[I will address the title topic working from a recent Foreign Affairs article by Fareed Zakaria. I will supplement that material with observations from The Economist, David Brooks of the NY Times, James Madison, Edmund Burke, Sir Winston Churchill, Jeremy Grantham of GMO, Dr. Robert Gordon of Northwestern University, market watcher John Mauldin, and the Boston Consulting Group—and my own comments, of course. It is not a simple or short treatment of the issue. Dealing with such questions seldom is.]
Whenever Fareed Zakaria writes or speaks on a subject, it is worth considering what he has to say, and his reasoning. Here, he takes us beyond the short-term considerations of the "fiscal cliff," debt ceiling, and budget management. Here, he invites us to consider the longer-term cause: a crisis in American democracy and our political process that has become increasingly dysfunctional for the past half century.
Yet, it is just those shorter-term issues—and even more serious problems approaching our doorstep—that are proliferating and making clear just how critical a more effective representative government is to the future we all want. Mr. Zakaria's observations and those of others I will offer make clear the necessity that our representative democracy must soon be functioning at its best: its most resilient, best informed, and most compromising, its most timely and cost-efficient. In effect, we need much more effective leadership out of the elected representatives that we have, or we need to reform the model. Being well prepared to meet our future demands it.
From Mr. Zakaria's recent article in Foreign Affairs:
[…] Studies show that the political divisions in Washington are at their worst since the years following the Civil War. Twice in the last three years, the world's leading power—with the largest economy, the global reserve currency, and a dominant leadership role in all international institutions—has come close to committing economic suicide. The American economy remains extremely dynamic. But one has to wonder whether the U.S. political system is capable of making the changes that will ensure continued success in a world of greater global competition and technological change. Is the current predicament, in other words, really a crisis of democracy?
He asks the question about a crisis in democracy, but it is a rhetorical question, of course. His answer is a foregone conclusion and it is his analysis and reasoning that we are interested in. Can it be fixed? That is the real question. The article continues:
[…] Is there a new crisis of democracy? Certainly, the American public seems to think so. Anger with politicians and institutions of government is much greater than it was in 1975. According to American National Election Studies polls, in 1964, 76 percent of Americans agreed with the statement "You can trust the government in Washington to do what is right just about always or most of the time." By the late 1970s, that number had dropped to the high 40s. In 2008, it was 30 percent. In January 2010, it had fallen to 19 percent.
But perhaps the more tangible measure, the better measure, is the condition and advancement of society and the economy. And while there have been ups and downs over the last half-century, the longer-term trajectory appears decidedly down, or at least toward slower or no growth, less opportunity, and more inefficient government. Mr. Zakaria takes this position and argues his case:
But it is also possible that the public is onto something. The crisis of democracy, from this perspective, never really went away; it was just papered over with temporary solutions and obscured by a series of lucky breaks. Today, the problems have mounted, and yet American democracy is more dysfunctional and commands less authority than ever -- and it has fewer levers to pull in a globalized economy. This time, the pessimists might be right.
The mid-1970s predictions of doom for Western democracy were undone by three broad economic trends: the decline of inflation, the information revolution, and globalization. [The latter two, he notes, contributed materially to the fall of the Soviet Union.] […] The result was a rebirth of American confidence and an expansion of the global economy with an unchallenged United States at the center. A generation on, however, the Soviet collapse is a distant memory, low inflation has become the norm, and further advances in globalization and information technology are now producing as many challenges for the West as opportunities.
The jobs and wages of American workers, for example, have come under increasing pressure. A 2011 study by the McKinsey Global Institute found that from the late 1940s until 1990, every recession and recovery in the United States followed a simple pattern. First, GDP recovered to its pre-recession level, and then, six months later (on average), the employment rate followed. But then, that pattern was broken. After the recession of the early 1990s, the employment rate returned to its pre-recession level 15 months after GDP did. In the early part of the next decade, it took 39 months. And in the current recovery, it appears that the employment rate will return to its pre-recession level a full 60 months -- five years -- after GDP did. The same trends that helped spur growth in the past are now driving a new normal, with jobless growth and declining wages.
And through this evolving and increasing economic weakness, America—both the federal and state governments, and individual consumers, too—indulged their appetites with what Mr. Zakaria calls "magic money": credit, cheap credit, debt and more debt. And the distended and increasing government debt is managed only by rolling it over, borrowing more and more to retire earlier debt and meet increasing financial needs. It is what several observers have taken to analogizing to a huge Ponzi scheme that could reach a point where it all falls apart. The article continues:
The broad-based growth of the post-World War II era slowed during the mid-1970s and has never fully returned. The Federal Reserve Bank of Cleveland recently noted that in the United States, real GDP growth peaked in the early 1960s at more than four percent, dropped to below three percent in the late 1970s, and recovered somewhat in the 1980s only to drop further in recent years down to its current two percent. Median incomes, meanwhile, have barely risen over the last 40 years. Rather than tackle the underlying problems or accept lower standards of living, the United States responded by taking on debt. From the 1980s on, Americans have consumed more than they have produced, and they have made up the difference by borrowing.
