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Monday, June 21, 2004

ECONOMIC DEVELOPMENT: WHAT EXPLAINS THE ONGOING US LEAD IN INNOVATION? 5th in a Series

This, the 5th article in the mini-series on economic development, resumes the argument where it was left dangling at the end of previous article. Its theme: why convergence theory --- which postulates that follower countries with good human skills, good institutions, and good economic policies should eventually close the gap in per capita income and productivity with the lead countries --- is generally sound except in one instance: where the gap relates to the US. This is a big problem that has to be explained. The various convergence mechanisms entail, after all, a prediction of such catch-up growth; and yet the US has remained the lead country for over 120 years now . . . something that shouldn't occur if convergence theory is sound.

As things now are shaping up, please note, there will probably be a need for 3 or 4 more articles in this series on development. In the meantime, shift your attention now to the current argument. Its first two parts will unfold here in this 5th article; the next two parts will figure in the 6th article of the series. Why two articles. Dividing the argument this way seems to be a good simplifying device, a way to keep your attention jogging along at a comfortable pace; nothing more profound anyway.


PART ONE:
INTRODUCTORY COMMENTS: THE US FORGES AHEAD AGAIN


In more concrete terms, the need for an explanation of the ongoing US lead, now 120 years old, is all the greater because Germany and Japan --- the two other major capitalist countries in the world --- had closed the gap with the US in per capita income to around 90% by the end of the 1980s . . . exactly as convergence catch-up growth had predicted. The closer they came to that 90% level, the more droves of observers --- European, Japanese, even American --- talked about US decline, relative or even in some instances absolute. Absolute decline: was that possible? Yes, to judge by the rhetoric of the day anyway. Recall the presidential campaign of 1992 here. The present generation of Americans, it was repeatedly said in that campaign, might be the last to enjoy a living standard better than that of their parents.

The Reality?

Even in 1992, such rhetoric was thoroughly misguided. Since then, we know that even talk about relative US decline has turned out to be wrongheaded, a topsy-turvy form of hot air.

Consider the evidence in the following table and diagram. The table is the buggy prof's: note that per capita income is estimated through 2004 (based on OECD projections for the last six months of the year); all other figures are for the start of 2004. The diagram is from IMD, a prominent Swiss Business School that, for years now, has annually ranked dozens of countries in terms of their overall competitiveness, and on four composite sets of quantitative measures: economic performance, government effectiveness, business effectiveness (including labor markets), and infrastructure quality. Generally, it and the World Economic Forum --- another Swiss-based institute (with links to Harvard) --- put out the best overall rankings of comparative economic performance . . . including prospects for the future.



Untitled Document
  Population in Millions GDP PPP$ $Billions % of World GDP GDP per capita PPP 2004 Est. Defense Spending $Billions Defense Spending % of GDP
World 6300 $50,000 ------- $7, 900 $900 1.8%
USA 280 11,200 22.0% $39, 400 $390 3.8%
EU-15 380 9,900 19.0% 26, 300 140 1.4%
Germany 80 2,300 4.5% 27, 200 38 1.4%
France 60 1, 800 4.0% 27, 900 45 2.5%
Britain 60 1, 900 4.0% 28, 100 32 1.7%
Russia 140 1,400 2.5% 9,400 55 4.5%
Japan 129 3, 700 7.0% 28, 700 45 1.2%
China 1200 7100 14,.0% 6,000 100 1.4%
Sources: OECD, EU, The Economist, CIA WorldFactbook

Here's the IMD rankings: to save space, only the first half of the 60 countries evaluated are found in the diagram. Note how large the US lead is over the 2nd, 3rd, and 4th countries. Note too that Germany --- ranked 20th last year --- is now in 21st place; the UK is ranked just behind it, 22nd place; and Japan is ranked 23rd.

PART TWO:
WHY DID THE RHETORIC OF DECLINE TAKE SUCH A HUMPTY-DUMPTY DIVE IN THE 1990s?


