 |
From NewsLink Fall 2002
BookMark
|
From NewsLink, Vol. 7, No. 1, Fall 2002
Conventional analysis strongly suggests that productivity, the prime mover of economic growth, depends on a nimble admixture of four essential components: physical capital (factories and tools, for example); human capital (educated workers); natural resources (trees, oil and ore); and technology (electricity and computers and the managerial insight to deploy both effectively).
In measuring a nation's growth in terms of Gross Domestic Product (GDP), economists have obsessed about how each of these four components dynamically come into play. Some nations that lack natural resources, such as Japan, can compensate for the lack of oil for instance if they excel in the other components such as physical and human capital.
In particular, economists are interested in how, over the course of time, living standards of millions of people across the globe improve dramatically. As is the nature of science, most economists look for a root cause of sustained growth (or even slow growth) to fit nicely into a theory or model. Often they look at the introduction of the printing press, the thresher, the cotton gin, electricity, the automobile and more recently the new economy based on computers and the Internet. As such, economists are always searching for the next benchmark or Industrial Revolution. Perhaps with less flair they look for the type of discontinuity found by Arnold Toynbee, who wrote of a society "suddenly broken in pieces by the mighty blow of the steam engine and the power loom."
Economic journalist Jeff Madrick strongly believes mainstream economics is terribly wrong. A contributor to the "Economic Scene" column in the New York Times and adjunct professor of the Humanities at Cooper Union, Madrick argues relentlessly in his new polemic, Why Economies Grow, that the expanding size of markets, of which America has long benefited, explains growth much better than any other variable. He believes such an "organic view," based on economic history, makes more sense in part because the alternatives are lacking. "The modern practice of economics has a disturbing tendency to seek such universally applicable solutions based on theoretical principles that I believe a disinterested view of history does not bear out." Yet in his rush to debunk classical economics his own analysis falls short
.
At first glance Madrick makes a persuasive case that markets - specifically domestic markets - are absolutely critical to economic growth. For most of its history, the US benefited from the addition of people through immigration and the abundance of land- enabling it to induce the consumption of farm products and manufactures. To be sure, Madrick acknowledges the contributions of capital and technology. But it is markets that enable the use of capital and technology rather than the other way around. He maintains that population growth and the sheer number of people exchanging goods and services, and the role in which government plays, is far more important than recent efforts to stimulate national savings, deregulate industries and embrace high technology.
He thinks less of free market growth policies and is dismissive of tax policy that might encourage capital formation. In fact he says the capital investment model can only take one so far. Savings of this sort did not improve after the Reagan tax cuts in 1981 nor when the Clinton administration raised taxes in 1993, he says.
"It is controversial to deduce a rise in savings will result in a rise in investment. History strongly suggests the opposite. Savings are important to economic growth but not a first mover. Investment was induced by the opportunity created by growing markets or new products more so than the availability of savings."
Madrick goes on to say that neither entrepreneurs, nor banks, nor balanced budgets nor the introduction of technologies provide answers to his question. Upon closer inspection, highly touted technologies take time to permeate an economic system. Electricity was discovered long before engineers found a way to use it in factories. Moreover, the application of technology is usually secondary to managerial wit. "Technological innovation as pure invention is not even always a necessary condition of economic growth. Henry Ford's great innovations were much more managerial than technological," writes Madrick. This however, poses a definitional problem as most economists would include Ford's approach as part of technology.
Why do large markets matter? "The importance of economies of scale is generally underestimated in economy theory," says Madrick. In early markets consumers did not benefit from the division of labor. But such a division of labor could only take place in large and growing markets of consumers.This, according to Madrick, wasn't lost upon entrepreneurs who saw in large markets opportunities to market standardized products. The economies of scale in the automobile industry created demand for petroleum products and in turn allowed greater number of workers to become specialists. These economies of scale hinged upon the ability of American industry to standardize its products. In contrast to the modern economy, with its emphasis on niche markets, the American economy of the early 20th century was able to reduce distribution and marketing costs per unit.
Madrick's contention can be challenged on two fronts: First, economies of scale are more important in some industries (e.g. autos) than others (e.g. high-end tourism). Small countries can become rich by exploiting niches; Iceland has 250,000 people, yet is one of the richest countries in the world.
