Nobelist on America’s Missing Economic Mojo — and How To Get It Back

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Economist Edmund Phelps has spent most of his career investigating the conditions of economic growth. It is a worthy topic of a life’s focus, given that an increase in growth from the current level of about 2% to 4% would solve most of America’s (and arguably the world’s) most pressing problems, from high unemployment and budget deficits to bankrupt entitlement programs. And indeed, Phelps is credited with deepening our understanding of how national savings effects economic growth, as his 2006 Nobel Prize attests.

But in the middle of the last decade, he grew frustrated with the way that most economists approach one of the key components of growth, namely technological innovation. Because it’s so difficult to understand how and why technology advances, mainstream economists have, historically, just left it out of their models, preferring to focus on more measurable variables like investment — meanwhile chalking up technological advances to scientists who operate outside the real economy.

But while science has advanced throughout human history, it wasn’t until the 19th century (and only in a few select places) that the whole of human knowledge was transformed into outstanding economic growth. What was it about places like Britain and America that allowed such innovation? And, more important, why has innovation — measured by the growth in the productivity of the workforce — generally slowed since the late 1960s? Those are the questions Phelps attempts to answer in his new book Mass Flourishing: How Grassroots Innovation Created Jobs, Challenge, and Change, which was released on Sunday.

(MORE: America’s Productivity Problem)

To answer this question Phelps goes back to the 19th century, the scene of what economists call The Great Divergence. In America and Britain, and to a lesser extent the countries of Western and Northern Europe, institutions developed, like capital markets and a legal system that allowed for limited liability corporations and bankruptcy, that promoted commerce and risk taking. This was also a time when representative democracy began to take hold, allowing governments to shift their focus from protecting the narrow interests of the aristocracy towards a rule of law which assured the rights of any property owner.

But capitalist institutions and a democratic form of government aren’t the only preconditions for dynamism, according to Phelps. What supported the creation of these institutions was a cultural revolution in which these societies began to move away from what Phelps calls “traditionalist” values to “modernist” ones. Modernist values, Phelps explains,

include norms like thinking and working for your self and self-expression. These values also include attitudes towards others: readiness to accept change caused or desired by others; eagerness to work with others; the desire to test one’s self against others, thus to compete; and the willingness to take the initiative . . . other modernist attitudes are the desire to create, explore, and experiment, the welcoming of hurdles to surmount, the desire to be intellectually engaged, and the desire to have responsibility and to give orders.

In Phelp’s view, modernist values contrast with what he calls traditionalist values, which generally prize and promote stability, security, and responsibility to the community. These have been resurgent in Europe since the middle of the 20th century and in America since the late 1960s, he argues, and are largely responsible for the decline in innovation that we’ve seen since then. In the realm of government, for example, this ethos has led to the rise in welfare programs, which Phelps argues dull the incentives of both workers and employers to create an economic environment where work is enjoyed and well-rewarded.

Interestingly, Phelps argues that corporations have been equally energetic about dulling the impact of competition. One measure of the way in which corporate America is more keen to cozy up to Washington than to fairly contend with competitors is the growth of money in politics. According to data from the Brookings Institute and the American Enterprise Institute, candidates for Congress spent more than $1.5 billion on their campaigns, more than eight times what they spent in 1980. Federal regulations have exploded since the late 1960s, with the number of pages in the Federal Register (the compendium of federal regulations) more than quadrupling in that time period. Phelps doesn’t argue that all regulation is bad. Indeed, rules that promote trust by outlawing harmful products can even bolster economic growth. But too often, he says, they’re actually a tool that big business uses to stave off competition.

(MORE: Feds Say No Way to Using Eminent Domain to Help Underwater Homeowners)

Another troubling development, in Phelps’ view, is the culture of short-termism that has enveloped both corporate America and Wall Street. America’s most significant firms are run not by entrepreneurs but by professional managers who are incentivized to think about quarterly profits rather than long-term growth. Indeed the average tenure of a Fortune 500 executive is just 4.6 years, hardly enough time to lead a company towards visionary innovation. And as the financial sector becomes more and more concentrated, these firms are being funded by a small number of massive funds that are concerned about short term profits while having little intimate knowledge of the businesses to which they allocate capital.