There are two answers, both arriving at the same conclusion. A fairly simple, straightforward explanation will figure in this section. The deeper explanatory endeavor will unfold later in Parts Three and Four of the argument (found in the next article in this series): it will look at and analyze the prevalent forms of capitalism in the industrial world --- the Anglo-American, the EU welfare-state, and the East Asian (Japanese-inspired) --- in a key comparative respect: their ability to innovate bold, radically restructuring technologies of the kind that alter the basic techo-economic structure and institutions of a country when they materialize. Tersely put, each one of these distinguishable capitalist models entails a specific kind of national-innovation system --- with of course variations across specific countries in each model --- and for 120 years now, the US has been by far the most dynamic and innovative here.
 

A Quick Clarification of Terms

Note that the key term we'll be using in Parts Three and Four is innovation-system, not overall economic well-being.

The latter is largely subjective. If, for instance, West Europeans prefer more leisure over work than Americans, then that is the kind of economies they enjoy: in the process, they may sacrifice about 30 -35% of disposable income that Americans earn, but they also work on an average about 250-300 hours a year less . . . in the German case, almost 400 hours less! Of course, there are always trade-offs. The regulations, fairly high minimum wages, and high taxes in the EU may entail more vacations and holidays for the West European populations, but they also entail a much higher level of long-term structural unemployment than in the US . . . roughly two to three times higher, and on an average for both short- and long-term about twice as high. That's been the case for over two decades now in the EU. And the long-term unemployment is especially acute among young West Europeans looking for a career job, and among the immigrant minorities.

The trade-offs for US workers? If disposable household income is much higher in the US than in the EU by about a third, Americans also work much longer and --- as most observers who've lived in the US and West Europe would probably agree --- much harder. As in the rest of the English-speaking countries that use the Anglo-American form of capitalism, moreover, wage inequality is higher here too on a post-tax and post-transfer payment basis. (Transfer payments refer to unemployment insurance, welfare subsidies, and government paid social security.)

Specifically, with the Scandinavian countries and Holland ranking highest in income equality, the US comes in 41st, Britain 63rd, and Australia 74th. See
this link for the stats. All three countries, plus New Zealand, have purposefully cut taxes, welfare payments, and regulations the last two decades, in order to achieve more economic dynamism and job-creation. As a general thing, they've achieved it. Britain --- whose per capita income was about 10% lower than that of France or Germany in 1980 --- now enjoys about a 7-10% lead over them, and its unemployment is roughly half that of those two countries. Australia, which had looked like something of an economic basket-case by the early 1980s, is now ranked by the IMD as the 4th most competitive country in the world. New Zealand, whose economic performance has also improved notably since it scrapped its huge welfare-state and regulatory-system in the 1980s, is ranked 18th. Canada, ranked no. 3 in the IMD poll, has expanded its welfare-state system over the last three decades, but even so, it too has experienced a noticeable increase in income-inequality in the process as it seeks to recover its economic flexibility and dynamism.



Another Rapid-Fire Clarifying Remark Or Two: Measuring income-inequality, both within and across countries, isn't as straightforward as it seems on the face of it.

(i.) For instance, the statistics in the previous paragraph refer to the income-gap across households within the US, the UK, Australia, etc., then are compared with the income-gap across households in other countries. But households may be misleading as a demographic basis. Why not count individuals? After all, the bottom 20% of US households in income have only 13% of the population; the top 20% households have about 27% of the population. The top income-earning households, as it happens, also have two to three times as many active workers as the poorest households. The average worker in that category also logs in far more hours a week on his or her job.

When, for example, African-American households contain a two-parent family, their earnings are almost identical to those of white Americans. By contrast, when there is only one parent in a household with children --- almost always a single-mother --- the earning level drops to about 60% of the white average. (For what it's worth, good studies in the early and mid-1990s found that for every 10% increase in welfare, there was an 11% increase in illegitimacy. It's findings like these, plus the clear correlation between single-parent families and children who have emotional troubles, do badly in school, and turn eventually to crime as they grow into adulthood, that led to the bipartisan reform of welfare for families with dependent children in the late 1990s.)

(ii.) Then, too, what do you do with in-kind (non-cash) payments that the US welfare-system tends to use more than that of other industrial democracies: for instance, food-stamps and direct rent-subsidies in place of monetary income transferred by the government? If the poverty level in the US --- a flexible estimate, which changes over time as the level does in other countries --- is around 12% of the population in money-terms, it falls considerably if in-kind subsidies are included.

