Crisis of Command
America’s Broken Civil-Military Relationship Imperils National Security
From Wall Street to K Street to Main Street, pessimism about the global economy has become commonplace. The world economy may have finally emerged from the financial crisis of 2008, but according to conventional wisdom, it remains fragile and unsteady, just one disruption away from yet another perilous downturn.
In October, the International Monetary Fund warned that a return to robust global growth remained “elusive.” Others are gloomier. Former U.S. Treasury Secretary Larry Summers has said that the world faces looming “secular stagnation”—a persistent period of low growth, low inflation, and low interest rates—as the developed countries remain caught in a deflationary trap, China struggles with an uncertain transition to a consumer economy, and the developing world reels from the collapse of commodity prices and the contraction of global credit. A rising chorus of voices is also warning of the dangers of income inequality, and no wonder: middle-class wages in the United States have been stagnant for more than three decades, while the wealth of the top one percent continues to rise.
GDP growth is no longer an especially useful way of measuring the health of modern economies.
Familiar as it is, however, this story is also fundamentally flawed. It depends on measurements of economic growth, such as GDP, that are ill suited for the modern digital age, and it ignores some crucial good news: the decrease in the cost of living across much of the world. Although global economic and political institutions tend to focus on maximizing GDP growth, a future in which economic growth remains low would not be nearly as bad as most people assume—provided that the cost of living also continues to fall.
This is more than just a problem of perspective. The view that growth is stagnating leads to a crisis mentality that makes policymakers adopt measures designed to boost growth: stimulus spending, tax cuts, investments in higher education. Some of these may be beneficial, but they can also crowd out other actions that may be more beneficial: investing in greater efficiency, developing a leaner bureaucracy, and, above all, establishing and securing a baseline minimum standard of living. A society that followed these steps would be better off in the long run.
Ever since the Great Depression, which coincided with the invention of measurements such as GDP, nearly everyone has considered growth to be the most important indicator of an economy’s health. Governments have risen and fallen according to their ability to maximize prosperity as measured by increases in output and income (which includes both wages and other sources of money, such as dividends).
Income, of course, is simply a means to obtain life’s necessities: food, clothing, shelter, health care, education, and leisure. Historically, rising incomes and wages have been closely connected with a rise in the quality of life. Last year’s Nobel laureate in economics, Angus Deaton, has written powerfully about this connection, showing that rising incomes have led to longer life spans, reduced societal violence, and greater personal fulfillment.
In theory, however, people can obtain all of life’s essentials by means other than income. Such was the promise of communism, for instance: that collective ownership of goods would translate into universal prosperity. Even though communism failed in practice, it remains true that expanding GDP is not the sole way to generate collective prosperity or well-being. In fact, even when incomes do rise, inflation, which increases the costs of goods and services, can undermine any resulting gains, as generations of Social Security recipients have discovered when their cost-of-living adjustments have failed to keep pace with their rising household expenditures. On the other hand, falling costs of vital goods and services can preserve or even enhance standards of living during a time of stagnant wages.
Despite these truths, the institutions that steer modern economies, and the measures they rely on, typically focus more on the income side of the economic ledger and neglect to consider costs. Both academic and government economists track cost-of-living indexes and purchasing power, but only secondarily to GDP, income, and inflation. Even the more astute chroniclers of economic growth, such as Deaton and his fellow Nobel Prize winner Amartya Sen, exhibit this bias.
During much of the twentieth century, the costs of goods and services rose as fast as wages—and often even faster. Today, however, costs are falling around the world. Since 2010, global inflation has mostly hovered around 3.5 percent, roughly equal to the rate of real global growth and significantly lower than the over five percent inflation rate experienced during the two decades preceding 2010. In the developed world, meanwhile, inflation has fallen even further, to below two percent.
Technology deserves most of the credit for this trend. True, automation may be eroding wages and threatening many forms of work; the McKinsey Global Institute recently estimated that robots could perform as much as 45 percent of all the tasks currently carried out by human workers, representing as much as $2 trillion worth of annual wages. But by making manufacturing more efficient, technology is also driving down the cost of almost every good in the world, from hamburgers to automobiles. And innovations such as fracking have reduced the costs of energy and commodities. Technology is also driving down the costs of many essential services. The cost of traditional higher education, for instance, has been rising far faster than the rate of inflation, but the price of online education, with the rise of MOOCs (massive open online courses), is far lower—at times even zero.
Because GDP measures simply the value of all the goods and services produced by a country, lower costs can reduce it; economies that depend on high prices will contract as prices fall. That is true both for real GDP, which adjusts for price changes and inflation, and for nominal GDP, which does not. And this contraction alarms not only economists, such as Summers, but also most government officials, whose legitimacy has become tethered to their ability to increase GDP growth.
Even though wages have flatlined, so, too, have costs.