Second, standardization doesn't come early in the technology cycle. The economist Ray Vernon argues that there is a product cycle: at first, technology is developed close to where there is demand, but it is unreliable and caters to the rich few; then local production expands; eventually, production is so routine that it can be done in low-wage countries. This cycle fits products such as televisions very well. The US profited in the early phases of the cycle, but now television manufacturing is so standard that it is no longer done in the US.
The short-termed productivity growth of the late 1990s bears some semblance to the golden age of economic growth in America. "Technological advance manifested itself in specific ways in the late 1990s and was closely dependent on the size and sudden rapid growth of the U.S. market." While inflation was held in check, high tech industries were able to benefit from a demand for standardized products such as Microsoft, Cisco and Oracle just as centuries before consumers delighted in the products of Singer Sewing Machine, Standard Oil, U.S. Steel, A&P, McDonalds, and AT&T.
On the other hand, Madrick attempts to offer an explanation for the great productivity slowdown of 1973-1995. The growing demand during this period for high quality specialized goods fragmented the market and took its toll on productivity. Because of the de-emphasis of standardized products (attractive to the middle class) in favor of so-called higher quality (sought by high income earners) firms sought to satisfy upper class demands. "Meeting these niche markets was not as given to efficiencies as providing standardized products to mass markets." For example it took more marketing resources to attract the attention of higher income individual not to mention more labor costs. This fragmentation is likely to constrain future growth.
But this rationale is less appealing than others. Environmental rules began to bite "diverting" a significant chunk of investment, but getting us a cleaner environment (at the expense of slower economic growth); the oil price shocks rendered a chunk of the capital stock obsolete, and it had to be replaced which took some time; the workforce became, on average, less experienced with a huge influx of women (but this then worked to the economy's advantage in the 1990s as experience levels rose); the rapid educational gains of the 1950s and 1960s slowed down in the 1970s; R&D spending as a percentage of GDP fell after 1973. In short, the fragmented-market explanation looks lame incomparison with these.
Madrick sees government as smoothing out market failures. He thinks, contrary to the current market-oriented school of thought, that people ought to be reminded of government's activist virtues. He says economic growth was at its height in the<1950s and 1960s, when tax rates were very high and government was growing rapidly. Yet even with higher rates, tax collections as a percentage of GDP were lower during this period.
Despite the commanding heights of capitalism, Madrick thinks citizens ought to be reminded that government is more than a necessary evil. But Madrick's action agenda treads no new ground here; it is written with all the dryness of the Democratic Party platform.
In the past, government saw fit to intervene not only to protect property rights but also to enforce anti-trust regulations to ensure competition. He also believes that the nation's physical and social infrastructure has been neglected - a dubious claim given the growth of government over the last 30 years. The research on whether increasing public spending on infrastructure substantially increases productivity is inconclusive. And despite the weakening of organized labor he thinks management has reached the end of the road in terms of capping labor costs.
Madrick writes that "assessing and ranking the causes of growth requires humility," although it is ironic that he shows no humility whatsoever in attacking the economics profession. "Mainstream economics, at least for the moment, has aligned itself closely with individualism and minimal government. We cannot ignore how some of the precepts of contemporary mainstream economics, from the free flow of capital to restrained government spending and emphasis on strong currencies, also are consonant with the foremost desires of the world's richest financial institutions." This is not an argument but a jeremiad. It is the last refuge of a post-Keynesian upset with all those Nobel prizes lauded upon free-market economists.
Adam Smith, whom Madrick quotes profusely on the division of labor, warned against conspiracies by businessmen to raise prices. While some conservatives misread Smith, most mainstream economists working within the neoclassical framework recognize the role of government in dealing with externalities such as pollution and the provision of public goods. Most economists are well attuned to the tradeoff between imperfect markets and imperfect governments.
More troubling is Madrick's overarching foray into sociology. In the end, he views the American national character based on individualism and free choice as a disadvantage. If Americans are reluctant to adopt a "new social contract" it is with good reason. The European welfare state model Madrick apparently admires presents its own set of unique problems. Chronic high unemployment is not an American way of life. The inflexibility of German and Italian labor laws, for example, has restrained their growth potential. Agricultural subsidies across Europe, which dwarf those (still indefensible) subsidies received by American farmers, are unfortunate restraints to trade. Most Americans do not ignore the complexity of modern economics. History shows that as both consumers and citizens in matters of political economy they have made a good case for American exceptionalism.
NewsLink is the quarterly newsletter of the Beacon Hill Institute for Public Policy Research at Suffolk University. © 1996-2002. All rights reserved.
HTML format revised on 7/3/03 12:09 PM