(iii.) Another uneven influence across countries intrudes too: immigration.

Though it has been high in the EU and Canada for the last two decades, it has been at a near-record level in the US. More specifically, since the immigration law was changed in 1965, about 40 million legal immigrations have streamed into the US: most, though hardly all, are low-income earners. The federal government also estimates there are about 8-12 million illegal immigrants here, most of them apparently holding low-wage jobs. To be more precise, immigrants are 60% more likely to be in low-skilled jobs than native-born Americans. The result? A huge increase in the supply of workers competing for low-wage jobs is bound to keep the wages in the bottom quintile of American households from rising much over that period . . . though, interestingly, when unemployment dipped below 5.0% in the US economy in the late 1990s --- for the first time since the late 1960s --- the wages of the bottom 20% of workers rose faster than that of the top 20%.

This, by the way, isn't an argument against immigration --- not the legal sort anyway. Most of us would agree that our country benefits from it. Illegal immigration, by contrast, ought to be stopped, and it would stop provided American businesses and well-to-do families restrained from hiring cheap labor, Democrats stopped chasing votes, and Congress and the Executive --- at a time when border controls are especially important for security reasons --- got serious about enforcing existing laws. (The best work on the effects of low-skilled immigration on US wages, at any rate in low-skilled occupations, is by George Borjas of Harvard. For his latest article, go here.)

(iv.) Then there's the problem of the underground economy. Lots of low-income households on welfare, it appears, have other forms of income that isn't reported to the tax authorities. How do we know? When the Census Bureau does random surveys every year of typical households, it finds that the bottom quintile in income actually spends about 40-50% more on consumption than it reports in income earnings. It's true that the underground economy --- tax-evaded income, however earned --- would also inflate the earnings of other quintiles, but then, at any rate in the US, the underground economy is much smaller than in the EU: roughly 7-8% of official GDP here, as opposed to 15-20% there.

(v.) Finally, several studies --- academic in nature --- have found noticeable upward mobility in the US economy, so that most people who are in the bottom 20% quintile in one year aren't there the next two or three years. (For the sources, go to this link.)

  • "A 1992 Treasury Department study showed that between 1979 and 1988, 86 percent of those in the bottom income quintile moved to a higher quintile, and 35 percent in the top income quintile moved to a lower quintile.


  • "A 1995 Federal Reserve Bank of Dallas report showed that almost three-fourths of those in the bottom quintile in 1975 were in a higher quintile by 1991, and almost 40 percent in the top quintile moved down to a lower quintile over the same period.


  • "A 1996 Urban Institute study showed that large numbers of Americans move into a new income quintile, with estimates ranging from 25 percent to 40 percent in a single year. The same study found even higher mobility rates over longer periods: about 45 percent over five years and 60 percent over 9-year and 17-year periods.


  • "In 1998, the Census Bureau reported that, on average, over 41 percent of Americans increased their inflation-adjusted income by 5 percent or more per year from 1984 to 1994. The primary reasons for changes in income from year to year were changes in marital status, changes in the number of workers in the household, and moving into or out of full-time, year-round employment.


  • "A 2000 Economic Policy Institute study showed that almost 60 percent of Americans in the lowest income quintile in 1969 were in a higher quintile in 1996, and over 61 percent in the highest income quintile had moved down into a lower income quintile during the same period. "








Why the US Has Reasserted and Increased Its Lead In Innovation and Per Capita
Income: The Simpler Explanation


For the time being, fix your attention on a more modest answer as to why the US --- far from suffering a relative decline --- has once more pulled way ahead of its economic rivals. Fortunately, the more modest comments that follow will be good preparatory steps for the more profound explanatory endeavor in Parts Three and Four. A duo of straightforward points constitute the simpler explanation:

 



For one thing, The economies of Germany and Japan have both staggered over the last 13 years or so. Japan has compiled the worst growth record of any industrial country since the era of the Great Depression, its economy rising by less than 1.0% a year since 1991; industrial productivity by the end of the 1990s had actually fallen further than it had in the US during the 1930s. Germany's growth record hasn't been much better. It has slipped in and out of recession now for nearly four years, stuck --- like the Japanese --- with tiny mountains everywhere of market rigidities and other inefficiencies; in the process, since 1991, it has been the slowest growing economy in the EU. the US --- reinvigorating its economy by trailblazing a way to a new form of capitalist development, the knowledge-based economic system --- has pulled ahead again, increasing its lead over its front-running rivals in the EU and Asian Pacific to a point not seen since the mid-1960s.

