Fast Growth: Pain Now, Gain Later

Part 2 of an excerpt from Michael Mandel's Rational Exuberance discusses how job creation and wages can leap in the long run

Rational Exuberance: Silencing the Enemies of Growth and Why the Future Is Better Than You Think

by Michael Mandel

Chapter 3: How Innovation Matters

(Part 2, click here for Part 1)

Bigger Wage Gains

In the short run, it's possible or even likely that some workers may be hurt by technological change, if their jobs are eliminated or transformed. There is, however, little reason to doubt that the best way to raise the wages of the poor and the working class is to encourage rapid exuberant growth. In The Wealth of Nations, Adam Smith said it as clearly as possible:

Though the wealth of a country should be very great, yet if it has been long stationary, we must not expect to find the wages of labour very high in it.

Over the long term, wages basically rise parallel with productivity. True, there is usually a bit of a lag between changes in productivity growth and changes in wage growth. When productivity accelerated in the exuberant growth period of the second half of the 1990s, it took a couple of years before those gains showed up in higher wages. Eventually, though, they did, and real earnings of virtually all workers soared. From 1993 to 2003, real wages for all workers, adjusted for inflation, rose by 9 percent, based on wage and price data from the Bureau of Labor Statistics. That's outstanding, especially when compared with a gain of only 1 percent from 1983 to 1993, the previous 10-year period.

It wasn't just the well-to-do and educated who benefited. Real hourly earnings for production and nonsupervisory workers rose by 8 percent. The percentage of families living below the poverty line fell sharply, from 12.3 percent in 1993 to 9.6 percent in 2002, the last year available. By comparison, the poverty rate was flat in the stretch from 1983 to 1993. Even the 2001 recession and subsequent slow downturn seems to have eroded only part of the gains. By contrast, the periods when cautious growth has dominated have typically had very slow wage growth, adjusted for inflation, especially for the people at the bottom.

For the most part, the historical record suggests that periods of innovation have generally been a good thing for the working class. For example, the question of what happened to workers during the rapid technological change of the British Industrial Revolution of the 19th century has been hotly debated. Nevertheless, from 1810 to 1850, argued Jeffrey Williamson, a Harvard economic historian, "blue-collar workers' real wages doubled." Williamson also estimated that the percentage of paupers in the population -- the extreme poor -- dropped from 15 percent in 1812 down to 10 percent in 1850 and 6.2 percent in 1867.

In the 20th century, it was the leading-edge industries such as automobile manufacturing that were able to afford to pay the best wages. It was automobile pioneer Henry Ford who boosted his factory's daily wage to $5 a day in 1914, when the going wage for factory workers was less than $2.50 per day. More recently, workers in the tech sector enjoyed some of the biggest wage gains in the 1990s.

It's often a nasty battle over how the free lunch will be split. But if the surplus doesn't exist, there's nothing to fight over.

The right way to think about it is that innovation generates a surplus -- the free lunch -- which goes to workers, in the form of higher wages, and to companies, in the form of higher profits. It's often a nasty battle over how the free lunch will be split. But if the surplus doesn't exist, there's nothing to fight over.

More Jobs

Both logic and history suggest that it's far easier to generate highpaying, attractive new jobs in an exuberant economy, compared with a cautious one. Typically big technological breakthroughs create new and profitable industries, which need a lot of workers and are willing to pay good money.

It's possible to go down the list of industries published by the BLS and identify what innovations in the past led to which jobs. Today there are perhaps 9 million workers employed making motor vehicles and airplanes, selling them, servicing them, or working in closely connected industries. Another 4 million are directly engaged in making high-tech equipment, selling it, or helping people deal with it. Another 1 million work in the electric utility industry, or building electrical equipment. Another 1.5 million or so work in the telephone, radio, and television industries. Then, of course, there are the indirect jobs that are spun off from the original innovations. Virtually the entire travel industry depends on the availability of cheap air and land travel. Destinations such as Disney World would not be economically viable if their customers could only come from the surrounding areas.

Similarly, the retail and wholesale industries are absolutely dependent in their current form on the truck/air/rail distribution system. Wal-Mart, the largest private employer in the country, built its business model around effective use of information technology and far-flung sourcing of cheap products. And while it's not possible to separate out the effects of medical innovation on health care employment, there's no doubt that there would be far less money spent on health care, and far fewer health care jobs, if it wasn't for all the new treatments introduced over the last 50 years.

