28/8/2012: Challenging 'perpetual growth' hypothesis

Once in a while, there is a fascinating piece of thinking that focuses on the long-term economic trends that is worth reading. Robert J. Gordon's "Is the US Economic Growth Over? Faltering Innovation Confronts the Six Headwinds" (NBER working paper 18315 published last week - link here) is exactly that.

The study looks at an exceptionally complex issue of long-term (centuries-long) trends in growth from the point of questioning the basic premise of economics - the premise that future growth is a 'continuous process that will persist forever'.

Quoting from the paper, the author establishes the following basic points concerning the prospects for future growth (up to 50 years out from 2007 and abstracting from the fallout from the ongoing crisis):

1. "Since Solow’s seminal work in the 1950s, economic growth has been regarded as a continuous process that will persist forever.  But there was virtually no economic growth before 1750, suggesting that the rapid progress made over the past 250 years could well be a unique episode in human history rather than a guarantee of endless future advance at the same rate."
2. "The frontier established by the U.S. for output per capita, and the U. K. before it, gradually began to grow more rapidly after 1750, reached its fastest growth rate in the middle of the 20th century, and has slowed down since.  It is in the process of slowing down further."
3. "A useful organizing principle to understand the pace of growth since 1750 is the sequence of three industrial revolutions. The first (IR #1) with its main inventions between 1750 and 1830 created steam engines, cotton spinning, and railroads. The second (IR #2) was the most important, with its three central inventions of electricity, the internal combustion engine, and running water with indoor plumbing, in the relatively short interval of 1870 to 1900.  Both the first two revolutions required about 100 years for their full effects to percolate through the economy. During the two decades 1950-70 the benefits of the IR #2 were still transforming the economy, including air conditioning, home appliances, and the interstate highway system. After 1970 productivity growth slowed markedly, most plausibly because the main ideas of IR #2 had by and large been implemented by then."
4. "The computer and Internet revolution (IR #3) began around 1960 and reached its climax in the dot.com era of the late 1990s, but its main impact on productivity has withered away in the past eight years.  Many of the inventions that replaced tedious and repetitive clerical labor by computers happened a long time ago, in the 1970s and 1980s.  Invention since 2000 has centered on entertainment and communication devices that are smaller, smarter, and more capable, but do not fundamentally change labor productivity or the standard of living in the way that electric light, motor cars, or indoor plumbing changed it."
5. "... It is useful to think of the innovative process as a series of discrete inventions followed by incremental improvements which ultimately tap the full potential of the initial invention. For the first two industrial revolutions, the incremental follow-up process lasted at least 100 years. For the more recent IR #3, the follow-up process was much faster. Taking the inventions and their follow-up improvements together, many of these processes could happen only once. Notable examples are speed of travel, temperature of interior space, and urbanization itself."
6. "The benefits of ongoing innovation on the standard of living will not stop and will continue, albeit at a slower pace than in the past. But future growth will be held back from the potential fruits of innovation by six “headwinds” buffeting the U.S. economy, some of which are shared in common with other countries and others are uniquely American.  Future growth in real GDP per capita will be slower than in any extended period since the late 19th century, and growth in real consumption per capita for the bottom 99 percent of the income distribution will be even slower than that." 
7. "The headwinds [to growth] include the end of the “demographic dividend;” rising inequality; factor price equalization stemming from the interplay between globalization and the Internet; the twin educational problems of cost inflation in higher education and poor secondary student performance; the consequences of environmental regulations and taxes that will make growth harder to achieve than a century ago; and the overhang of consumer and government debt.  All of these problems were already evident in 2007, and it simplifies our thinking about long-run growth to pretend that the post-2007 crisis did not happen."

An interesting and highly illustrative chart plotting growth evolution:

And the conclusion? "A provocative “exercise in subtraction” suggests that future growth in consumption per capita for the bottom 99 percent of the income distribution could fall below 0.5 percent per year for an extended period of decades." Illustrated here: