A turtle that represents our slowing economy and the Great Stagnation
Economics

What’s Our Problem with the Great Stagnation?

August 28, 2019

There’s a clear cause of the widespread economic problems facing America today. 

But for some reason, nobody in power wants to admit this problem. They all act like wizards at Hogwarts tiptoeing around He-who-must-not-be-named.  

What’s the problem? 

GDP growth (and thus, median real income growth) in the US has been in decline since the 1970’s. This might be the biggest issue we all face in America today.

This problem is not a secret.  People with large platforms like Peter Thiel and Tyler Cowen have sounded the alarm.  Cowen even wrote an entire book about this (that I will refer to plenty below)!  But for some reason, other economic issues like the minimum wage, government benefits, and globalization have taken center stage over this critical economic trend.  

Below, we’ll look at:

  1. The foundation of this slowing growth and what it means, borrowing quite a bit from Cowen
  2. How changes in innovation in America has altered the nature of this growth without altering expectations, and finally
  3. How and why our government exacerbates this problem rather than getting to the root from it, borrowing again from Cowen and Peter Thiel

Who cares about slowing GDP??  Boring!

First things first, let’s set the stage of this issue.  GDP (or gross domestic product) refers to the market value of all of the goods and services produced in a country.  When the GDP of a country grows, it means that that country has produced (likely) more valuable goods and services and more of those goods and services.  It literally creates a larger economic pie for the people of that country to share in.  Generally speaking, a growing GDP improves the lives of everyone in that country.

In theory, median real income grows when GDP grows.  Real income refers to income of individuals taking into account inflation and purchasing power.  So all else equal, as real income grows, people can purchase more or higher quality goods and services.  You can think of median real income as a standard of living proxy; it reflects how the majority of people in a country live because it is not as heavily influenced by billionaires and the ultra-wealthy.

Now that we understand GDP and median real income, let’s get to the problem.

Here it is in two charts.  

US GDP Growth Rate

Clearly, you can see both GDP growth and median real income growth slowing from the 1970’s until today.  It’s not that our economic pie isn’t growing; rather, the pie and our standard of living are growing more slowly than they have in years past. 

Tyler Cowen, of Marginal Revolution fame, wrote extensively about this economic slowdown in his book “The Great Stagnation.” His major thesis: we’ve plucked all of the low hanging fruits of innovation during the 19th and 20th centuries, and struggle to build new life-altering technologies today.  This innovation slowdown transfers directly to our GDP and real income growth slowdowns.  

Cowen views this slowdown through a “public vs. private goods” framework.  In the 19th and 20th centuries, think of all of the new, world changing technologies created: railroads, electricity, running water, the combustion engine. 

We take all of these technologies for granted today. But think about how massively transformative they were at the time. An average American family sat down to dinner by candlelight, drinking water they fetched from a well eating food they purchased (or grew themselves) close to home.  In a matter of decades, they ate dinner as we do today: with electric lights illuminating their cups of water filled from a running tap with food transported from across the country.  

Cowen views these 19th and 20th century technology developments as public goods since they created massive consumption benefits for every single American, and the wealth generated from their development poured into the pockets of everyone.  Now, compare that to the technologies developed today: faster email, social media, new financial instruments, more efficient refrigeration. Useful technologies to be sure, but: 1) they do not dramatically alter our lifestyles and 2) most of the wealth generated flows into a smaller number of pockets.  

To further cement the point, he explains:

“Contemporary innovation takes the form of expanding positions of economic and political privilege, extracting resources from the government by lobbying, seeking the sometimes extreme protections of intellectual property law, and producing goods that are exclusive or statues related rather than universal, private rather than public…..a lot of the gains from recent financial innovations are captured by a relatively small number of individuals.”

Except for the internet (an enormous “except” that a completely different post could be written on), life today looks quite similar to life in the early to mid 20th century.  Herein lies one of the fundamental problems:

We quickly developed and brought these powerful public technologies to market, and struggle to replicate those same breakthroughs in public life today. 

Higher expectations of government and of our economy exacerbate this public vs. private goods innovation framework even more.  Cowen says that people want to continue to buy more and more goods and services that we simply cannot afford.  

We can see this through our ballooning national debt.  According to NPR and the Congressional Budget Office, despite being in the second-longest economic expansion since the post–World War II boom, the U.S. is projected to rack up annual deficits and incur national debt at rates not seen since the 1940s.  We have $22 TRILLION dollars of debt.  