President Ronald Reagan came to power in 1981 as a monetarist and acolyte of Milton Friedman, arguing for small government and balanced budgets. But he governed as a Keynesian, pushing through large tax cuts and a huge run-up in defense spending. (Tax cuts are just as Keynesian as government spending; both pump money into the economy and increase aggregate demand.) Reagan ended his years in office with inflation-adjusted federal spending 20 percent higher than when he started and with a skyrocketing federal deficit. For the 20 years before Reagan, the deficit was under two percent of GDP. In Reagan's two terms, it averaged over four percent of GDP. Apart from a brief period in the late 1990s, when the Clinton administration actually ran a surplus, the federal deficit has stayed above the three percent mark ever since; it is currently seven percent.
John Maynard Keynes' advice was for governments to spend during busts but save during booms. In recent decades, elected governments have found it hard to save at any time. They have run deficits during busts and during booms, as well. The U.S. Federal Reserve has kept rates low in bad times but also in good ones. It's easy to blame politicians for such one-handed Keynesianism, but the public is as much at fault. In poll after poll, Americans have voiced their preferences: they want low taxes and lots of government services. Magic is required to satisfy both demands simultaneously, and it turned out magic was available, in the form of cheap credit. The federal government borrowed heavily, and so did all other governments -- state, local, and municipal -- and the American people themselves. Household debt rose from $665 billion in 1974 to $13 trillion today. Over that period, consumption, fueled by cheap credit, went up and stayed up.
[NY Times columnist David Brooks addresses the same issue from his own perspective in a 1.1.13 NY Times column, "Another Fiscal Flop," and reminds us that it is ultimately the voters who have to take responsibility for the representatives we elect and the unworkable demands we may put upon them as their constituencies. For if a democracy is to stand on any principle, it has to be that it is to the people that their elected representatives owe their best efforts in policy, legislation and leadership. If they fail us and the nation, the only recourse is for the people to throw the rascals out, and replace them with different folks with a better approach. But in the last election, with but a few changes, the people returned the same rascals to the same responsibilities with the same power relationships. So, if the performance of our elected officials has been poor, it was not a very encouraging or responsible performance by the people, either. (See my recent post on his column, "It's not Just Congress; We Voters Lack Accountability, Too .")
[In an earlier column, Mr. Brooks also reminds our political leaders that we are a representative democracy, and those representatives have a larger, more responsible leadership role to play than merely acting as mouthpieces for their constituents. More on the implications of it all for American democracy a little later. GH]
Other rich democracies have followed the same course. In 1980, the United States' gross government debt was 42 percent of its total GDP; it is now 107 percent. During the same period, the comparable figure for the United Kingdom moved from 46 percent to 88 percent. Most European governments (including notoriously frugal Germany) now have debt-to-GDP levels that hover around 80 percent, and some, such as Greece and Italy, have ones that are much higher. In 1980, Japan's gross government debt was 50 percent of GDP; today, it is 236 percent.
Okay, so all this isn't exactly shocking to those of us who have followed and read about the financial crisis over the last few years; yet, it is increasingly troubling to appreciate it in the context of the longer-term, the evolving and deteriorating financial accountability of government and citizens alike. And it is also instructive in considering what remedial actions might be taken. Mr. Zakaria thinks the answer is not extreme austerity, although budgetary discipline and deficit reduction are essential parts of any intermediate-term solutions. Rather, he believes our goals are better served by going to the heart of the issue and stressing major structural reforms and, even more urgently, government investment. But first, he needs a government responsible enough to do it. Mr. Zakaria explains:
Reform and Invest
When Western governments and international organizations such as the International Monetary Fund offer advice to developing countries on how to spur growth, they almost always advocate structural reforms that will open up sectors of their economies to competition, allow labor to move freely between jobs, eliminate wasteful and economically distorting government subsidies, and focus government spending on pro-growth investment. When facing their own problems, however, those same Western countries have been loath to follow their own advice.
Current discussions about how to restore growth in Europe tend to focus on austerity, with economists debating the pros and cons of cutting deficits. Austerity is clearly not working, but it is just as clear that with debt burdens already at close to 90 percent of GDP, European countries cannot simply spend their way out of their current crisis. What they really need are major structural reforms designed to make themselves more competitive, coupled with some investments for future growth. The danger for Western democracies is not death but sclerosis.
Not least because it boasts the world's reserve currency, the United States has more room to maneuver than Europe. But it, too, needs to change. It has a gargantuan tax code that, when all its rules and regulations are included, totals 73,000 pages; a burdensome litigation system; and a crazy patchwork of federal, state, and local regulations. U.S. financial institutions, for example, are often overseen by five or six different federal agencies and 50 sets of state agencies, all with overlapping authority.