For another thing, the US --- as we could tell by the end of the 1990s --- has managed to reinvigorate its economy once more, just as it had done repeatedly in the 19th and 20th centuries, and mainly by means of pioneering breakthrough technologies of a radically restructuring sort that change the ways in which we work and live . . . not to mention the distribution of global power. In particular, American firms, workers, and researchers have managed to trail-blaze what appears to be a new form of capitalist development: the knowledge-based information economy, AKA the New Economy.

Until then, convergence catch-up growth did apply to the US. In particular, for about three to four decades --- roughly from the early 1950s on --- its growth rate in per capita income and labor productivity had lagged behind that of the EU countries and Japan for a good three to four decades from 1950 on. That is exactly what should have happened in catch-up growth. All that changed in the most recent wave of breakthrough innovations that the US pioneered starting in the late 1970s and early 1980s, with the leap ahead in US productivity taking several years --- roughly starting in 1996 ---to materialize because of the need for US firms and workers to learn how to use these new innovations with skill.

 

The New Wave of Revolutionary Technologies

No surprise by now what these new radically restructuring general purpose technologies --- to use the current economics term --- are: first and foremost information-and-communication technologies (ICT) then bio-tech . . . with huge breakthroughs in nanotechnology (working with materials at their molecular level) looming just on the horizon. UCSB and UCLA, together with private firms, have recently set up a joint project of R&D worth $500 million to hasten the marketability of these nanotech innovations. There are other similar projects elsewhere in the country. Already, too, looming on the same breakthrough-horizon, we can glimpse a radical shift in energy systems: in particular, away from carbon-based sources and toward more environmentally sound ones of a high-tech nature: hydrogen-based, solar-based, and maybe --- who knows? --- a more benign form of fusion-formed nuclear energy.

If past experience with previous long-wave quantum-leaps in technological breakthroughs is anything to go on, then we are only about half-way through the current innovation cycle. That means that innovation should be slowing down in this decade, at any rate if the past is a good guide here. And that means, sooner or later, that the huge new US lead in per capita income --- which we'll document in detail in the next part of this article --- will be eroded again by follower countries with impressive institutions, good policies, and high-quality human skills.



 

But Note: Will Past Experience Prove True Again?

Maybe; but not necessarily.

Look more deeply, for a start, at the previous waves of revolutionary technologies from the 1770s until the start of the 1980s. Four such waves can be distinguished:



  • in textile and iron in the first long-wave, 1770-1830s;


  • or in steel, steam ships, and railways in the second long wave, 1830s-1880s;


  • or in electrification, the internal combustion engine, chemicals, mass production techniques (assembly line production) and new credit facilities in the third wave, 1880s-1930s;


  • or synthetics, airplane travel, mass tourism, and the mass media (radio, movies, TV, VCRs) in the fourth wave, 1930s-1980




In each of these earlier waves of breakthrough innovation, what happened in the new manufacturing and service industries followed a clear pattern, at any rate in the lead country where they first appeared: sooner or later, roughly half-way through each 50-60 year cycle, the pace of innovation would slacken markedly, the production processes would be standardized more and more, and capital investments would entail diminishing returns. The slow-down, to repeat, would appear first in the innovating pioneer country --- the British (and French) initially in the first two waves, the US in the latter two after 1880. It was then that follower countries, which had been busy importing and adapting the radically new technologies in their own economies, would generally engage in catch-up growth.