So not only do we see our nation’s GDP growth and median real income growth slowing down: we see our propensity to consume and borrow going UP with no regard to this very real gap in funding and true innovation.  

We are literally outrunning the Red Queen.  

As a country, we’re like that guy who makes $50k a year and owns a $150k house, but once he gets a raise of $5k, upgrades to a $500k house and a Bentley.  An obvious recipe for financial destruction. 

To wrap up this thought, Cowen says,

“Furthermore, every time a politician talks about quick recovery, it makes the problem a little bit worse. People think they can go back to their old habits, when we first need to produce some more wealth before previous spending patterns can prove sustainable.” 

More on this later.  

The changing landscape of innovation in America without changing expectations

Okay, so GDP growth and median real income growth has slowed for the past 50 years and we continue to borrow and spend like it hasn’t.  The root theory: the nature of innovation has changed and directly contributed to this slowdown.

How did we get here and why did innovation change? 

An excellent paper out of Duke University discusses exactly this, fittingly titled, “The changing structure of American innovation: Some cautionary remarks for economic growth.” (shout out to @patrickc on Twitter for sharing this paper a while back).  I’d recommend reading the entire paper for an interesting history of innovation in America.

For our purposes here, we’ll start in the late 1800’s, where the authors discuss corporations purchasing innovations from amateur innovators and inventors.  Literal amateurs created technologies purchased by corporations!   Think: Thomas Edison and Alexander Graham Bell.  

The bar for anyone to become involved with scientific discovery remained extremely low compared to today.  

In other words, billions of dollars need to flow to an R&D project to get it off the ground today; the necessary amount of resources and manpower needed to invent in the 1800’s was simply lower.  

These amateur inventors created the technologies that simultaneously benefited the public and pushed the wheels of economic growth forward.  Individuals plucking low hanging technological fruit dominated the innovation landscape.  

(Photo by Underwood Archives/Getty Images)

From “American innovation”:

“Corporate engagement in research began modestly. The leading American firms of the 1870s and 1880s largely relied on external inventions; the railroad companies did not invent steam engines or breaking systems, nor did Western Union invent telegraphy. Instead, Railroads and other large firms relied upon acquiring inventions from inventors. In many instances, these inventors worked for the railroad but were not hired to invent.”

But in the beginning of the early 1900’s before World War 2, corporations quickly realized they could benefit from bringing these inventors in house to push technological progress forward, rather than paying them for their individual inventions.  Thus, the birth of the R&D department. Corporations collaborated closely with researchers at Universities on solving specific economic problems within their industry.  

University professors hesitated at working within the private sector at first.  However, an abundance of funding and access to expensive, sophisticated equipment drew many of the era’s best minds to work on specific economic problems for companies.  Incentives aligned for talented researchers and corporations to continue to research and improve upon public goods (chemistry, electrical engineering, petroleum engineering, etc.), in Cowen’s vernacular.  

This collaboration in innovation between Universities and corporations quickly dissipated after WW2.  Federal funding began pouring into Universities and into academic research due to Cold War pressures. An “infusion of German-trained expatriates imbued a new goal of pursuing science for its own sake in these institutions” as well. 

Scientists in Universities wanted to research problems they had an interest in – not necessarily problems that could apply to specific industrial use cases. Despite this, corporations continued to expand their R&D budgets, developing powerful new technologies internally (and borrowing externally) to bring to market.

Post 1980: where we begin to run into the slowing innovation problems.  According to the authors,

“The task of converting scientific insights into inventions that could be the basis of new products and processes became a specialized one. Universities were not well placed to “translate” research findings into executable solutions. Corporations – especially those which lacked internal labs familiar with mission-oriented research – also found it difficult.”

As research became more specialized and divided further into sub-problems, corporations found it difficult to translate academic research into practical market-based solutions.  Publications to scientific journals decreased over time.

“Of the 341 public firms publishing at least one scientific article in 1980, 223 (65.4%) saw a drop in publications in 1990. Similarly, 280 out of 470 firms (59.6%) publishing at least one scientific article in 1990 saw a drop in 2000. The comparable figure for the 2000-2010 period is even higher: 671 out of 902 (74.4%) firms publishing in 2000 produced fewer publications in 2010.”   