If the case for reform is important, the case for investment is more urgent. In its annual study of competitiveness, the World Economic Forum consistently gives the United States poor marks for its tax and regulatory policies, ranking it 76th in 2012, for example, on the "burden of government regulations." But for all its complications, the American economy remains one of the world's most competitive, ranking seventh overall -- only a modest slippage from five years ago.
In contrast, the United States has dropped dramatically in its investments in human and physical capital. The WEF ranked American infrastructure fifth in the world a decade ago but now ranks it 25th and falling. The country used to lead the world in percentage of college graduates; it is now ranked 14th. U.S. federal funding for research and development as a percentage of GDP has fallen to half the level it was in 1960 -- while it is rising in countries such as China, Singapore, and South Korea. The public university system in the United States -- once the crown jewel of American public education -- is being gutted by budget cuts.
The modern history of the United States suggests a correlation between investment and growth. In the 1950s and 1960s, the federal government spent over five percent of GDP annually on investment, and the economy boomed. Over the last 30 years, the government has been cutting back; federal spending on investment is now around three percent of GDP annually, and growth has been tepid. As the Nobel Prize-winning economist Michael Spence has noted, the United States escaped from the Great Depression not only by spending massively on World War II but also by slashing consumption and ramping up investment. Americans reduced their spending, increased their savings, and purchased war bonds. That boost in public and private investment led to a generation of postwar growth. Another generation of growth will require comparable investments.
The problems of reform and investment come together in the case of infrastructure. In 2009, the American Society of Civil Engineers gave the country's infrastructure a grade of D and calculated that repairing and renovating it would cost $2 trillion. The specific number might be an exaggeration (engineers have a vested interest in the subject), but every study shows what any traveler can plainly see: the United States is falling badly behind. This is partly a matter of crumbling bridges and highways, but it goes well beyond that. The U.S. air traffic control system is outdated and in need of a $25 billion upgrade. The U.S. energy grid is antique, and it malfunctions often enough that many households are acquiring that classic symbol of status in the developing world: a private electrical generator. The country's drinking water is carried through a network of old and leaky pipes, and its cellular and broadband systems are slow compared with those of many other advanced countries. All this translates into slower growth. And if it takes longer to fix, it will cost more, as deferred maintenance usually does.
Spending on infrastructure is hardly a panacea, however, because without careful planning and oversight, it can be inefficient and ineffective. Congress allocates money to infrastructure projects based on politics, not need or bang for the buck. The elegant solution to the problem would be to have a national infrastructure bank that is funded by a combination of government money and private capital. Such a bank would minimize waste and redundancy by having projects chosen by technocrats on merit rather than by politicians for pork. Naturally, this very idea is languishing in Congress, despite some support from prominent figures on both sides of the aisle.
The same is the case with financial reforms: the problem is not a lack of good ideas or technical feasibility but politics. [Italics added.] The politicians who sit on the committees overseeing the current alphabet soup of ineffective agencies are happy primarily because they can raise money for their campaigns from the financial industry. The current system works better as a mechanism for campaign fundraising than it does as an instrument for financial oversight.
[T]he problem [i]s politics rather than economics. All the advanced industrial economies…have reached a stage of development, however, at which outmoded policies, structures, and practices have to be changed or abandoned. The problem, as the economist Mancur Olson pointed out, is that the existing policies benefit interest groups that zealously protect the status quo. Reform requires governments to assert the national interest over such parochial interests, something that is increasingly difficult to do in a democracy.
But the founding fathers and drafters of our Constitution had very clearly in mind a dynamic republic, a representative democracy, where elected representatives attended closely to the views and wants of their constituencies, but were first statesman-leaders and patriots who acted in the national interest. They exercised their own best judgment on what best served the nation, and in turn its people.
A NY Times column by David Brooks last year, "The Politics of Solipsism" (5.5.11) made the point that the more our country moves toward direct or plebiscite democracy, the more it denies it's representatives the ability to meet their responsibilities as statesman-leaders. Mr. Brooks piece is well complemented by a Leaders editorial and article in The Economist, "The Perils of Extreme Democracy" (4.23.11), which provides a revealing and sobering review of the dangers and slippery slope of direct democracy. (See my post, "'Direct Democracy's Erosion of Representative Democracy—and the Republic" (4.29.11), which deals with both articles).
The Economist piece focuses on how California has created its own example of dysfunctional state government driven in large part by what is sometimes referred to as "referendum democracy." But direct democracy, by any other name, is not just the movement toward removing more issues from the legislatures' purview and presenting them directly to the people, as in the case of state referenda and ballot questions. As we've suggested, de facto variations of it also evolve from the changing roles and constituent expectations of our representatives—and also from the effects of years of partisan "gerrymandering" (of which we will speak more, presently).
