i.e. small-scale, privately owned) solar arrays.


My point is simply that technology already offers us many ways to consume less and produce the same output. But rather than seek ways to reduce consumption, we currently prefer to hope for some magical new source of energy.


Why? Partly because we can--the level of pain is nowhere near high enough--and partly because we've always been "saved" in the past 40 years: by the discovery of the North Sea, West Africa and North Slope oil fields, by the emergence of desktop computers, by the Internet, etc.


These "saviors" enabled our consumption to continue rising and our productivity to make significant gains, decade after decade. Those new energy sources and quantum jumps in productivity may well be one-time events.


4. I agree with Michael that education is still stuck in the mass-production factory era and sorely needs real institutional innovations on a systemic scale. Is Our Education System Based on a Factory Metaphor? (November 15, 2005). Like all the other fiefdoms and cartels with a stranglehold on the machinery of governance and the national income, the Education Industry is resisting "threats" (i.e. innovation) to its power and income with every fiber of its being.


Continuous failure doesn't draw attention; only sudden failure attracts a crowd.That's the U.S. Status Quo in a nutshell. As long as the fiefdoms, cartels and the Central State can stave off any visible implosions, then the nation will continue to habituate to continuous failure as "the new normal."


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