Arnold Kling  

Not as Rich as We Think

PRINT
Kling Interviewed... Shorter Arthur Brooks...

Tyler Cowen writes,


This is the era of the rude economic awakening, and Greece is simply an extreme manifestation. The new European bailout plan is a denial of this truth rather than recognition of the new reality that a lot of countries, most of all Greece, aren't as rich as we used to think.

He has been riding this horse for quite some time. It is the sort of statement that resonates with non-economists' natural pessimism. That is, after a crash it is very tempting for people to believe that the previous prosperity was false. However, there is a good economic case for presuming that it is a recession that is an aberration, not prosperity. For example, a graph of long-term GDP growth shows a steady upward trend, to which we return even after severe recessions.

We still have the capacity to produce the output we produced in 2006. Therefore, to a first approximation, we should still be able to consume what we consumed in 2006.

Within economics, it is not so easy to come up with reasons why we are not as rich as we used to think we were--that is, reasons that what we produced and consumed in 2006 overstates what we can produce and consume going forward. At the moment, I can think of these possibilities:

1. Mismeasurement. For example, as Cowen points out, government's contribution to GDP is measured as the cost of the inputs employed rather than the value of the services produced. If costs are high relative to value, this means that national income is overstated and government consumption is in some sense unsustainable.

2. Capital consumption. We could enjoy a high standard of living at the expense of leaving a smaller legacy to future generations. The smaller legacy would consist of either less physical capital or a slower rate of technological innovation. The housing bubble gave us residential construction that, ex post, had low value at the margin compared with alternatives.

3. Failure of Ricardian Equivalence. That is, when the government runs a deficit, we act as if wealth had been created. People who own government bonds do not realize that their savings are going to be taxed or defaulted away.


Comments and Sharing





COMMENTS (16 to date)
Brent Buckner writes:

I think there's an argument that time-varying risk premia could be an additional factor, as could changing global relative scarcities.

I can easily believe that U.S. GDP in 2006 was 10% over what might in some odd way be thought of as "potential".

Rebecca Burlingame writes:

My husband's concern is that it is not possible for some manufacturing to return, in that factories need considerable upgrading. And more specifically, auto machining equipment which didn't get auctioned or purchased sits in salvage yards around the country, out in the elements slowly degrading with no roof overhead.

My concerns tie in with this as to local municipalities: do they realize their role in revitalizing economies? For as long as they try to achieve maximum taxation, businesses can not necessarily afford - for example - to put roofs over deteriorating equipment. The bar for entry into economic activity is high at most every point, and recognition of the need to lower the bar overall could go a long way toward money being utilizable again at local levels.

steve writes:

Should we be using 2006 for comparison, in the middle of a bubble? Should we use 2001, at the start of the bubble? How do we compare a non-bubble economy with a bubble economy?

Steve

EH writes:

My interpretation: the immense growth of wealth we owe to the breakthroughs in physics of the 19th (and early 20th) century is drying up, and the past century hasnt put much exciting things close on the horizon. The discovery of the quarck isnt going to do to the 21th century what the discovery of the electron did to the 20th.

Real growth of wealth and productivity is stagnant, or declining even, taking demographic into account. Yet all our economic intuitions and thinking accumulated over the past century, has been shaped by the background signal of steady wealth growth. Borrowing isnt nearly as fun if your real debt no longer shrinks as fast as you and your creditors were used to.

Reorganizing our finances to this new reality is going to be painfull in the short run, but I agree, there is no fundamental reason why we wouldnt be able to hold on to our earlier wealth, except for transient effects.

That said, all the expenditures pushed into the future as entitlements comines nastily with decling long term wealth growth. If you are under 40, dont count on the state to take care of you in old age. Ponzi schemes arnt very stable under anything but exponential growth.

MernaMoose writes:

EH,

My interpretation: the immense growth of wealth we owe to the breakthroughs in physics of the 19th (and early 20th) century is drying up, and the past century hasnt put much exciting things close on the horizon.

In terms of the advance of basic science -- maybe, perhaps you're right. But I think it's more along the lines of steady growth, as opposed to the big burst of break-throughs. Materials science for example, as well as automatic (or I should say autonomous) control systems and theory, are still moving along, and these are just topics I'm immediately familiar with. There are others.