Perhaps the biggest driver of this slowing innovation growth: firms found it harder to get a return on R&D research as costs skyrocketed and easy breakthroughs became sparse.  Pouring money into R&D appeared riskier to investors. Again from American Innovation:

“As competition intensified and the interval between invention and commercialization narrowed, it became increasingly difficult for corporations to profit from their in-house research. Standard theory implies that firms reduce research when the knowledge spills out, particularly to rivals.”

Today, even major technology companies like Apple and Google sit on massive reserves of cash.  This retweet I saw from Epsilon Theory better explains a potential reason for this better than I can:

Okay, so what’s the point understanding all of this innovation history?  

Technology used to fall within the reach of anyone.  Individuals could create technologies applicable to improving the daily lives of everyone.  Corporations continued this investment and poured money into developing these publicly beneficial technologies.  Over time, specialization, costs, and risk increased, and the University-Corporation idea transfers became harder to manage.  

This slowing of pumping radical technologies into the market has contributed to slowed GDP and median real income growth.  Our wealth simply stopped increasing as fast as it did in the past. Our world-class innovation could not keep pace with its own history.  

But no one talks about this.  Our expectations do not match reality.  We still spend our money in expectation of growth we saw in the 30 years post WW2.  And this behavior coupled with the slowing innovation (and thus slowing growth of our economic pie) contributes to our enormous economic problem today.     

Do our institutions make this problem worse?

So: 

  • we see our economy growing slower than it has in the past 
  • We see less innovation
  • This underlies most of our economic problems

Why don’t we do anything about it?

It’s complicated.  We expect a lot from our government.  Provide for the common defense, a judicial system, a minimum standard of living for everyone.  For the most part the government does an excellent job providing for Americans.  

With this fundamental economic problem however, our institutions intensify it by simply ignoring it.

I love how Peter Thiel, a Silicon Valley entrepreneur, investor and contrarian describes this problem on Eric Weinstein’s podcast, The Portal.  In essence, he says that our institutions predicated on growth lie about this issue in order to protect themselves.  He particularly hones in on Universities, where tuition continues to skyrocket and where students amass huge debt and can’t find jobs post-graduation.  Schools would not dare discuss slowing growth for fear of less students attending. They have perverse incentives. They exaggerate the merits of a degree in order to protect their own interests at the expense of students.  

Universities are not the only institutions ignoring the dangerous economic undercurrent.  We saw Cowen blame our government for perpetuating this problem in the first section. In The Great Stagnation, he further explains:

“For the last forty years, most Americans have been expecting more than their government is capable of delivering. That mistake is at the root of why our government is functioning poorly. Instead of admitting its limitations, or trying to manage our expectations, government starts lying to us about what is possible……

“Only lies and exaggerations can promise voters and other citizens a much higher rate of real income growth, and so our politics has become increasingly full of … lies and exaggerations. The options are the “tax cut exaggeration” and the “redistribution exaggeration.”  

It’s a smoke and mirrors trick.  With all of us being tricked. Our government promises quick fixes through tax cuts and redistribution of wealth.  Neither will solve the underlying problem. It’s simply too big and hairy for one group of politicians to fix during an election cycle, and it’s easy to lie about and ignore because people still behave as if growth has not slowed.  

And it’s not just politicians who have no idea how to solve our slowing growth and innovation challenges.  

Thiel also calls out Google’s chairman Eric Schmidt in a 2017 interview for having “no idea how to invest that money [$73 Billion in cash] in technology effectively.”  This comment reveals the widening innovation gap we’ve seen: companies do not know how to invest in R&D OR the low-hanging technological fruit is gone OR they refuse to take on risk to do so.  

Thiel even goes on to say that an “investment in Google is a bet against advancements in technological search.”  Again, these comments are directed at Google, but paint a much broader picture: even our best technology companies do not and cannot create new world-changing public innovations as quickly as they have in the past.  

Conclusion

If you are expecting a solution to this slowing growth and innovation problem,  unfortunately I do not have one for you. Cowen suggests “that we should all revere creators and scientific innovators” for the purpose of creating more potential for scientific and technological breakthroughs.  

Personally, this solution leaves me wondering if we truly have no escape from our current economic contraction, aside from massive societal behavior changes.  Perhaps new FinTech companies can nudge us towards more saving and less consumption. Maybe we’ll end up complacent and the problem takes care of itself.      

This “Great Stagnation” definitely should sit on the same level of urgency as climate change, nuclear war, and our current political divide.  

Let me know if you have other ideas on how we should think about solving this messy economic problem that appears destined to upend the entire world economy and standard of living for billions of people.  

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