Social Democratic America (15 page)

FIGURE
4.10 When did US and Swedish GDP per capita diverge?

Natural log of inflation-adjusted GDP per capita. A log scale is used to allow comparison of rates of change. The lines are linear regression lines.
Data source
: Angus Maddison,
www.ggdc.net/maddison/historical_statistics/vertical-file_02-2010.xls
.

The final outcome is GDP per capita. Here the model clearly stumbles. As
figure 4.10
shows, the gap between the two countries isn't recent; it started more than a century ago. Apart from a few hiccups, each country has stayed on its long-run growth path throughout the past one hundred years, with Sweden slowly catching up to the United States.

The really interesting question posed by Acemoglu, Robinson, and Verdier is whether innovation will slow in the United States if we strengthen our safety net and/or reduce the relative financial payoff for entrepreneurial success. I doubt it will, for three reasons.

The first is America's past experience. According to Acemoglu and colleagues' logic, incentives for innovation in the United States were weakest in the 1960s and 1970s. In 1960, the top 1 percent's share of pretax income had been falling for several decades and had nearly reached its low point. Government spending, meanwhile, had been rising steadily and was close to its peak level. Yet there was plenty of innovation in the 1960s and 1970s, including notable advances in computers, medical technology, and other fields.

Second, the Nordic countries, with their low income inequality and generous safety nets, are now among the world's most innovative countries. The World Economic Forum's Global Competitiveness Index has consistently ranked them close to the United States in innovation. The most recent report, for 2012–13, rates Sweden as the world's most innovative nation, followed by Finland. The United States ranks sixth. The World Intellectual Property Organization (WIPO)-INSEAD Global Innovation Index 2012 ranks Sweden second and the United States tenth. This suggests reason to doubt that modest inequality and generous cushions are significant obstacles to innovation.

Third, if Acemoglu and colleagues are correct about the value of financial incentives in spurring innovation, we should see this reflected not only in the United States but also in other nations with relatively high income inequality and low-to-moderate government spending, such as Australia, Canada, Ireland, New Zealand, and the United Kingdom. But as
figure 4.11
indicates, we don't.

There is one additional possibility worth considering. If financial incentives truly are critical for spurring innovation, it could be the opportunity for large gains that matters, not the absence of cushions. Suppose we increase government revenues in the United States by imposing higher taxes on everyone—steeper income taxes on the top 1 percent or 5 percent plus a new national consumption tax. Imagine we use those revenues to expand public insurance and services—fully universal health insurance, universal early education, a beefed-up EITC, a new wage insurance program, more individualized assistance with training and job placement. These changes wouldn't alter income inequality much, but they would enhance economic security and opportunity. Would innovation decline? I suspect not.

We may get a test of this moderate-to-high inequality with generous cushions scenario at some point. I suspect this is where America is heading, albeit slowly. Interestingly, the Nordic countries, where the top 1 percent's income share has been trending upward, might get there first.
³³

FIGURE
4.11 Is type of capitalism a good predictor of innovation when we include additional “cutthroat” nations?

“Cutthroat” nations: Australia, Canada, Ireland, New Zealand, United Kingdom, United States. “Cuddly” nations: Denmark, Finland, Norway, Sweden. Innovation rank: average ranking on the World Economic Forum's innovation index in 2008–09 and 2012–13.
Data source
: World Economic Forum,
Global Competitiveness Report
,
www.weforum.org/
reports, pillar 12. Top 1 percent's income share: share of pretax income, excluding capital gains, 1989–2007.
Data source
: World Top Incomes Database, topincomes.g-mond.parisschoolofeconomics.eu. Government expenditures: government spending as a share of GDP, 1989–2007.
Data source
: OECD, stats.oecd.org.

If healthy economic growth doesn't require small government, institutional coherence, or high income inequality, what
does
contribute to growth? Surprisingly, when it comes to rich nations, we don't really know.

Consider the United States since World War II. From the mid-1940s through the early 1970s, the American economy experienced healthy growth, low unemployment, and modest inflation. But then the economy sputtered for a decade—a deep downturn in 1973–75, followed by high unemployment and inflation, followed in turn by a double-dip recession in 1980 and 1981–82. Stagflation, manufacturing decline, and foreign competition had policy makers befuddled.

The changed context spurred a slew of recommendations on how to rejuvenate the economy. The right blamed government overreach. Taxes, regulations, Keynesian demand management, and welfare state generosity had all, in this view, gone too far.
³⁴
The left proposed myriad solutions, including industrial policy, managed trade, a stakeholder-centered financial system, flexible specialization, lean production, corporatist partnerships between business, labor, and government, and collaboration between and within firms.
³⁵

In the mid-to-late 1990s, during the Clinton presidency, a Clinton-Reich-Rubin-Sperling variant of pro-growth progressivism emerged.
³⁶
It embraced some of these ideas but emphasized education and skill development, free trade, and a (social democratic
³⁷
) commitment to balance the government budget during economic upswings. Like the “Third Way” orientation championed by Anthony Giddens and Tony Blair in the United Kingdom,
³⁸
the aim was to reconcile traditional justice and fairness concerns of the left with an emphasis on economic growth. The approach maintained a commitment to basic economic security but de-emphasized equality of outcomes in favor of enhancing opportunity, capabilities, and employment.