Real growth of wealth and productivity is stagnant, or declining even, taking demographic into account.

This I definitely disagree with.

We are still seeing the benefits roll out, from the advent of computers. The computers themselves may not be any big deal anymore for the home user, or even at your place of work. But the "stuff", the electronic gadgets, sensors, actuators, etc etc, that we now have (and cheap!) today, are a spin-off of the fact that computer manufacturing processes are just part of the ho-hum industrial base. Plus you're seeing advances due to the fact that increasingly powerful CPUs, that are one or two generations old, are now so cheap that you can afford to integrate them into all kinds of things (refrigerators, washing machines, etc etc, just get out the old imagination and let it run wild).

Software is most definitely still progressing (because it's increasing productivity). But I mean software that's beyond the view of the average Joe on the Street.

Operating systems and standard office software are stagnant or (quite arguably) declining (in net value for each successive generation), yes. And I'm happy to say that people besides me (who's been saying this about this software niche for years now) are beginning to say the same thing. I'd say change on this front is now just a question of time.

But the software that enables us to bring new and better products to market, on much shorter time cycles, is most certainly still advancing, and at a very nice pace. Manufacturing processes and technologies to support the same, are also moving along nicely.

Man has been making things out of metals for at least 5,000 years, and our basic understanding of metals is pretty good today (compared to a century ago when the Titanic went down in good part due to a bad batch of iron). But polymers only became widely commercially available for less than a century now. We have been, and still are, learning about them steadily, and will be able to do more things with them as time goes on.


Medical technology will very likely explode in the 21st century (if we can keep the socialists out of out way). This is possible entirely because of the combined advances in computers and materials science and technology. Not to mention "little" things like lasers, which have always had huge potential uses but they were always too expensive, too big and bulky, too complex to use -- and yet, advances in electronics and materials are changing that so lasers are still getting cheaper and better all the time.


I have the definite impression that non-scientist and technology people, have no real grasp of what computers have done for us. Sure, people laid down the foundations of the partial differential equations (PDEs) that govern, say 80% of the known universe, in the 19th and early 20th centuries. But do you know how limited our understanding of the implications of those equations has been -- due to the simple fact that we had so few solutions to those equations?

There are basically two ways to solve a PDE: hammer out a solution by hand (very hard, and very few exist), or do it numerically on a computer. Computers have opened up huge doors for us, and we've barely even gotten these doors more than cracked open.

We're steadily learning more, due to the simple fact that with computers we can explore solutions spaces that were impossible to get even a glimpse of 20 years ago.

This trend is not going away, and I don't see it slowing down either.

And btw I lead R&D teams for a living -- if you're one of those who believes today's young people are dumb, I beg to differ.

Don't be so glum. The threat isn't that we're running out of ideas, avenues for further advancements, or stagnating productivity.

The threat you should be most worried about lives in places like Washington, D.C.

Write me a thread where you're crying about that, and I'll be on board with you.

MernaMoose writes:

EH,

For what it's worth, there are fronts where I see obstacles. The two big ones that immediately jump out are high density energy sources and actuator technology.

High density energy sources -- I don't mean "ohmyGOD we're running out of oil" (I've yet to see clear evidence that we are). I mean, we need sources that pack far more energy into a given volume. This is a major limitation on building human sized robots today, just for example. Batteries don't pack much energy, even if you go to the emerging fuel cells. And on smaller robotic devices, even you went the direct fuel fired route, the amount of energy you can pack on board is still inadequate to let a device operate for significantly long periods of time.

We need a breakthrough here.

Actuators face the problem of limited power density, and this also restricts what we can do with robotics today. Again I don't see much for major advances on the horizon here.


But don't underestimate what's happening today with materials. The combination of 19th/20th century discoveries, and the advent of increasingly powerful computers, is opening up doors that it's hard for the layman to comprehend. When you start talking about the chemistry behind materials science, the "trade space" as we call it is HUGE. And so is the potential.