Today, the ideological left want no changes to social programs at all, however necessary and appropriate they are, just as the ideological right want lower taxes and nothing short of privatization or dismantling of such programs, however critical appropriately reformed and sustainable versions of those programs are to our society and economy. And then you have the Tea Party folks, who vote with the ideological Right but take the irreconcilable position that they should have both lower taxes and (like the Left) unchanged social security and Medicare programs. Statesmen, arbiters and honest educators of the public are few and far between. More and more their representatives are mere mouthpieces for the more strident and commonly-held views of their singular districts—and they fear they risk losing the next election if they speak the truth to their own constituencies. Both parties fail in this, and so does the president and his administration.
And that brings us back to gerrymandering. So, let's take a look at the black art as practiced over the decades and ask, What role or impact has resulted from the partisan state redistricting process known as gerrymandering?
In large part, it is the extensive gerrymandering that creates safe Republican and Democratic districts where extreme views, Right or Left, are more likely to dominate, and where more extreme candidates are therefore successful. More, those districts will vote their representatives out for any deviation from district orthodoxy. And in the Republican districts, Grover Norquist and the anti-tax lobby stand ready to run a more conforming candidate in the next primary against any who veer at all toward independent thinking or compromise. At the time of the 2012 national elections, one television commentator opined that only about 100 of the 435 seats in the House are still realistically contested. That is why we always come down to the same few "swing districts" and "swing states." An enlightening review of the process and effects of gerrymandering is provided in an excellent article in The Atlantic, "The League of Dangerous Mapmakers," (October 2012). (See my post on the article, "Winning by Gerrymandering—The Nastiest Politics," (10.17.12).)
In effect, gerrymandering and other factors, including changing attitudes toward representative democracy and direct democracy, have resulted in the electorate in most districts and areas of the country viewing their representatives as serving only as a proxy for their wants and views. They have evolved into something much closer to a proxy for direct democracy than representative democracy, as originally envisioned by the Founding Fathers and practiced for so long.
It was James Madison, an architect and draftsman of our Constitution and the Bill of Rights, an author of the Federalist papers, and President of the United States--as well as other early thinkers on democracy--who warned of the dangers of direct or plebiscite democracy. As today's leaders abdicate their roles and duties, we move more, faster in that direction. Mr. Madison:
Pure democracies have ever been spectacles of turbulence and contention; have ever been found incompatible with personal security or the rights of property; and have in general been as short in their lives as they have been violent in their deaths.
[And further:] The effect of [a representative democracy is] to refine and enlarge the public views, by passing them through the medium of a chosen body of citizens, whose wisdom may best discern the true interest of their country, and whose patriotism and love of justice will be least likely to sacrifice it to temporary or partial considerations.
---The Federalist Paper No. 10, Publius (James Madison)
And England's estimable, ever vigilant and thoughtful Edmund Burke offered the following reflection making the same point:
Certainly, Gentlemen, it ought to be the happiness and glory of a Representative, to live in the strictest union, the closest correspondence, and the most unreserved communication with his constituents. Their wishes ought to have great weight with him; their opinion high respect; their business unremitted attention. It is his duty to sacrifice his repose, his pleasures, his satisfactions, to theirs; and, above all, ever, and in all cases, to prefer their interest to his own. But, his unbiased opinion, his mature judgment, his enlightened conscience, he ought not to sacrifice to you; to any man, or to any sett of men living. These he does not derive from your pleasure; no, nor from the Law and the Constitution. They are a trust from Providence, for the abuse of which he is deeply answerable. Your Representative owes you, not his industry only, but his judgment; and he betrays, instead of serving you, if he sacrifices it to your opinion.
---"Speech to the Electors of Bristol," Edmund Burke (3 Nov. 1774), Works of the Right Honourable Edmund Burke, 1:446--48 (London: Henry G. Bohn, 1854--56)
Edmund Burke and President Eisenhower also embraced the same view on the imperative of a compromising spirit in leadership:
All government, indeed every human benefit and enjoyment, every virtue, and every prudent act, is founded on compromise and barter.
---Edmund Burke
People talk about the middle of the road as though it were unacceptable. Actually, all human problems, excepting morals, come into the gray areas. Things are not all black and white. There have to be compromises. The middle of the road is all of the usable surface. The extremes, right and left, are in the gutters.
---President Dwight D. Eisenhower
It is hard not to see the warned-against weaknesses of a de facto direct democracy playing their part in the crisis levels of our national and local debt, especially that incurred to support unsustainably expensive and inefficient programs that must be reformed. It is sad and dispiriting, but so very human, to observe the demands from every income level or political orientation that someone else bear the costly burden of economic recovery--including the cost and impact of essential reform to necessary public goods, human services, and retirement and health programs. And that prominently includes high-income folks.
But that is what the early critics of direct democracy warned of: the people voting themselves more and more and contributing less and less until the nation was as bankrupt as the political system. Only the healthy exercise of our Constitutional checks and balances, and the strong, responsible, and compromising spirit of its elected leaders could maintain the strength and integrity of the nation and its political system.
