What Would Make the Economy Roar Again?

The last week-end edition of the Wall Street Journal contains an article by Marc Levinson entitled “Why the Economy Doesn’t Roar Anymore”.  Marc Levinson is a former finance and economics editor of the Economist.  He points out that in the last few years, our economy has struggled to make a 2% annual growth.  During the 60 years after the end of WWII we averaged between 3 & 4%.  In an election year, our politicians are promising that they can get us back to that level.  He points our that he believes productivity growth is the key to economic growth and productivity growth is not something a president can decree.  He says we have little idea of how the government can stimulate innovation.  He points out that over the past two centuries the compound growth rates of the advanced economies – including the U.S. – have been in the range of 1.5-2.0%.  That – he points out – may be normal, and the second half of the 20th century may have been an exception due to factors outside of the government.  During the 1970’s he writes, government leaders thought they knew how to stimulate the economy using interest rates, taxes, and government spending.  But he says “when it came to finding a fix for declining productivity growth, their toolbox was embarrassingly empty.”  Maybe 2% growth rate is normal and government can’t change it, so we should ger used to it.

I wouldn’t disagree with his article, but I don’t think it’s the whole story.  I learned in business school that to commit money to capital projects one should do financial analysis based on annual forecasted sales and costs that calculate the annual payout and % return.  That to go forward with the project the return on investment should exceed the cost of capital.  Later when I was working for a Fortune 500 company I learned that the biggest factor in the analyses and the most uncertain was not the cost of capital but the forecast of product sales.  The cost of capital could vary considerably without making much difference in the return and whether the project went forward or not, but sales growth was critical.  To build new plants, sales growth might be the most critical factor.  Much has been written about the boom at the end of WWII.  But the critical item might be the boom in demand.  It was partly but not totally pent-up demand from the constraints on consumption during the war (rationing).  But rather it was likely a combination of things. During the war, there was a lot of research but most of the demand was for military items.  After the war there were new commercial products as a result of the war research.  Also we were helping rebuild Europe and helping Japan re-develop.  All of which no doubt stimulated demand growth.  But one of the most critical items that lasted in some form or other for the next 50 years was the “Baby Boom”.  The growth in population had a direct stimulus to growth in demand for products.  Improvement in productivity helped, but,  I think, that was not the only significant driving force.

Toward the end of the period that Mr. Levinson cites – a period that went from the end of WWII to the early 1970’s, the U.S. had the reputation of being the world’s most productive country with the best knowledge of how to manage productive industry.  But we had steel capacity to meet our needs from plants built-in the late 30’s to early 40’s.  Much of this was going to the military during the war, but after the war much of that shifted to the civilian products without requiring an increase in production capacity.  By the 1970″s, the steel market – including U.S.demand was going to Japan.  One of the reason’s cited by numerous sources was that Japan had built new steel plants in the 50’s and 60’s after the war and ours were 10-20 years older and therefore not as efficient.  Innovation can drive productivity, but innovation alone is not necessarily going to result in new plants.  In the petrochemical industry in the 1970’s, I learned the M.E.P. acronym (Modern Efficient Plant).  The demand for petrochemicals and plastics was growing rapidly and a round of new larger capacity plants were being built every 2-4 years.  Innovation was driving plant efficiency, but it was the volume that was driving the new construction of the necessary MEP’s.  The new plants were producing more product volume per plant, and the plant processes were largely automated which meant a large “fixed cost” component in per unit production costs.  When production is done with automated processes and high fixed costs, the productivity per person-hour goes up significantly and the unit cost is reduced.  But as with the steel industry, the savings alone is not necessarily enough to drive new MEP construction without an increase in demand.

With the “baby boomers” retiring today and in the next few years.  It is not likely that demand for many things is going to grow as it did in the last 50 years of the last century.  As Mr. Levinson points out the government doesn’t have much control over innovation.  And traditional economic stimulus programs like lower interest rates aren’t going to have much effect on either growth or productivity.  However with demand growth seemingly tied to population growth, it is at least predictable.   And it would seem that our  working population is going down for the next 15 or 20 years.  Can the government do much about that?  Maybe.  But traditional macro-economic theories of what the government should be doing are not working for all the reasons cited in previous posts.  (See Micro-Economics and the Ideal Gas Law, and The definition of insanity and the Fed)

There are some things that the government might try in this slow population growth environment.

  • The other thing that affects growth in demand is personal wealth.  Most of the countries of the world are not as well off as we are in the U.S.  Increasing immigration would help with the work force size and U.S. consumption of products.  We are after all a society that made up of many years of immigrants which has helped both the immigrants and our economy.  Poor immigrants become better off and need and can afford more consumption.  Increasing immigration could increase both work force and the demand for goods and services.  This worked well in the 1800’s and early 20th century.  But that was in a time when our character traits put a premium on personal responsibility and not looking toward a Socialist Government to bail us out.  Would it work today?
  • Then there is the matter of Free Trade Agreements:  The free trade agreements are two-edged swords to a degree.  The negative edge is that we can lose jobs to foreign countries, but with a shrinking workforce that might happen anyway.  The government could probably help this with making corporate tax rates at about the same level as other countries.  But we would probably lose some jobs anyway and U.S, wage rates would likely be held down by the foreign competition.  But with low-income countries improving, it would likely grow international demand way more than anything the U.S. might do internally.  And in the U.S., the costs of products (inflation) would no doubt be held down as well, which would help with low wage increases (which would likely be low anyway).  This could be a net positive for our economy – or not.  But it might be worth a try.

There is probably no magic here, but we probably need some new outside the box thinking in order to get through this in the best way.  It’s not clear that the government will have too much control over any of this – certainly not the way we’ve heard in this election cycle.

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About tjc13

BE - Chem Engineering, Vanderbilt Univ, MBA, University of Tulsa - Worked for an energy and chemical company for many years and then started a management consulting business working for both for-profit and not-for-profit organizations.
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