Did Demographics Cause 1970s Stagflation?
Was the stagflation of the 1970s really a result of a compliant Federal Reserve turning on the taps to suit Richard Nixon? That’s the conventional wisdom. But an interesting series of posts that started with Steve Randy Waldman suggests that it was actually the result of the demographic changes of the 1970s. Here’s Karl Smith, arguing that Fed Chairman Arthur Burns's problem was not bad character but bad models.
In any case Steve Waldman suggested a few posts back that the Great Inflation was a reasonable response to the Baby Boomers entrance into the workforce. The economy could not absorb all of those workers at prevailing real wages and so real wages had to be driven down to maintain full employment. Folks attacked this argument from a number of levels, but I was somewhat sympathetic because I tend to think far little attention has been paid to the rapid increase in the work force due to the entrance of baby boomers and women. Economists are so sensitive to any argument against immigration they seem to forget that any growth model that I am aware of will predict a decline in per capita GDP if the population rises fast enough.
There isn’t enough capital to go around -- buildings, equipment, roads, etc -- and it is simply inefficient to try to build it all overnight. The optimal thing to do is to allow per capita GDP to fall. Else, you end up with sucking up all of societies produce trying to build new capital for the new comers.
Basically, this made Burns think that potential output should be higher than it actually was. Because the economy was running “below potential,” he turned on the monetary tap. The rest is, well, monetary history.
As a big believer in the power of demographics, I find this intriguingly plausible (though I’m ever mindful of the warning I once received from an older economics journalist: “If you spend enough time with demographers,” she told me, “you quickly start thinking that demographics explains 150 percent of economic variance.”)
But of course, there’s also a corollary: If we look to the baby-boom bulge to explain the 1970s, we should probably also look to demographics to explain the 1950s and 1960s. To wit: In World War II, somewhere north of 400,000 Americans serving in the military were killed, maimed too badly to work, or missing. That depressed the size of the labor force. That cohort was followed in the 1950s by the Great Depression babies, the products of a greatly depressed birthrate. So you had two decades of lower than normal workforce growth.
This potentially explains not only the greater productivity of the era (higher than normal ratio of workers to capital assets), but also the low levels of inequality. If you look at what followed the Black Death (admittedly an extreme example, but extreme examples are often where it’s easiest to see common phenomena), the great dying was followed by rising wages and productivity, because you had more land per worker and fewer mouths to feed. But it was also followed by a radical shift in social relations. Feudal landowners had enormous power, and wealth, in the Europe of 1300. But after the plague passed, their lands were suddenly worth dramatically less because they couldn’t compel workers to show up and perform the labor that kept those lands producing. The labor shortage made the common folk much wealthier, but it made people who lived off capital poorer, because relatively scarce labor was now much more valuable than plentiful capital.
The nice thing about this is that it explains the global phenomenon -- inequality contracted across the developed world in the 1950s and 1960s and has increased almost everywhere since then. Because the Great Depression and World War II had depressed birthrates in most of those places, this is not surprising.
What this also suggests is that we may be chasing a chimera when we talk of going back to the halcyon days of the 1950s and 1960s. If it was labor scarcity that drove the income compression, we’ll have a hard time replicating those conditions.