But let's return to Mr. Zakaria's critique of the direction of American democracy and the increasing challenges it now faces. For next, he wants to lead us in consideration of another major issue and its political implications: changing demography, both in the U.S. and the rest of the world. You have likely come across some of these rather troubling data and projections elsewhere; they have been around awhile. But they are relevant to our discussion here because they add to the demand for political focus already created by so many other issues that cry out for informed and prudent leadership—if we are to successfully engage a more challenging economic future. Again, Mr. Zakaria:
Political Demography
With only a few exceptions, the advanced industrial democracies have spent the last few decades managing or ignoring their problems rather than tackling them head-on. Soon, this option won't be available, because the crisis of democracy will be combined with a crisis of demography.
The industrial world is aging at a pace never before seen in human history. Japan is at the leading edge of this trend, predicted to go from a population of 127 million today to just 47 million by the end of the century. Europe is not far behind, with Italy and Germany approaching trajectories like Japan's. The United States is actually the outlier on this front, the only advanced industrial country not in demographic decline. In fact, because of immigration and somewhat higher fertility rates, its population is predicted to grow to 423 million by 2050, whereas, say, Germany's is predicted to shrink to 72 million. Favorable U.S. demographics, however, are offset by more expensive U.S. entitlement programs for retirees, particularly in the area of health care.
To understand this, start with a ratio of working-age citizens to those over 65. That helps determine how much revenue the government can get from workers to distribute to retirees. In the United States today, the ratio is 4.6 working people for every retiree. In 25 years, it will drop to 2.7. That shift will make a huge difference to an already worrisome situation. Current annual expenditures for the two main entitlement programs for older Americans, Social Security and Medicare, top $1 trillion. The growth of these expenditures has far outstripped inflation in the past and will likely do so for decades to come, even with the implementation of the Affordable Care Act. Throw in all other entitlement programs, the demographer Nicholas Eberstadt has calculated, and the total is $2.2 trillion -- up from $24 billion a half century ago, nearly a hundredfold increase.
However worthwhile such programs may be, they are unaffordable on their current trajectories, consuming the majority of all federal spending. The economists Carmen Reinhart and Kenneth Rogoff argued in their detailed study of financial crises, This Time Is Different, that countries with debt-to-GDP burdens of 90 percent or more almost invariably have trouble sustaining growth and stability. Unless its current entitlement obligations are somehow reformed, with health-care costs lowered in particular, it is difficult to see how the United States can end up with a ratio much lower than that.
What this means is that while the American right has to recognize that tax revenues will have to rise significantly in coming decades, the American left has to recognize that without significant reforms, entitlements may be the only thing even those increased tax revenues will cover. A recent report by Third Way, a Washington-based think tank lobbying for entitlement reform, calculates that by 2029, Social Security, Medicare, Medicaid, and interest on the debt combined will amount to 18 percent of GDP. It just so happens that 18 percent of GDP is precisely what the government has averaged in tax collections over the last 40 years.
The continued growth in entitlements is set to crowd out all other government spending, including on defense and the investments needed to help spur the next wave of economic growth…On its current path, the U.S. federal government is turning into, in the journalist Ezra Klein's memorable image, an insurance company with an army. And even the army will have to shrink soon. (Italics added.)
Rebalancing the budget to gain space for investment in the country's future is today's great American challenge. And despite what one may have gathered during the recent campaign, it is a challenge for both parties. Eberstadt points out that entitlement spending has actually grown faster under Republican presidents than under Democrats, and a New York Times investigation in 2012 found that two-thirds of the 100 U.S. counties most dependent on entitlement programs were heavily Republican. (Italics added.)
[…] The U.S. government currently spends $4 on citizens over 65 for every $1 it spends on those under 18. At some level, that is a brutal reflection of democratic power politics: seniors vote; minors do not. But it is also a statement that the country values the present more than the future.
This is a sobering and humbling reflection for us all, regardless of political orientation or wealth. It is, in my view, as much a call to selfless patriotic service—or at least a selfless, patriotic attitude—as any other threat to our country, now or ever. It is just that real. And it demands a willingness on the part of citizens to pay more in taxes—but progressively, according to how much of a burden they can fairly bear—and forego, or pay the fair market value for, access to public social programs like Medicare and Medicaid (and social security) if your personal income or wealth is such that you can afford to access private services (also referred to as "means testing").
But there is yet another factor that further heightens the threat to a dysfunctional democracy: the slowing economic growth in the U.S. and advanced world that is taking shape and will sooner or later be a larger problem for us. And there are a number of subordinate issues that bear on the declining growth questions of What, where, how much, and how soon? (Italics added.)
I have long worried about the finite limitations for growth and profits in market capitalism, limitations made clear by basic mathematical projections reflecting global population growth, consumption growth, and the limitations of finite global resources consumed at increasing rates. But no one talks much about it, least of all self-interested corporations and the political apologists for them. But it's a simple matter of growth in markets, profits and consumption versus sustainability of resources. And science is now treated as just another voice in the marketplace to be denied or undermined or re-spun when it's message is too inconvenient for threatened financial or political interests. So then, when finite resources are depleted, who will stand accountable?