But GDP growth is no longer an especially useful way of measuring the health of modern economies. Many of the most important developments in the modern economy contribute little to official GDP figures. Browsing on Wikipedia, watching videos on YouTube, and searching for information on Google add value to people’s lives, but because these are digital goods that have zero price, official GDP figures will consistently downplay their impact. Improvements in efficiency, which reduce costs, have a negative impact on GDP. Consider solar panels: their installation boosts GDP initially, but thereafter the savings in oil or gas will reduce GDP.
The combination of lower costs and less growth can lead to the same endpoint as higher costs and higher growth. But most economists and central bankers fear deflation even more than they fear inflation. They worry about a deflationary trap: if prices fall, people have less incentive to spend today, as they can simply wait for cheaper prices tomorrow. If consumers keep their wallets shut, the economy will grind to a halt, resulting in falling prices, and the cycle continues. To make matters worse, deflation increases the cost of debt, which can further depress spending. And deflation is often taken as a sign that demand is weak, which in turn is interpreted as a sign that consumers lack spending power.
But some of these fears are ungrounded. Although it is true that deflation offers little relief to those in debt, it, like income, matters only to the extent that it affects people’s affluence and quality of life. Deflation and lower demand may hobble growth, but they do not necessarily jeopardize prosperity. One country knows this better than most: Japan.
For almost three decades, since Japan’s immense property and asset bubbles burst in 1991 and growth suddenly decelerated, pundits from across the political spectrum have used the country as a cautionary example of what can befall economies that become ensnared in the trap of large amounts of government debt, zero inflation, and little to no growth. Search the Internet for “Japan syndrome” or “lost decade,” and you’ll find scores of articles and papers addressing the country’s purported malaise and the lessons it offers to other societies hoping to avoid its fate.
But the reality is that there is nothing really wrong with Japan. It may have negative real interest rates, an undervalued currency, a debt-to-GDP ratio approaching 250 percent, and an average annual GDP growth rate over the last decade of less than one percent. Yet it is also one of the richest and most stable countries in the world.
On almost every major metric that societies use to measure individual and collective well-being, Japan ranks near the top. Life expectancy is among the highest in the world; crime rates are among the lowest. The Japanese people enjoy excellent health care and education. The UN Human Development Index, the Legatum Institute’s Prosperity Index, and the Better Life Index of the Organization for Economic Cooperation and Development all regularly give Japan high marks. Income inequality in Japan has increased in the past decade, as it has in much of the world, but that shift has not meaningfully eroded living standards for the bulk of the population. What’s more, Japan’s very high level of public debt hasn’t led to financial collapse.
Economic stagnation, in short, has had little impact on the Japanese public’s high quality of life. This realization has led to a wave of new thinking in Japan that emphasizes a “degrowth,” or post-growth, model and focuses on well-being rather than income or output. The massive success of the Japanese author Marie Kondo’s books on how to pare down one’s belongings to the essentials, rather than accumulate more and more stuff in a fruitless attempt to generate happiness, encapsulates the emerging Japanese model. And the fact that her book has sold more than two million copies worldwide suggests that the message is popular far beyond Japan’s shores.
In the United States, meanwhile, inequality and income stagnation rank among voters’ most pressing concerns, according to recent Gallup polls. Economic luminaries such as James Galbraith, Paul Krugman, Branko Milanovic, Thomas Piketty, and Joseph Stiglitz have all argued that inequality in income and wealth threatens the country’s very democracy.
Middle-class wages stopped rising more than 30 years ago, but it was only with the financial crisis that this issue became a pressing economic concern. Before the crisis, a booming equity market, low interest rates, a soaring housing market, and easy credit obscured the problem, allowing people to bridge the gap between their stagnant incomes and their spending. But when the crisis hit, and credit contracted, that extra source of income evaporated.
The combination of lower costs and less growth can lead to the same endpoint as higher costs and higher growth.
But even though wages have flat-lined, so, too, have costs—which has prevented living standards from declining. Millions of families, of course, have confronted unemployment and falling incomes, and millions have been unable to meet their basic needs; their stories rightly dominate the public discussion. But overall, for a substantial majority, shrinking costs and a wider range of available goods and services have offset the negative effects of declining incomes.
Consider some of a family’s most important expenses: food, energy, and housing. In 1950, the average U.S. household spent 30 percent of its income on food. By the turn of the century, the figure had fallen to 13 percent, and in 2013, it stood at just ten percent. (Not surprisingly, that share is much higher for the poor, but food stamps and other government programs offset their expenses.) Housing in major cities accounts for a larger percentage of income than it did in the mid-twentieth century, but housing in general does not. And energy expenditures have tumbled, thanks to much greater energy efficiency in automobiles, better insulation for homes, and, recently, cheap oil and gas.
