Monday, April 20, 2009

The US growth curve

One thing I get a little confused about is the implicit notion in the media that because the United States is more developed, we are bound to continue our development much more slowly than developing countries.

I believe the root of this problematic belief can be traced to two particular concepts - the "S-curve" of industry development taught in every business school in the country and the structure of most of the basic models of macroeconomic development, which hold that the level of capital stock and labor in a country approaches an equilibrium growth rate (sometimes of 0) that slows down as you get closer to that growth rate. Both of these teachings completely ignore the sources, structure and benefits of innovation. S-curves can "restart" or "shift" or change or steepen midstream with technological developments that are not featured in the curve (implicitly, they're exogenous). Macroeconomic models almost always explicitly hold technological development or capital/labor efficiency gains as partially or completely exogenous. These exogenous technical changes aren't necessarily apparent year to year, but in long term projections, they're almost never measured right. When did people start seeing the internet coming?

Proponents of this theory point to the narrowing of the gap between the US and the rest of the world over the last thirty years. The US used to represent nearly half of world GDP, and now it's about a quarter.

However, these assertions all implicitly require one of two conditions:
1) We are reaching a "peak" of development that is hard to go past. (implicit in any S-curve argument)

2) Growth for every country constantly is slowing down towards some long term equilibrium rate, or is already there. (implicit in any basic macroeconomic model argument)

In every age we've hit except for possibly the Middle Ages, the world has been at a "peak of development". Britain's been at the "peak of development" for three centuries and actually managed to accelerate growth for a century and a half. Greece and Rome had the same story. The Vatican was such for much longer than that. China's had some millennium-long stretches, and kept growing quickly. The world as a whole has accelerated its growth as it has developed, not slowed it down.

Technological development is only partially exogenous - yes, some of it is the genius of men and women who happen to stumble upon things. But much of it is also endogenous - what we invest in our capital stock, what we spend on R+D and science research, what we spend on education and how we structure it, how we prevent crime and recidivism, etc. The returns to these endogenous factors are also tremendously variable and complicated - for example, reducing recidivism can help a lot if our education system has the ability to absorb those young men and women, but won't help that much if it doesn't.

There is one compelling argument for why different countries should catch up to the US: they can see how we've done it, and copy us. However, this implies that other countries should grow faster than the US, not that the US shouldn't be growing fast (which is implicit in the commentary of half of the news, economic commentary and investment advice given out today).

That factor is a decent one, but here are a few more arguments for why the US may have fallen behind that don't involve some mythical growth curve. All of them may be controversial, but here are some observations:

1) A federal government increasingly reliant on income and sales tax revenues. Thus, the government's own expenditures are subject to the economy more than ever, incentivizing lots of "quick fixes" to business cycle problems to get government expenditures back on track.

2) Increasing the level of media coverage incentivizes politicians facing reelection to become more and more reactionary and populist, instead of having a solid opinion with firm grounding. The Kennedy-Nixon debate was scandalously hostile at the time, and is now basically considered a model of civil discourse as politicians need to cater to their electorate at all times, instead of serving as representatives to govern in the best interests of the electorate. There's a fine line between representative government and whim of the majority.

3) The Cold War and the subsequent collapse of the Soviet Union forced the US to take on a lot of "tragedy of the commons" type roles in the world, including policeman and provider of foreign aid.

4) Ignorance of foreign production potential in the creation of union contracts, and unions that grew into political powerhouses instead of useful negotiating tools. This killed a huge number of industries (See: UAW) and nearly killed many more (steel comes to mind).

5) The US education system became much less capable as it scaled.

6) Securities laws, accounting rules and fiduciary duty created corporations that were a) too highly scaled to be efficient and b) incentivized towards seeking out short-term gains over long-term ones.

7) The widespread introduction of trans-fats into our diet and the low-cost availability of high calorie foods increased a lot of health-related costs even as lifespans increased.

8) Related to the tragedy of the commons roles issue, we had a LOT of military involvements. Korea, Vietnam, every other small proxy war to fight the Soviet Union, Bosnia, Kosovo, Iraq parts 1 and 2, Afghanistan... Some military spending is tremendously good for us (Naval research has created an absurd number of new technologies now in very productive civilian use), but a lot of it has been terrible for our economic growth.

9) Overall, just a huge federal government, period. Bureaucracy rarely works well for long.

10) Most of Asia was starting from so low that it could grow quickly without having to worry about exhausting its massive labor supply. Efficiency of labor isn't important when there's so much of it that it's super cheap.

However, there are some decent reasons why the US can keep growing quickly, if it enacts good policy.

1) Our combination of capital stock per capita and overall capital stock is still incredibly high and can foster further technological development.

2) As long as redistribution doesn't get too high, our incentives for innovation (stable laws, our system of bankruptcy, our incredible network of supporting industries, etc) are still extremely high.

3) We still have a virtual monopoly in a number of areas, including elite higher education and healthcare. Maybe these will be narrowed, but catching us will not be easy, unless restrictive immigration laws or bad healthcare reform derails us.

4) Until this past year and a half, credit has been incredibly easy to come by relative to other countries. While this can create bubbles when the credit is not priced appropriately, availability of credit is a key reason why we had the industrial revolution and will continue to help us as long as its not regulated away.

5) Reasonably low tariffs. We have them, and 99% of them suck (I've seen the estimated benefit to Americans of getting rid of all existing tariffs at about $12,000 in purchasing power per person per year), but we have less than a lot of other countries.

6) A predictable relationship between the government and its citizens. I predict that within the next 5 or 10 years, China will have a major incident around this issue.

7) Ultra cheap labor can't last forever. South America and Asia (excluding Japan) will need to start allowing its own citizens to "consume" more (both important things, like food, shelter and healthcare, as well as less important things) and will need to start investing more heavily in widespread education. Their surge has been a filling out to capacity as much as it has been a growth in capacity. Their capacity will keep growing in spurts, as ours will, but the filling out won't last forever.

America still has a good system in place. China, India, Russia, Brazil and the rest of the developing world hopefully do have a bright future, because the alternative sucks. But growth never travels as smoothly as theory or the market likes to predict. It happened to Rome, it happened to China a number of times in its history, it happened to South Africa, it happened to the Soviet Union, it happened to Japan, it's happened to the US and it will keep happening to almost any country that has a spurt of growth. Growth comes in ebbs and flows. Our system is much better suited than that of almost every other country in the world to withstand those ebbs and flows, as long as we can keep investing in our future, both in terms of education and capital stock, and keep our populist urges in check.

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