But there are respected, reputable economic and investment researchers and analysts addressing these questions. Jeremy Grantham, a respected founder of investment firm GMO, writes periodically about aspects of the problem. Yes, a capitalist who cares enough about the economic framework and resource assumptions to address the failures in the thinking about them. Last year, he offered some of his observations in a piece on sustainability of resources titled, "Your Grand Children Have No Value (And Other Deficiencies of Capitalism):"
[…] A few painstaking readers might remember my "Farmer and The Devil" story of last July. In it I showed how a good capitalist farmer had to sign a contract in which the Devil guaranteed a quadrupling of the farmer's income through very aggressive farming practices at the hidden cost of 1% a year of his soil. The farmer would enormously profit and eagerly re-up through the first several 20-year contracts only to end up with no soil, no food, and no people at about 100 years out. Yet each time the farmer re-upped, he did the sensible capitalist thing. In this case, Adam Smith's "invisible hand" failed, and fatally so.
Damage to the "commons," known as "externalities" has been discussed for decades, although the most threatening one – loss of our collective ability to feed ourselves, through erosion and fertilizer depletion – has received little or no attention. There have been no useful tricks proposed, however, for how we will collectively impose sensible, survivable, long-term policies over problems of the "commons." To leave it to capitalism to get us out of this fix by maximizing its short-term profits is dangerously naïve and misses the point: capitalism and corporations have absolutely no mechanism for dealing with these problems, and seen through a corporate discount rate lens, our grandchildren really do have no value.
[…] It gets worse, for what capitalism has always had is money with which to try to buy influence. Today's version of U.S. capitalism has died and gone to heaven on this issue. A company is now free to spend money to influence political outcomes and need tell no one, least of all its own shareholders, the technical owners. So, rich industries can exert so much political influence that they now have a dangerous degree of influence over Congress. And the issues they most influence are precisely the ones that matter most, the ones that are most important to society's long-term well-being, indeed its very existence.
Thus, taking huge benefits from Nature and damaging it in return is completely free and all attempts at government control are fought with costly lobbying and advertising. And one of the first victims in this campaign has been the truth. If scientific evidence suggests costs and limits be imposed on industry to protect the long-term environment, then science will be opposed by clever disinformation. It's now getting to be an old and obvious story, but because their propaganda is good and despite the solidness of the data, half of the people believe the problem is a government run wild, mad to control everything. So the "industrial complex" (or parts of it) fights to increase the inherent weaknesses of capitalism. They deliberately make it ever harder to reach the very long-term decisions that will serve us all.
One might consider how compellingly this, too, speaks to the need for more responsible and courageous leaders among our elected representatives. And this is not new. Anyone who has bothered to ask the next logical questions and consider the resulting, troubling answers understands on some level that this threat, this inevitability, awaits us in the shadowed and foggy periphery of our collective uncritical thinking. But there is more, of course. The sustainability of resources is just one of the factors that suggests a steady decline in economic growth that more and more thoughtful scholars and professionals are projecting. In his last quarterly article, Mr. Grantham offered another provocative but well-considered topic: "On the Road to Zero Growth" (November 2012). Here, some excerpts from a much longer article:
[…] Introduction: Wishful Thinking
Attitudes to change are sticky. We cling to the idea of the good old days with enthusiasm. When offered unpleasant Ideas (or even unpleasant facts) we jump around looking for more palatable alternatives. Critically, the tech boom and bust and the following housing boom and housing and financial busts helped camouflage the recent unpleasant economic development lying below the surface: the steady and important drop in long-term U.S. growth. Someday, when the debt is repaid and housing is normal and Europe has settled down, most business people seem to expect a recovery back to America's old 3.4% a year growth trend, or at least something close. They should not hold their breath. A declining growth trend is inevitable and permanent and is caused by some pretty basic forces. The question here is not "Has the growth rate dropped?" (yes, it has) or "Will it continue to drop?" (yes, it will). The question is "At what rate will it drop?"
Summary (excerpted)
The U.S. GDP growth rate that we have become accustomed to for over a hundred years – in excess of 3% a year – is not just hiding behind temporary setbacks. It is gone forever. Yet most business people (and the Fed) assume that economic growth will recover to its old rates.
Going forward, GDP growth (conventionally measured) for the U.S. is likely to be about only 1.4% a year, and adjusted growth about 0.9%.
Population growth that peaked in the U.S. at over 1.5% a year in the 1970s will bob along at less than half a percent. This is pretty much baked into the demographic pie. After adjusting for fewer hours worked per person, man-hours worked annually are likely to be growing at only 0.2% a year.
Productivity in manufacturing has been high and is expected to stay high, but manufacturing is now only 9% of the U.S. economy, down from 24% in 1900 and 15% in 1990. It is on its way to only 5% by 2040 or so. There is a limit as to how much this small segment can add to total productivity.
