The Slow Growth Mystery: Can We Cure the Cancer?

In 1990 Stanford economist Paul Krugman wrote a superb primer on U.S. economic policymaking in the 1990s that he called The Age of Diminished Expectations. In it he argued that the most important problem facing the United States was a slowdown in long-term economic growth. As usual Krugman got his economics right. But his description of the mood of America in the 1990s was wrong. Instead of bringing their expectations into line with the economy's lower productive potential, Americans have been in continual denial, lashing out at foreign competition, immigrants, the poor, minorities, declining values, and above all, big government as the source of their problems.

In The End of Affluence, Jeffrey Madrick follows in Krugman's footsteps with a lucid, well-documented portrayal of America's economic plight. Madrick's central thesis is that America has entered a new era of slow growth that requires a radical change in mindset. While his message is not original, it certainly warrants repetition, since so few Americans have taken the implications of slow growth to heart, and no one has yet come up with a complete explanation for why it has happened and a full prescription for what should be done about it. Madrick's book is interesting chiefly for its description of the disease. But his analysis of the disease's origins is faulty, and his prescriptions are weak.

THE TWO-PERCENT DISSOLUTION

For over a century after the Civil War, the U.S. economy grew at a yearly rate of 3.4 percent. For the past two decades, by contrast, the pace has been almost a full percentage point slower. For over a century, growth was driven by output per worker that was rising two percent annually, enabling real wages to grow at a similar rate. This "two-percent solution" was the key to the American Dream. The miracle of compound interest resulted in wages that doubled every 35 years, and so, for over a century, each generation lived twice as well as its predecessor.

As Madrick notes, the achievement of the dream not only brought prosperity, it also shaped attitudes. It both reflected and reinforced Americans' optimistic, individualistic, self-reliant ideology. The achievement also shaped Americans' attitudes toward the poor. In an economy of opportunity, which rewards diligence and hard work, the belief went, those who fail have only themselves to blame. By contrast, in European economies with longer traditions of shared misery, solidarity with the less fortunate became more common.

But since the early 1970s, America has been rudely awakened from its dream. The pace of labor productivity growth has been cut by more than half. Between 1973 and 1994 the average growth in output per worker in the business sector was less than one percent, and reflecting this slow productivity growth, wage growth has slowed to a crawl. Had the long-run growth rate in real compensation of two percent per year been maintained since 1973, average compensation today would be higher by more than a third.

Moreover, the aggregate data disguised a second noteworthy development: growing inequality. Only families in the top fifth have experienced any income growth at all. Similarly, college-educated workers have been the beneficiaries of all the wage growth that has occurred; wages of workers with a high school education or less have declined outright.

Madrick does a convincing job of documenting these changes and drawing out some of their effects on policy. Had the economy grown just one percent per year faster over the past two decades, the recent feuds over health care and the budget would not have taken place. All Americans could easily have been provided health care. Given actual spending outlays, federal tax revenues would have been sufficient to cut the national debt in half. Or, had Americans chosen to, they could have had both more spending and tax cuts. Madrick also points out that despite these changes, the attitudes of earlier times prevail. Americans retain their optimism and, mercilessly rejecting politicians speaking of malaise, reward those proclaiming "morning in America." They see no reason to provide more help to the poor even in an environment with diminished opportunities. Indeed, they are taking steps to end welfare as we know it in an effort to foster attitudes of self-reliance.

FLEXIBLE RESPONSE

What explains the end of affluence? According to Madrick, the causes are technological change and international competition. The golden era of American growth was driven by mass production in a self-sufficient economy with large internal markets. The new era is based on flexible production methods in an economy with fragmented markets. Under the old system, sustained and predictable gains in productivity growth came from applying routinized mass production methods on an ever-increasing scale. This evolution provided a secure environment that supported large firms prepared to invest in capacity and hire unskilled workers for jobs that were stable and relatively well paid. In the new era, however, economies of scale are less important. The capacity to produce flexibly allows for increasing product and service differentiation. It provides opportunities for smaller firms to fill niche markets and reduces the competitive advantages of large firms.