Interestingly enough, periods of innovation and exuberant growth also seem to be the periods of the lowest unemployment and the fastest job growth. In the 1960s, when productivity was growing very quickly, unemployment dropped below 4 percent. As innovation and productivity growth slowed in the 1970s and 1980s, unemployment rose. And then, as the economy went through another innovation and productivity spurt in the 1990s, unemployment dropped below 4 percent again.

Why should this be? During periods of cautious growth, companies have only one way to boost productivity and profits -- by cutting costs and trimming the ranks of workers. These surplus workers are left unemployed, or they may move into the service sector -- the dry-cleaning, health care, restaurant, retailing, and other service jobs that grow almost every year, along with the population. The problem is that these jobs don't necessarily pay well. Restaurants always need waiters and waitresses, but that doesn't mean that they can afford to pay a good wage.

However, during periods of exuberant growth, both companies and workers have other options. Innovation enables companies to compete -- not necessarily by cutting labor, but by using new technology to make existing workers more productive. And when workers are laid off, there are innovative new industries that are hiring.

In an exuberant economy, workers have something to aspire to -- there's unclaimed territory where smart and hardworking Americans can make their mark. Without innovation, the job market congeals and stagnates. There is no way for anyone to move up without bumping someone else down. Easier Retirement

Exuberant growth is absolutely essential for dealing with the biggest economic problem that we face today: the looming task of financing the retirement of the baby boom generation. There are lots of different parts to this puzzle -- the rising number of retirees compared with working people, the soaring costs of health care, the need to find resources for long-term care -- but they all come down to the same thing. The economy has to grow -- a lot -- over the next 20 years to pay for all the obligations, and cautious growth simply won't be sufficient to make the economic pie big enough for everyone. Exuberant growth, however, makes the retirement problem tractable, as the to this chapter shows.

Improved Competitiveness

Equally important, exuberant growth is the only way that a mature industrial economy such as the U.S. can compete against low-cost competitors overseas. If the U.S. is not extending its technological lead, it becomes much easier for other countries to catch up. For example, it was during the 20-year period of cautious growth, from 1973 to the mid-1990s, that the U.S. lost much of its international competitiveness, the U.S. trade deficit exploded, and manufacturers moved jobs out of the country.

During this period, the U.S. seemed helpless to hold back the tide of imports from overseas. Cautious growth depends on investment in physical capital, and that's not one of America's strong points. Other countries have much higher savings rates, as well as less expensive workers. There was no way for the U.S. to compete on those terms.

Exuberant growth, instead, builds on the real competitive advantage that the U.S. has -- not in capital, not in education, but in risk-taking. Other countries simply don't have the resources to take a chance on an expensive new technology the way that the U.S. does. At the same time, exuberant growth in the U.S. turns out to be enormously beneficial to other countries as well. Think of the process of economic development as a ladder. The bottom rung is agriculture and natural resources. The next rung up is light manufacturing, such as textiles and clothing. Then comes heavier industrial processes such as steel making, followed by more advanced industrial production such as automobiles, which is in turn followed by high-tech products such as electronics. It is only natural for successful countries to keep moving up the ladder. That's what happened with Japan, Korea, and Taiwan, and that's what is happening now with China and India. As countries develop, their industrial capabilities increase, and so does the range of products that they can make.

Exuberant growth has the effect of allowing the U.S. to keep moving to higher and higher rungs on the ladder. Technological change creates new products and new markets that can be exploited for a time, before other countries catch up. In the 1990s it was high tech, software, the Internet, and biotech leading the way. And as the U.S. and other advanced countries move on to new markets, it opens up the lower rungs of the ladder for other nations. Taiwan and Korea can move up to producing electronics components and even whole computers for the U.S., while China can produce the toys and other products that were once "Made in Taiwan." India can attract call centers and help desks -- routine and repetitive tasks that can easily be outsourced.

Higher Purposes

We can't simply compare exuberant and cautious growth based on economic considerations. No matter what is taught in Econ 101, most people are not motivated purely by pecuniary motives or by self-interest (with the notable exception of some Gordon Gecko "greed is good" types who may be found on Wall Street or in Silicon Valley). There has to be an emotional component, to keep us going, and a higher purpose, to satisfy our souls.

The result of innovation is not just economic growth, but growth of the human spirit as well.

What the best innovations do is create new possibilities that didn't exist before. The airplane opened up entirely new avenues for travel and trade. The radio created new possibilities for entertainment and communication. The result of innovation is not just economic growth, but growth of the human spirit as well. It reinforces curiosity and risk-taking, and the idea that there is always something new behind the next mountain.