Our understanding of anything beyond crystalline metals is still so rudimentary.....take for example a "simple" binary metallic glass like electroless nickel. There is so much we don't yet understand about these "simple" materials.

But computational materials design is in its infancy. Combine it with a decade or two of experimental investigations, and people are going to be opening doors that we can't even imagine right now.

I wouldn't bet much money on the idea that the energy source or actuator problems are intractable. And while computers seem to be up against some thermal problems at the moment, I'd liken that to a recession -- it's temporary. We already know a lot about how to solve the thermal problems, it's just that the solutions aren't cheap and easy enough (yet).

EH writes:

We are still seeing the benefits roll out, from the advent of computers. The computers themselves may not be any big deal anymore for the home user, or even at your place of work. But the "stuff", the electronic gadgets, sensors, actuators, etc etc, that we now have (and cheap!) today, are a spin-off of the fact that computer manufacturing processes are just part of the ho-hum industrial base. Plus you're seeing advances due to the fact that increasingly powerful CPUs, that are one or two generations old, are now so cheap that you can afford to integrate them into all kinds of things (refrigerators, washing machines, etc etc, just get out the old imagination and let it run wild).

Question: how does putting a chip in a refridgerator have anything resembling the impact of, say, the refridgeration itself, a key component in freeing up the vast majority of our labor force from toiling in the field?

The segway is not the railroad, and the PDA is not the radio. Sure, handheld computing is awesome, and indeed, the computer revolution is still churning out real growth of wealth, but it just doesnt have the same profound implications as being able to coordinate economic activity across the globe.

Im not saying there isnt real growth of wealth happening out there. But 5% average per year, thats an historic anomality, judged over the millenia.

Medical technology will very likely explode in the 21st century (if we can keep the socialists out of out way). This is possible entirely because of the combined advances in computers and materials science and technology. Not to mention "little" things like lasers, which have always had huge potential uses but they were always too expensive, too big and bulky, too complex to use -- and yet, advances in electronics and materials are changing that so lasers are still getting cheaper and better all the time.

We failed there, didnt we? The only major power truely honoring its patent law is now going the way of the price control. Glad im not working in the field.

Either way, there is indeed some revolutionary stuff to be expected on the horizon. Biotech, cheap and functional robotics, halfway intelligent AI. But they are all like fusion research: chronically overestimated. Im not expecting anything big (functional, affordable, more than just a toy) from either of those for 30 years or so.

I have the definite impression that non-scientist and technology people, have no real grasp of what computers have done for us. Sure, people laid down the foundations of the partial differential equations (PDEs) that govern, say 80% of the known universe, in the 19th and early 20th centuries. But do you know how limited our understanding of the implications of those equations has been -- due to the simple fact that we had so few solutions to those equations?

Preaching to the choir here; computational physics is my baby. Fully simulating a cell, and truely intelligently designing pharmaceuticals would be really cool for instance. But yeah, have some patience.

I dont disagree that things are happening, but they seem more and more marginal compared to the truely big things that have driven the past century. That, plus demographics, is going to require a lot of re-rationalization (of the usual bad and backwards kind) in the abysmal science. Rationalizing sillyness like deficit spending yourself out of a recession by digging ditches might require more cognetive dissonance than most people are capable of when technological advancement no longer outpaces the growth of political arrogance.

And btw I lead R&D teams for a living -- if you're one of those who believes today's young people are dumb, I beg to differ.

Thanks, I dont think of myself as dumb.

Don't be so glum. The threat isn't that we're running out of ideas, avenues for further advancements, or stagnating productivity.

The threat you should be most worried about lives in places like Washington, D.C.

Write me a thread where you're crying about that, and I'll be on board with you.

I think we are on the same team here.

fundamentalist writes:

Let's get back to basic econ. As I tell my classes, and this comes from the textbook, investment creates growth; consumption retards growth. Government is consumption, not investment, regardless of what politicians claim. Some of it is necessary consumption, just as eating and buying clothing is necessary consumption. But most government spending is not. We have been consuming far more than we invest, and consuming a great deal of capital (past investment) in the process.

In addition, inflationary policies, even mild 3% inflation, makes it difficult for businesses to replace worn-out equipment and other capital because they pay high taxes on inflated profits, which leaves less money to invest, and inflation makes replacement costs much higher than depreciation contributes.