And finally Phelps argues that the American populace itself has lost its appetite for innovation. New businesses are being started at a slower rate than they have been in more than 30 years, and fewer Americans work at small companies. Phelps cites studies which show that while Americans haven’t lost their appreciation for entrepreneurial values, they increasingly value the safety and stability of a job at a large company and more robust government benefits.

Phelps’s book deserves credit for showing that the strength of an economy doesn’t depend on small differences in the tax rate, or the tactics of a country’s central bank. Phelps rightly points out that economic dynamism depends on much deeper issues like a culture’s affinity for risk taking and respect for individual achievement. And he wields convincing statistics that suggest actors in our political economy, from our government, to corporations, to workers, have to some extent lost their reverence for these values.

It seems to me, unfortunately, that Phelps offers little in the way of fresh solutions for these seemingly intractable problems. For instance, how to fix the financial system and reduce the influence of big Wall Street banks without handing too much power over to a less-than-efficient federal government? And how does the average citizen participate in capital markets without handing money over to those same firms which serve as the gatekeepers?

(MORE: President Obama, Defender of the 30-Year, Fixed-Rate Mortgage)

I’d also argue that Phelps underestimates the price a society pays for the dynamism that characterized the first half of this country’s history. Government programs that transfer wealth to the poor, or regulations that try to protect the environment, didn’t appear out of nowhere. These developments arose after years of confronting the sometimes harsh consequences of unbridled capitalism. As the country became more politically inclusive, those who had been left behind by our economic system demanded a piece of the pie, and that powerful corporations be held responsible for the damage they sometimes did. These were more or less democratically-motivated outcomes, and it’s difficult to reconcile Phelps’ obvious respect for democracy with his distaste for the direction the country’s taken in the past 50 years.

Phelps is right to direct our focus towards the entrepreneurial spirit and innovation, for these values have proven to be priceless tools for furthering human welfare, and there are surely steps we can take to reintegrate these values into our economy. But we’ve also seen that there are problems, like global warming or poverty, that economic growth has been unable to fix — and we’re right to look for better solutions.

5 comments
JKBullis
JKBullis

A major shift in our attitude toward our resources is needed, where we no longer can afford not to use our massive land resources more effectively.  This could be the productivity opportunity that would put us back in economic balance with the world.

The key opportunity would be unlocked by building the infrastructure that would enable universal irrigation and wise distribution of the water.  A secondary, though huge, benefit would be the capability to control drought and flood impacts.

Environmental considerations have to mature, but this all could be done with due consideration for species protection; stopping short of species protection paralysis as we see it now.

We are working in anticipation of better thinking, on projects that are directed toward better use of land resources.  See: www.miastrada.com

jdyer2
jdyer2

Wouldn't it indeed be wonderful if we could continue innovating and creating economic growth forever.  However, the planet is finite, with limited resources.  Every time you read about good economic news, the price of oil shoots up.  It drops when there is bad news.  That tells you that our economy is constrained by energy, not innovative ideas.  You're ideal of 2-4% growth would lead to more carbon emissions, more depletion of our aquifers, more cutting down forests.  There is no panacea.

MichaelrDunklin
MichaelrDunklin

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contactme
contactme

Lack of a government active in anti-trust is part of the problem...and therefore a potential solution.

Why should the biggest economy on earth have only three car companies?  How could trouble at a small handful of financial institutions threaten to bring down the whole market?

Smaller firms are hungry and therefore more competitive firms.  They must accept market conditions, rather than dictate them.  They create more jobs.  Their smaller size means each one has less influence on the government.

One day I hope America wakes up and sees what many giant firms too often become:  anti-competitive, overly government-influencing, labor-bullying oncologies on the face of the otherwise admirable free market system.  

Like cancer in biology, they are a special pathology in economics where intervention (though imperfect) is the lesser-evil option; either in the form of regulation or breaking them up.