God is a Capitalist

Tuesday, February 4, 2014

The Great Stagnation Explained

A few economists are worried about the great stagnation, the apparent plateauing of wages and economic growth. Some attribute the malaise to rising inequality or technology having picked all of the low hanging fruit, or other causes. Any time someone identifies a problem every person with an ideology to promote offers their pet ideology as the cause or cure. Here is my take on it:
The industrial revolution caused per capita incomes in the West to rocket from $3/day in 1700 to as much as 130 times that amount today. A graph of incomes produces a “hockey stick” as this graph from the Atlantic that demonstrates:

Chicago economist Deirdre McCloskey’s explains in her book Bourgeois Dignity: Why Economics Can’t Explain the Modern World that the innovation caused the rapid take off in incomes, but innovation requires that society value business and innovation and adopt “bourgeois values.” She devotes a large portion of the book to slaying zombie explanations for the rise in incomes, including thrift, capital accumulation, greed, the Protestant ethic, colonialism, education, transportation, geography, energy, trade, slavery, exploitation, commercialization, genetics, institutions, and science.
How is it possible for innovation to benefit all of society and not just the inventor? After all, successful inventors become very wealthy. The answer is that innovators capture merely 2% of the total benefit of their inventions according to Yale economist William D. Nordhaus in his paper “Schumpeterian Profits in the American Economy: Theory and Measurement.” 

Workers and consumers get the other 98% through higher wages and lower costs. That means innovation in free markets is the largest positive externality in all of economics. Negative externalities are costs that neither producers nor the direct consumers pay for. The most popular negative externality is pollution. Coal-fired electrical generating plants cause air pollution that neither the generator nor the electrical consumer pays for. Electricity generated in Oklahoma may pollute Vermont. 
Positive externalities are benefits the public receives without paying for them. Economics textbooks fall back on trivial examples such as the benefits an orange grower might get from a neighbor raising bees, or benefits of flu shots. 
Based on Nordhaus’s work, the greatest positive externality of all time is innovation in a free market. It produces far greater positive effects than the monster negative externality, pollution. Increased wealth leads to better diets and healthcare, longer lives and population growth. Those benefits introduce pollution but greater wealth provides the means to clean it up. 
As McCloskey reminds us, innovation needs the greenhouse atmosphere of the bourgeois values to flourish. Does the US still hold to those values? They have taken a beating over the last 60 years. All presidents since Hoover have tried to destroy them through higher taxes and massive regulations. The Federal Register of new regulations accumulated over three million pages of regulations since 1970. Hollywood ensures that every young person despises business. Public education credits all things good to the state and discredits businessmen as “robber barons.” 
The past 14 years have witnessed a great deal of stagnation. Maybe the cause is the starvation of innovation as a result of the death of the bourgeois values.

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