The Bear’s Lair: The secular stagnation that wasn’t

Rarely can two economists of such eminence have been made to look foolish so quickly. In 2015, Robert J. Gordon wrote a book proclaiming that the lousy productivity growth that we had seen in recent years was the best we could expect, and in January 2016 Paul Krugman reviewed it enthusiastically in the New York Times. Within two years, it is becoming increasingly clear: productivity is rebounding to historic levels, its malaise having been due to the misguided economic policies Krugman and Gordon favored, and its recovery at least partly due to the policies of a President both men regard with unmitigated and unprecedented loathing. Cheerful, hysterical laughter is the only possible response, together with an iron determination not to let either man near the levers of economic power again.

I reviewed Gordon’s original article in the National Bureau of Economic Research in 2012. Even at that stage, when the U.S. productivity malaise had only recently become acute, Gordon’s theory seemed to me unlikely to be correct. More resources were being devoted to research than at any previous time, and the pace of intellectual advance seemed likely to have been accelerated by the entry of Chinese and Indian researchers into the global conversation. It thus seemed very unlikely to me that the pace of innovation would have slowed to a crawl through natural means, and even less likely that the slowing would, as Gordon claimed, mark the beginning of a productivity growth dearth that would last for the rest of the 21st Century.

Over the next four years, the productivity growth malaise intensified, increasing the fashion for Gordon’s theory. With nearly a decade of feeble productivity growth behind us in 2016, it really did seem possible that the industrialized world had reached a state of sclerosis, in which further productivity gains would be minimal. Poorer countries would catch up, by adapting the techniques of the rich world, but the “frontier” of human achievement and living standards would remain static. Add to that an intensification of inequality, as Thomas Piketty postulated, and the future looked dreary indeed for all but the fortunate top 1%. Then, as Krugman noisily maintained, the only hope for human advancement would be ever more extravagant programs of government waste and income redistribution.

In 2015-16, this column fought back against this narrative. For one thing, it noticed that productivity growth had been appallingly low, even negative, in all the countries that had experimented with “stimulus” monetary policies in 2009-16. This suggested that the problem might well lie with negative real interest rates, which distorted capital allocation and thereby prevented productivity-enhancing investments. Such an effect would start fairly small, but would become more severe as the low-interest rate period was prolonged, and allocators of capital came to believe that the condition was permanent.

Second, this column pointed out repeatedly a problem in the United States after January 2009 and perpetually in the European Union: the prevalence of productivity-destroying regulations, especially in the environmental and “global warming” areas, where leftist activists had removed all semblance of rational decision-making from the regulators. U.S. productivity growth had taken a substantial long-term lurch downwards after the blizzard of new agencies set up in the early 1970s, notably the Environmental Protection Agency and the Occupational Safety and Health Administration. It seemed reasonable to suppose that under the aggressively regulating Obama administration productivity growth would have been dinged again.

Only the similar productivity malaise in other “funny money” countries suggested that regulatory excess was not solely to blame. However, the global warming nonsense got into high gear around 2007, producing an especially toxic miasma of market-blocking regulation and mindless subsidy that was imposed more or less worldwide. Thus, the precise division of blame between regulation and monetary policy for the appalling economic performance of 2011-16 was unclear. Contrary to Gordon and Krugman’s belief, though, there was a very good a priori case that their favored policies were between them responsible for the unprecedented problem.

When there is this kind of dispute, a controlled experiment is needed. And lo and behold, we got one! The U.S. electorate in its infinite wisdom elected Donald Trump, a candidate both personally and politically anathema to the “secular stagnation” team. Krugman went so far as to predict on election night that the stock market would collapse under President Trump. Certainly, based on Krugman’s stated economic beliefs, that is what should have happened. If existing economic policies were not to blame, and Trump was indeed a boorish incompetent, there should have been no reason to expect a recovery in economic growth, nor in productivity growth, and every prospect of a major recession, since it had been almost a decade since the last one.

On monetary policy, the current controlled experiment has a certain messiness. Janet Yellen had made one interest rate increase before Trump was elected, then made four more between December 2016 and December 2017. This was a sudden acceleration in monetary tightening, which Keynesians such as Yellen herself would have expected to be highly negative for economic activity. However, the interest rates reached at the end of 2017 were still well below an appropriate market level, with the 10-year Treasury bond rate still below market expectations of inflation. In other words, while monetary policy had been substantially improved, the money market is still artificially distorted, if less so, and interest rates are still not at an appropriate level, given the position in the economic cycle, let alone the grotesquely overvalued U.S. stock market.

This may change if Trump’s new Fed Chairman Jerome Powell moves in a different direction, but the market is not anticipating a change, and Powell has given every indication of continuity with the Yellen regime. In the short-term therefore, monetary policy will remain too weak and asset prices too inflated. In the longer term, there is a greater danger in the next downturn — Powell may repeat the Bernanke/Yellen recipe of zero or even negative interest rates and massive asset purchases. Should that occur, the distortions in the U.S. economy may well become sufficient to cause a death spiral, in which productivity shrinks rapidly and economic activity uncontrollably declines.

On regulation, however, the lesson of the last year is crystal clear. Trump has not even deregulated much, he has merely stopped adding to the mountains of regulation, yet productivity growth for the first two complete quarters of Trump’s administration averaged a healthy 2.3% annually and there is every sign that the quarter just ended will produce a further strong figure. In other words, three quarters of better regulatory policy and modestly better monetary policy have seen a recovery in productivity growth at least to its 1973-2010 average level. We may have some chance of a further recovery to pre-1973 levels if President Trump’s corporate tax changes work as advertised.

A productivity problem which solves itself within three quarters of a new regime of better policy being instituted is hardly “secular stagnation.” The problem was clearly caused by fatuous Keynesian socialism imposed by the governing class under President Obama. If the problem has indeed been solved, we can expect to see some productivity “catch-up” in the next few years, with any downturn in the economy being short-lived and mild and growth thereafter being exceptionally strong.

If we are allowed to enjoy a U.S. economy run on a free-market basis I have every confidence that the rate of new business formation will rebound, and that innovation will once again be spread through the economy rather than concentrated artificially among venture-capital funded hothouse blooms in Silicon Valley. (Leslie Hook of the FT had a very nice piece this week pointing out that the Silicon Valley nerds are a bunch of overpaid dumb-luck bureaucrats, and nothing like real entrepreneurs, who are red-blooded, risk-taking and Republican!) We need only think of artificial intelligence, self-driving cars, life extension and genetic engineering to perceive the potential to enjoy a third (or fourth, depending on how you count) Industrial Revolution that will dwarf its predecessors.

Regrettably we may not be destined to experience such joys. The electorate, which made at best an extremely tentative decision to trust Donald Trump, is now showing signs of regretting its decision and seeking to reverse it at the earliest possible date, electing Keynesian socialists whenever it gets the chance. The likely recession caused by over-inflation of asset values could further muddy the picture.

If the Keynesians are permitted to return in 2018 and 2020, the gloom of zero productivity growth, funny money, manic regulation and secular decline will once again settle over the United States. Professors Gordon and Krugman will be proved right, after all. But at what a cost to humanity!

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)