Growing Pains by Brink Lindsey
In an earlier column I explained the very real threat of a long-term slowdown in U.S. economic growth (and check out this column for why that matters so much). Demographic factors are the main culprit.
First, the employment-to-population ratio rose steadily for a century but now is falling. Second, high school and college graduation rates have been stalled for a generation. Growth in both the quantity and quality of labor has slowed to a crawl, and that puts a sizable drag on the growth of GDP per capita.
Let me now put these specific problems in a larger context. As I’ve explained in a recent paper for the Kauffman Foundation, what’s happening in the United States is part of a larger, global pattern of historical development. Specifically, as a country’s economy grows richer and more advanced, it eventually exhausts the easiest opportunities for growth, or what economist Tyler Cowen calls the “low-hanging fruit.”
Specifically, there are two basic types of growth. The easy kind is imitation: the expansion of existing activities or the application of existing knowledge. The hard kind is innovation: the development of new goods, services, and production process based on new ideas. As we get richer, the opportunities for imitative growth start getting scarce.
This dynamic is most obvious in the case of less developed countries. Because of their relative backwardness, they are able to enjoy accelerated “catch-up growth” by adopting technology and organizational forms developed abroad. This is the explanation for China’s rapid growth over the past three decades: it started its climb from an appallingly low base. As developing countries approach the technological frontier, however, they have to begin innovating on their own to keep growth going. And innovating is a lot harder than copying.
The fact that nothing fails like success is documented in a recent paper by economists Barry Eichengreen, Donghyun Park, and Kwanho Shin. Surveying the experiences of countries with sustained records of rapid growth since 1957, they find that growth rates tend to hit a wall when countries reach GDP per capita of around $17,000. After that, the average growth rate of the countries they studied dropped from 5.6 percent to 2.1 percent.
Although less obvious, the steady shift from imitation to innovation as the primary source of growth also occurs in advanced countries that have been at the technological frontier all along. As mentioned already, labor force growth slows as birth rates fall, the population ages, and the transition of women into the paid work force plateaus. Also, investments in mass schooling eventually yield diminishing returns.
In addition, changes in the composition of the economy switch from being a growth accelerant to being a growth retardant. As countries move from poor to rich, the composition of production and employment shifts in a way that speeds up the transition. Namely, output and workers move away from sectors with relatively low productivity (in particular, agriculture) and into the high-productivity sector of manufacturing.
Once countries get rich, however, the continued evolution of the economy cuts in the opposite direction. Manufacturing’s share of both output and employment starts shrinking, for the simple reason that sustained productivity growth means we need to spend relatively less of our total income and our total labor hours on producing the stuff we want to buy. And the new expanding sectors are ones with historically low productivity growth – think government, education, and healthcare.
In the United States, other peculiar historical circumstances created additional opportunities for imitative growth that boosted economic performance in years past. In the “Golden Age” of economic growth that occurred during the quarter-century after World War II, there was actually a significant element of regional catch-up growth.
Air conditioning and interstate highways triggered the rise of the Sunbelt, allowing the underdeveloped South and empty West to boom. Another kind of catch-up growth occurred due to pent-up supply and demand after the Great Depression and World War II.
New technologies developed during those decades couldn’t be commercialized due to the difficult conditions; likewise, consumers were compiling a backlog of wished-for purchases during the lean years. Part of the postwar boom was thus due to the fact that companies and their customers were making up for lost time. But by the 1970s, all of these forms of catch-up growth had run their course.
Meanwhile, in more recent decades, the Baby Boom accelerated growth rates by injecting an unusually large cohort of highly educated workers into the labor force. Alas, the boomers are now entering retirement.
Here then is the bottom line. The inevitable result of economic progress is to transform growth into something that occurs largely at the technological frontier – that is, through innovation. And that means that growth gets harder – a lot harder.
Therefore, economic policies and institutions that managed to produce acceptable results in the past will no longer suffice. In the United States and other rich countries, we are already confronting the daunting challenges of “frontier economics.” And today’s fast-growing emerging markets have them to look forward to.
Sooner or later, all of us out on the frontier face this stark choice: innovate or stagnate.
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