Growth in service productivity in contrast is low and declining. Total productivity is calculated to be just 1.3% through 2030, if we use current accounting methods.
However, current accounting cannot accurately handle rising resource costs. In reality, rising resource costs should be counted as a squeeze on the balance of the economy, as they lower our total utility.
Measuring the non-resource balance of the economy produces the correct effect. The share of resource costs rose by an astonishing 4% of total GDP between 2002 and today. It thus reduced the growth of the non-resource part of GDP by fully 0.4% a year.
Resource costs have been rising, conservatively, at 7% a year since 2000. If this is maintained in a world growing at under 4% and a developed world at under 1.5% it is easy to see how the squeeze will intensify.
The price rise might even accelerate as cheap resources diminish. If resources increase their costs at 9% a year, the U.S. will reach a point where all of the growth generated by the economy is used up in simply obtaining enough resources to run the system. It would take just 11 years before the economic system would
be in reverse! If, on the other hand, our resource productivity increases, or demand slows, cost increases may decelerate to 5% a year, giving us 31 years to get our act together.
Of course, with extraordinary, innovative breakthroughs we might do even better, but we certainly shouldn't count on that. (Bear in mind that we don't even know precisely why the prices started to rise so sharply in 2000.) Excessive optimism and doing little could be extremely dangerous.
Increasing climate damage, reflected mainly in food prices and flood damage, is going to increase. With any luck this will not be severe before 2030 (we allow for a 0.1% setback) but it is very likely to accelerate between 2030 and 2050. A great deal will depend on our responses.
The bottom line for U.S. real growth, according to our forecast, is 0.9% a year through 2030, decreasing to 0.4% from 2030 to 2050 (see table on Page 16). This is all done presuming no unexpected disasters, but also no heroics, just normal "muddling through."
Accurate measurements of growth must eventually include the full costs of running down our natural assets. True income (said Hicks) is meant to allow for sustained productive capacity, which our current measures clearly do not. If they had done so the developed countries might well have been in reverse for the last 20 years.
Conclusion
[…] The key issue will be how much unnecessary pain we inflict on ourselves by defending the status quo, mainly by denying the unpleasant parts of the puzzle and moving very slowly to address real problems. This, unfortunately, is our current mode. We need to move aggressively with capital – while we still have it – and brain power to completely re-tool energy, farming, and resource efficiency. We need to do all of this to buy time for our global population to gracefully decline. It can certainly be done.
For all the thoughtful and compelling analysis—and the unwelcome findings and projections—by Jeremy Grantham, John Mauldin, and other economic and investment analysts, it is research like that of Dr. Robert Gordon that lends academic credibility and heft to the analysis. He is a chaired professor of social sciences and economics at Northwestern University, a research analyst at the National Bureau for Economic Research (NBER), and a research fellow at the Centre for Economic Policy Research (London) (CEPR). In a paper written for the CEPR, he authored a much quoted and cited study with another provocative title, Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six Headwinds.
This too is a long report, and I will offer you only some excerpts from his basic points. Professor Gordon:
1. Since Solow's seminal work in the 1950s, economic growth has been regarded as a continuous process that will persist forever. But there was virtually no economic growth before 1750, suggesting that the rapid progress made over the past 250 years could well be a unique episode in human history rather than a guarantee of endless future advance at the same rate.
2. The frontier established by the US for output per capita, and the UK before it, gradually began to grow more rapidly after 1750, reached its fastest growth rate in the middle of the 20th century, and has slowed down since. It is in the process of slowing down further.
3. A useful organising principle to understand the pace of growth since 1750 is the sequence of three industrial revolutions. The first (IR1) with its main inventions between 1750 and 1830 created steam engines, cotton spinning, and railroads. The second (IR2) was the most important, with its three central inventions of electricity, the internal combustion engine, and running water with indoor plumbing, in the relatively short interval of 1870 to 1900. Both the first two revolutions required about 100 years for their full effects to percolate through the economy. During the two decades 1950-70, the benefits of the IR2 were still transforming the economy, including air conditioning, home appliances, and the interstate highway system. After 1970, productivity growth slowed markedly, most plausibly because the main ideas of IR2 had by and large been implemented by then.
4. The computer and internet revolution (IR3) began around 1960 and reached its climax in the dot.com era of the late 1990s, but its main impact on productivity has withered away in the past eight years. Many of the inventions that replaced tedious and repetitive clerical labour with computers happened a long time ago, in the 1970s and 1980s. Invention since 2000 has centered on entertainment and communication devices that are smaller, smarter, and more capable, but do not fundamentally change labour productivity or the standard of living in the way that electric light, motor cars, or indoor plumbing changed it.
