Bye, bye easy money

12th February, 2011

Don’t fixate on the financial crisis. Our economic problems have been far longer in the making, and would have caught up with us sooner or later anyway.

That is one of the conclusions I take away from two striking essays: “The Great Divergence”, published in Slate last September by the journalist Timothy Noah; and The Great Stagnation, just published as a short e-book by the economics professor and blogger Tyler Cowen.

The two essays describe two disturbing trends that, while logically separable, seem to be related. Noah discusses a sharp increase in income inequality in the US since the early 1970s. After analysing many explanations, he concludes that the chief culprits are a tolerance for super-high salaries and bonuses on Wall Street and in the boardroom, and a failure of the US education system. Blaming China is considered, but largely dismissed.

Cowen begins with the fact that median family income in the US has barely increased, again since the early 1970s. Its growth rate has been about 0.5 per cent a year after inflation. The median family income is the income of the family in the middle of the income distribution. It is a useful measure precisely because it ignores the action at the top: if a Connecticut hedge fund manager made an extra $11bn in a year, this would raise the mean income of the US’s 110 million-ish households by $100 each. It wouldn’t alter the median income by a cent.

In the UK, the situation is not as grim. Median earnings in the UK have increased by more than 1.25 per cent a year since 1968, over and above RPI inflation. That figure is for men working full-time; for women the gain is more than 2.25 per cent a year. At the bottom of the income distribution (the tenth percentile) the gain is slightly under 1 per cent annually for men and 2 per cent annually for women.

If Timothy Noah is right, part of the solution is to improve schools. (It is not clear whether voluntary pay restraint, or more redistributive taxation, would be effective in shifting more money to the median household. Perhaps.)

But if Cowen is right, it is not at all clear what the cure might be. Cowen blames the disappearance of “low-hanging fruit”. The US can no longer reap easy gains simply by sending more bright people to school. Better schools would help, but it used to be as simple as making sure bright 12-year-olds stayed in school for a few extra years.

Another easy gain in days gone by was to enjoy the gradual roll-out of the staggering array of vital innovations developed in the late 19th and early 20th centuries, including electrification, refrigeration, aeroplanes, indoor plumbing, bulk chemical processing, the internal combustion engine, and the telegraph, telephone and television. Everyday life was transformed by these technologies between 1930 and 1970, Great Depression notwithstanding. Since 1970, we have the rise of computers and mobile phones – truly wonderful inventions – but not much else.

In short, if Cowen is right, there will be less growth in future unless a new wave of technology arrives, and our political institutions will have to cope, if they can. The same argument surely applies to western Europe too, and will come as no news to Japan.

And the solution? I am not sure, and neither is Cowen. He hopes to raise the status of scientists and researchers – a good idea, but how? The UK coalition plans to introduce charter schools; we shall have to see whether that delivers results. The government is also reducing subsidies for universities and, indirectly, for public libraries. Both those policies are probably progressive: universities (certainly) and libraries (probably) tend to be middle-class haunts. But if the great stagnation is the problem, making access to knowledge more expensive is surely not much of a solution.

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