The Internet boom, along with a soaring stock market, provided both a positive emotional component and at least the hint of a higher purpose. People enjoyed what they were doing, for the most part, and they felt like they were making a difference. In the words of one Wall Street Journal columnist, recalling the 1990s wistfully, it was "the pure, simple, social fun of a real economy -- teams of people dreaming up ways to do things that have never been done before."

Silicon Valley was attractive both because people were making big money and because there seemed to be an opportunity to make a difference. Bringing the Internet to people became something of a crusade, and the people working in these companies felt like missionaries. Following the example of Apple Computer, Netscape and other leading Internet companies had employees who held a job with the official or unofficial title of "Evangelist" to spread the gospel of the Internet -- something that would not have occurred with a steel company or a car company.

Exuberant growth feels vibrant. Like hitting a rich vein of ore or sexual attraction, exuberant growth is what provides the excitement and the verve in mature economies. New opportunities open up to succeed -- and to fail.

Moreover, innovation gives a sense of progress, that things will be better for our children and our children's children. That's essential -- it provides a motivation for people that goes beyond the economic. It gives us a reason to wake up and go to work in the morning, if we believe that our efforts will make things better for other people.

Without innovation, the status quo solidifies. If the underlying technologies don't change, then the corporate and job structure don't change either. That makes it much harder for people on the bottom and for young workers to move up. Change and ferment provide an opening and an opportunity, give purpose to the people just starting out, and provide them with a reason to participate.

Appendix to Chapter 3: The Arithmetic of Baby Boomer Retirement

There's tremendous debate about the possibility of a demographic calamity in the U.S. when the baby boomer generation retires. However, the arithmetic of retirement changes dramatically depending on whether the U.S. experiences cautious or exuberant growth over the next three decades. Here are the simple demographic facts first. Over the next 30 years, according to the U.S. Census Bureau, the population in the U.S. will increase by roughly 27 percent. But the prime-age working population, ages 25–64, will increase only 12 percent. That means each worker has to become 13 percent more productive just to maintain a constant perperson income for everyone -- workers, retirees, children (see Table 2 for calculations).

Historical patterns indicate that a cautious-growth economy will generate productivity growth of only 1.1 percent per year, or only a 39 percent increase for the whole 30-year period. If 13 percent is already committed to compensate for the increase in the non-working population, that doesn't leave much for everyone and everything else.

In this scenario, per-person income would only rise at an annual rate of 0.7 percent over the next 30 years. That's compared to the long-term average annual gain of 2.1 percent. With cautious growth, the demographic drag would absorb a large portion of the productivity gains. The children of the middle class would do no better than their parents. And the generational wars would be horrendous.

These are the simple facts for an economy with cautious growth. No matter what kind of fancy private or public financing we whip up for Social Security, no matter how we try to reform the medical care system -- with a single payer model or complete privatization -- it's a recipe for political and technological disaster. There simply aren't enough resources.

By contrast, exuberant growth, powered by technological changes, makes the interlocked problems much more manageable. Over the 30-year period, productivity per worker goes up by about 92 percent. It then becomes possible to pay for the baby boomer retirement and rising medical costs, and still have plenty left over.

Table 2: Two Scenarios for the Next 30 Years

  % Increase, 2005-2035
  Cautious Growth Exuberant Growth
Total population 27 27
Prime-age working population 12 12
Rise in productivity needed to keep per-person income constant 13 13
Total rise in productivity 39 92
Amount available for higher per-person income 23 71
Annual increase in per-person income 0.7 1.8

The foregoing is excerpted from Rational Exuberance: Silencing the Enemies of Growth and Why the Future Is Better Than You Think

, by Michael Mandel. All rights reserved. No part of this book may be used or reproduced without written permission from HarperCollins Publishers, 10 East 53rd Street, New York, NY 10022

Imprint: HarperBusiness; ISBN: 0060580496; On Sale: 05/11/2004; Format: Hardcover; Trimsize: 6 x 9; Pages: 224; $24.95; $38.95 (CAN)

Mike Mandell is Chief Economist at BusinessWeek, responsible for formulating BusinessWeek's coverage of economic policy. Prior to this, he was economics editor and played a key role in defining and popularizing the notion of the New Economy. In 1998, Mandel won the Gerald R. Loeb Award, the most prestigious prize in business and financial journalism, for his coverage of the New Economy.

Mandel's most recent book, The Coming Internet Depression (Basic Books), came out in September, 2000, and predicted the end of the tech-driven boom of the 1990s. His 1996 book, The High Risk Society, (Times Business/Random House) foreshadowed the New Economy by arguing that the coming decade would be marked by a combination of high growth and high volatility.

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