As it turned out, America's economic growth from 1979 to 2007 was pretty healthy.
³⁹
It was slower than during the post–World War II “golden age.” But that isn't surprising; growth was especially rapid in those years because it had been so slow in the 1930s and because so much of the industrial capacity in Western Europe and Japan was destroyed during the war. US GDP per capita grew at a rate of 1.9 percent per year between 1979 and 2007. That's right on the long-run trend; the American economy's average growth rate from 1890 to 2007 was 1.9 percent.
⁴⁰
The United States also did well in 1979–2007 compared to nineteen other rich longstanding democracies. If we adjust for catch-up—nations that begin poorer grow more rapidly because they can borrow technology from the leaders—America's growth rate was third best.

Unfortunately, we know little about why. Was it due to the US economy's traditional strengths, such as its large domestic market and its array of large firms with established brands? To its strong universities and research and development (R&D), which keyed a successful transition to a high-tech service economy? To deregulation, tax cuts, and wage stagnation? To the adoption of some of the strategies proposed by the pro-growth progressives? To stimulative monetary policy (after the early 1980s)? To stock market and housing bubbles? To something else? We don't know.

Nor do social scientists have a compelling explanation for why some rich nations have grown more rapidly than others in recent decades. We know that catch-up matters. Limited product and labor market regulations and participation by business and labor in policy making (“corporatism”) seem to help, but they account for only a small portion of the country differences in economic growth between 1979 and 2007.
⁴¹
Even education seems to have played little or no role. Growth hinges on technological progress, which should be boosted by education, particularly in the modern knowledge-driven economy. Yet across the rich countries, those with higher average years of schooling, larger shares of university graduates, or faster increase in educational attainment have not grown more rapidly than others since the 1970s.
⁴²

An interesting and perplexing piece of the growth puzzle is the tendency of countries to do well for a while and then falter. In the past half century, a number of national models have gone in and out of fashion, first surging to the front and then falling back: Sweden (“middle way”) in the 1960s, Germany (“modell Deutschland”) and Japan (“Japan Inc.”) in the 1970s and 1980s, the United States (“great American jobs machine”) in the 1980s and 1990s, the Netherlands (“Dutch miracle”) in the 1990s, Denmark (“flexicurity”) and Ireland (“Celtic tiger”) in the 1990s and 2000s. Some later rebounded, such as Sweden in the 2000s and Germany in the 2010s.

Economic growth is valuable. Yet for affluent democratic countries, we know very little about what causes faster or slower
growth. Should we throw up our hands in despair? Not necessarily. The upside is that policies and institutions aimed at other outcomes, such as security and fairness, seldom doom the economy to stagnation.

Will the economies of rich nations such as the United States continue to grow at a healthy clip? Some are pessimistic. A key reason for pessimism is the shift from manufacturing to services. In most manufacturing industries, there is significant room for improvement in efficiency. In many services, that is not true. Think of cleaning rooms in a hotel or waiting tables in a restaurant or performing basic nursing tasks in a hospital. Productivity improvement in these jobs is difficult, in part because they are hard to automate. William Baumol calls this the “cost disease” of services.
⁴³
If a significant portion of our economy consists of such tasks, the thinking goes, we could be stuck with low growth.

I suspect this is wrong. While productivity improvement is difficult in low-end services, it is not impossible. Hotels, for instance, have made considerable strides in improving efficiency in room cleaning. Yes, improvement in services occurs at a slower pace than in manufacturing, but it happens. Think, too, of telephone operators, typists, bank tellers, and travel reservation agents. These positions have been largely automated via advances in technology.

Moreover, even if productivity growth is sluggish in low-end services, it may, as Baumol himself points out, be rapid in other parts of the economy.
⁴⁴
Technological advance and improvements in work organization can yield leaps forward. The computer and communications revolutions already have generated considerable advance in manufacturing, finance, and an array of other services. They will soon do so in medicine, education, and elsewhere.

In recent years, several analysts, including Robert Gordon and Tyler Cowen, have expressed pessimism about the likelihood of further productivity-enhancing innovations.
⁴⁵
The information technology revolution has largely run its course, they say, and in any case it never boosted productivity to the same degree as earlier innovations such as steam engines, railroads, electricity, the assembly line, indoor heating and air conditioning, running water, sewers, roads, and the internal combustion engine.

It's true that we don't see the benefits of the IT revolution in the productivity statistics. But that doesn't necessarily mean there has been a decline in innovation or in the payoff from innovation. For one thing, benefits may appear only after a nontrivial delay. The period of strongest productivity growth stemming from earlier innovation was the thirty years between the mid-1940s and the mid-1970s, but that was quite a while after the innovations occurred. The same may be true for the digital revolution.