As for the goods that households and businesses consume, globalized supply chains, along with the efficiencies generated by technology, have pushed down their relative prices. Even lower-cost goods imported from China have been getting cheaper—by more than two percent in the past three years, according to the U.S. Bureau of Labor Statistics. The costs of electronics and household appliances have been plunging for years, and furniture, clothing, and a host of other goods are all now becoming less expensive.
That leaves services, which represent an ever-larger share of spending. Here, the picture is more complex. The costs of some services, such as higher education, continue to rise far faster than the rate of inflation. Overall health-care costs have risen only modestly in the past few years, but certain types, such as drug prices and insurance premiums, have skyrocketed. The inefficiency and complexity of the health-care system have placed a severe financial burden on a substantial portion of the population. In the case of both education and health care, however, government programs and public and private subsidies, such as Medicare, Medicaid, Pell Grants, and massive student aid programs, reduce the amount of their own money that people actually spend.
What’s more, recent disruptive technologies are driving down the prices of many services. The car-hailing app Uber, for instance, has made getting a ride much cheaper and generated income for legions of drivers. The ability to make calls over the Internet, using applications such as Skype, has driven down the cost of phone calls close to zero. And after decades during which doctors’ house calls were prohibitively expensive, various smartphone video applications are making virtual house calls cheap and easy.
It’s not just in the United States that economists worry about slower growth. For nearly a decade, global growth was driven by the spectacular surge of China and the accompanying acceleration of emerging markets, but both these drivers now appear to have stalled. China’s economic growth has fallen from its double-digit highs to seven percent or less. Meanwhile, the commodity and energy boom sparked by China’s growth has also come to an end, with painful consequences for a number of countries, from Brazil to Russia to South Africa.
But as in Japan and the United States, the middle class in these countries is seeing rising living standards because the goods and services people require can be obtained more cheaply than ever before.
Just look at inflation. For an economy that was booming, China has been experiencing inflation that is startlingly low, at least according to official figures, staying under three percent for the last three years. In India, inflation is around five percent. Brazil is the most notable outlier, with inflation at around ten percent, but so much of Brazilian economic policy is idiosyncratic these days, from double-digit interest rates to the locking in by constitutional and congressional mandate of 90 percent of government spending, that it hardly contradicts the global trend.
Low inflation has also accompanied very low global interest rates. Such low rates make debt, which has historically been one of the heaviest burdens for both individuals and governments, much cheaper. As a result, an emerging global middle class now also has more access than ever to cheap capital.
In the stagnant 1970s, a chorus of prognosticators who harbored deep skepticism about the value of capitalism and economic growth issued dire warnings about the future. A group of experts called the Club of Rome, for instance, published a 1972 report titled The Limits to Growth, which projected several scenarios of economic and environmental collapse. Their forecasts proved incorrect, of course, and global growth picked up in the 1980s.
Today, the limits of growth should provoke considerably less anxiety. Growth is not the sole pathway to prosperity, even if it has long been the primary one. Slower growth need not entail the breakdown of capitalism and consumption. Much of the drive toward lower costs is a direct product of capitalist competition, as companies attempt to maintain margins and market share. The resulting gains in efficiency have allowed for a level of collective affluence hardly imaginable in the past. As technology continues to substitute for labor and synthetic solutions such as industrial composites become more important than raw materials, billions of people will be able to meet more of their basic needs. Although the environmental consequences of a booming global middle class have been severe, the worst may have passed: in 2015, carbon emissions actually fell.
But the world’s financial and political infrastructure remains dependent on the old model, in which GDP growth was all-important, and so lower costs, deflation, and slower economic expansion will continue to concern policymakers and central bankers. If there are no straightforward ways of measuring the gains from lower costs and only ways of measuring the harms of lower growth, then the world’s governments and economic institutions will continue to emphasize an unduly pessimistic view of the global economy and will continue to make policy prescriptions based on the misguided pursuit of economic growth for its own sake.
Rather than start with the assumption that growth is the only viable path to collective economic security, policymakers must first consider what ultimate goal they are trying to reach. Presumably, it is at least to provide all people with adequate calories, shelter, health care, education, clothing, appliances, and some basic opportunities to improve their station. This is hardly a new idea. It is close to what the UN’s Universal Declaration of Human Rights outlined in 1948.
With that in mind, policymakers should pay more attention to policies that can raise living standards—even if they might lower GDP. These could include offering more incentives for companies and individuals to adopt efficiency technologies, such as longer-lasting smart appliances and home energy gauges, which would help decrease energy consumption—things that would be good for the vast majority of people, despite lowering GDP.
A world where growth is lower but where more people than ever before have access to life’s essentials is hardly a dire scenario. In fact, it is just the opposite. The world may be reaching the limits of growth, but it has not begun to reach the limits of prosperity.