Socialists refuse to accept basic economics because they believe in abundance, not scarcity. They believe there is always an abundance of capital and goods and the only reason people don't invest or don't share the abundance is their selfishness. Therefore the state must take wealth away from the selfish and share it with the rest of us. Their answer to declining growth is for the state to take more from the wealthy and share it with the rest of us. And if they were right in their assumption of abundance, their policy prescriptions would be exactly what we need.

Floccina writes:

Yes the "Not as Rich as We Think" statement leaves me wondering what he is saying. We could then consume what we produces and not much more.

MicroNomics writes:

Another possibility is that we have had wealth inflation but not monetary inflation (as usually measured).

I am not an economist, so please correct me if I get some things wrong.

The thought comes from a discussion between Hernando de Soto, Naomi Klein, and Joseph Stiglitz. What was interesting was de Soto's analysis: the new financial instruments prevented buyers and sellers from really knowing who owned what (except for the home owner -- they owned their debt).

Now, allow home buyers to mortgage a house with no or little down payment and have these mortgages bundled and sold to buyers who were also highly leveraged, you have a situation where the value of the currency, i.e. the securities, swaps, etc., was worth much less than its face value. In other words, the Fed did not print money, Freddy, Fanny and the banks did it for them. Thus, we thought we had more wealth than we actually had.

floccina writes:
inflationary policies, even mild 3% inflation, makes it difficult for businesses to replace worn-out equipment and other capital because they pay high taxes on inflated profits

Are you forgetting about the depreciation expense. That you do not pay taxes on the money you uses to replace worn-out equipment because depreciation is an expense.

Timothy Taylor writes:

One main way in which our economies aren't as rich as many people thought has to do with expectations about the standard of living that most people will experience late in life. Europe isn't rich enough to have a huge share of its workforce retire before age 60--Greece is just an extreme example. The U.S. isn't rich enough to afford its current promises about Medicare, or about a number of public and private DB pension plans. High-income countries been pretending that we're rich enough to afford the promises that have been made about retirement, but we're not.

Rick writes:

What if instead of the equation looking like this:

GDP = C + Inv + G + (ex – im)

It looked like this:

GDP = C + Inv - G + (ex – im)

fundamentalist writes:

floccina: "Are you forgetting about the depreciation expense."

As I wrote above "...and inflation makes replacement costs much higher than depreciation contributes." Businesses don't pay taxes on profits protected by depreciation expenses, that's true. But depreciation is based on historical costs. After ten years of depreciation, new equipment will cost about twice as much as the old, depreciated equipment, so depreciation doesn't cover replacement costs.

micronomics: "In other words, the Fed did not print money, Freddy, Fanny and the banks did it for them. Thus, we thought we had more wealth than we actually had.'

Technically, that's what always happens. The Feds make loans to banks very cheap so that banks have more to loan out. The Fed "prints" money through the banks by enabling banks to expand credit. Had the Fed raised interest rates sooner, banks would have been much less inclined to lend so much on housing.

What mainstream economists are absolutely the worst at is analyzing the economy with a fixed money supply. If the money stock is fixed, that is not growing at all, then an increase in housing prices would make it necessary for other prices in the economy to fall by the exact same amount, and that would pop any bubble before it got started. Also, high demand for housing would cause interest rates to rise dramatically in an economy with a fixed money stock. The only way all prices can rise at the same time, and mortgage rates fall while demand remains high, is if the money stock is growing rapidly.

fundamentalist writes:

Rick, That's how it should look. The private sector creates wealth and jobs. The state sector does not. We care most about how well the private sector is doing. If GDP = G and nothing else, then GDP could be high but we would become much poorer much faster.

MernaMoose writes:

EH,

I think we are on the same team here.

Okay, maybe I misunderstood your drift.

Anyway, I still think chemistry for one field, is standing on something akin to the discovery of the Americas, and the 13 colonies aren't even established yet. No, we haven't discovered any new continents lately. But we've got a lot to do in exploring the ones we've only recently found (historically speaking).

Comments for this entry have been closed
Return to top