There were some exceptions, particularly for countries --- say, Germany after 1870 when it was united or Japan in the same era when it underwent the Meiji Revolution, or again Japan and Germany after WWII --- that either launched themselves for the first time on a path of sustained economic development or, as after WWII, had such ruined economies that their reconstruction would invariably hasten the pace of GDP growth, not to mention leave their firms with far newer manufacturing plants and machines. (Korea and Taiwan fit this pattern starting in the 1960s too.) As a general thing, though, most catch-up growth unfolded in the latter decades of the waning innovation cycle, in the third or fourth decade.

 

Can We Be More Specific Why Catch-Up Growth Went On?

Sure. To begin with, as innovation faded in the trailblazing lead country, and standardized production overtook the new, most promising industries that it had created, the more dynamic follower countries that were importing and adapting the new technologies --- like Germany, other West European countries, or Japan: more recently South Korea or Taiwan or Singapore or Hong Kong --- could tap their own country-specific strengths. In both East Asia and the EU, the rapidly growing countries there enjoyed 1) disciplined work forces, 2) impressive engineering skills, 3) high levels of investment, and 4) good institutions and policies suitable for exploiting these strengths. As one result, they tended about half-way through each long-wave cycle of innovation to improve, incrementally, on the production processes in the new industries. As another result, lower wages in the follower countries would combine with the incremental improvements in productivity to result in lower overall costs of production. There was usually a third resulting improvement too. In the follower countries with the best engineering skills, their lead firms would frequently find ways to improve on the quality of the end products, much to the benefit of consumers in their home countries.

What happened then followed another clear pattern. The lower-cost, better quality products in the more dynamic follower countries would begin to outpace the exports of the lead country in third market countries. Not long afterward, they would then export increasingly to the home market of the lead country in the very same industries.

Think here of Japanese cars, TVs, VCRs, and cameras; or Korean steel, shipbuilding, and DRAM chips; or German machine tools and luxury cars; or Taiwanese advanced electronics components. The result? Instead of their advances in per capita income and productivity slowing down markedly at the mid-point in a long-wave cycle of bold technological breakthroughs, their growth rates in both would tend to outpace those of the lead country . . . the US since 1880 or so.

 

The Globalization of Production Is Another Name For This Process

Nor was that all. The lead country's giant firms --- again, focus on the US -- were busy locating some production abroad in these dynamic follower countries, fueling the rhetoric --- now appearing again, oddly, in the form of worry about outsourcing jobs--- that American workers were losing their edge and headed for mass structural unemployment. Hard as it is to believe, the loose hot-air about American decline was actually sounded by Bob Dole, the Republican candidate for the presidency, as late as 1996: we were, he said, in the worst economy in modern history! More bizarrely still, the doom-doom rhetoric persists even now.

In particular, to believe the near-hysterical buzzsaw talk of Lou Dobbs --- the influential news commentator and financial analyst on CNN nightly who has been obsessing on this topic nightly for 8 months now --- most good ICT jobs for Americans will soon be in the hands of foreigners.

The reality? Most outsourcing by US firms has been to other US firms. So far, in the last 3 years of struggles with job creation --- now being rapidly reversed as GDP growth soars ahead --- the Labor Dept. finds that exactly 4300+ jobs have been lost in ICT to foreigners, mostly low-skilled ones. Oppositely, there will be a need --- according to the Bureau of Labor Statistics' report just issued last week --- for hundreds of thousands of new computer and knowledge-based workers with the most advanced skills over the next 8 years.

Specifically, the BLS estimates that jobs --- whose average salary is found in parenthesis for 2002 --- will rise in these three categories, where the Lou Dobbs rhetoric, now sounded by others, fears only losses:

Computer and information scientists ($80,510), will be up 29.9 percent. Computer software engineers-systems software ($75,840), up 45.5 percent. Computer systems analysts ($64,890), up 39.4 percent.

So much for the new up-to-date doomster rhetoric.

 

But Wait! Will History Repeat Even Itself?

In particular, will a knowledge-based information economy of the sort the US has pioneered experience the same slow-down in the pace of innovation that marked all the four previous waves of radically restructuring technologies?

THE ARGUMENT WILL BE CONTINUED TOMORROW IN THE NEXT ARTICLE IN THIS SERIES.