5. The paper suggests that it is useful to think of the innovative process as a series of discrete inventions followed by incremental improvements which ultimately tap the full potential of the initial invention. For the first two industrial revolutions, the incremental follow-up process lasted at least 100 years. For the more recent IR3, the follow-up process was much faster. Taking the inventions and their follow-up improvements together, many of these processes could happen only once. Notable examples are speed of travel, temperature of interior space, and urbanisation itself.
6. The benefits of ongoing innovation on the standard of living will not stop and will continue, albeit at a slower pace than in the past. But future growth will be held back from the potential fruits of innovation by six "headwinds" buffeting the US economy, some of which are shared in common with other countries and others are uniquely American. Future growth in real GDP per capita will be slower than in any extended period since the late 19th century, and growth in real consumption per capita for the bottom 99% of the income distribution will be even slower than that.
The [6] headwinds include:
the end of the "demographic dividend;"
rising inequality;
factor price equalisation stemming from the interplay between globalisation and the internet;
the twin educational problems of cost inflation in higher education and poor secondary student performance;
the consequences of environmental regulations and taxes that will make growth harder to achieve than a century ago; and,
the overhang of consumer and government debt.
Lastly, let's take a look at the unsurprising stock market implications if these analyses and projections are anywhere near accurate. John Mauldin is a market watcher, investment advisor, and author of a newsletter subscribed to by over a million folks serious about their investing. He explains that all this can only decrease the price-earnings ratios assigned to stocks and stock funds, which of course means lower stock values—and over time, perhaps dramatically lower.
It should also be observed that such an eventuality—low growth in GDP per capita, and decreasing equity values—can only produce consternation and sadness around issues like the investment and growth assumptions of public and private pension plans, IRAs and 401(k)s. Since they depend so heavily on the historically high returns from equity investments, returns not likely to be seen much longer, assumptions about retirement savings and retirement generally will also have to be thoroughly rethought.
From Mr. Mauldin's recent letter, "Somewhere Over the Rainbow," (borrowing the title of Professor Gordon's forthcoming book on his research):
[…] Last summer Bill Gross (chief investment officer of PIMCO) forecast that the US economy would grow at only 1.5% over the next decade. Recently, Jeremy Grantham of GMO (one of my investment heroes) wrote a paper called" On the Road to Zero Growth," in which he forecast that "Going forward, GDP growth (conventionally measured) for the U.S. is likely to be about only 1.4% a year, and adjusted growth about 0.9%."
Adding further to the sentiment, Dr. Robert Gordon, a very respected economist, wrote a paper for the National Bureau of Economic Research provocatively titled "Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six Headwinds." Quoting from the abstract:
Even if innovation were to continue into the future at the rate of the two decades before 2007, the U.S. faces six headwinds that are in the process of dragging long-term growth to half or less of the 1.9 percent annual rate experienced between 1860 and 2007. These include demography, education, inequality, globalization, energy/environment, and the overhang of consumer and government debt. A provocative "exercise in subtraction" suggests that future growth in consumption per capita for the bottom 99 percent of the income distribution could fall below 0.5 percent per year for an extended period of decades."
Even if Gordon does measure growth somewhat unconventionally, his is a very sobering forecast.
Finally, we have a paper called 1%... The New Normal Growth Rate? Authored by Chris Brightman of Research Affiliates, it presents their view that 1% is the "new normal" growth rate. Chris follows up on research presented earlier, in which they described what they call the "3-D Hurricane" of deficits, debt, and demography.
Game-Changer: Slower Economic Growth
As noted above, the longer-term assessments for GDP growth are turning decidedly lower than the long-term 3% we saw over the last century. Our purpose in this letter is to look beyond the details of each argument as to the prospects for growth. That is, our objective is to understand the long-term implications of growth for stock market returns. Whether your favorite economist foresees 2%, 1%, or 0% long-term growth, the outcome for returns is similar in direction: the impact will lie somewhere between bad and worse.
[…] Historically, the prospect of slower economic growth has not often been considered by economists and analysts, but it now looms large in mainstream thinking. The effects of slower growth on stock market returns will be dramatic for investors.
---"Somewhere Over the Rainbow," John Mauldin, Mauldin Economics (12.31.12)
Despite the time and space dedicated to them, it is not my purpose in presenting these analyses and data to determine whether we will soon experience slower growth, no growth or negative growth, or how likely each prognostication is, or how soon more noticeable decline will be upon us. There are many views. In fact, it is worth noting that The Economist takes a decidedly more optimistic or hopeful view of the possibilities for future innovation in its most recent edition in the first Leaders article, "The great innovation debate", and a related Briefing article on growth (1.12.2013). They reference Professor Gordon and others whose research and analysis raise serious concern about declining growth, but fail to address many of the challenges mentioned in the articles cited here. Yet, they nonetheless conclude on a cautionary note:
For governments that do these things well—get out of the way of entrepreneurs, reform their public sectors and invest wisely—the rewards could be huge. The risk that innovation may slow is a real one, but can be avoided. Whether it happens or not is, like most aspects of mankind's fate, up to him.
Like Mr. Mauldin, my purpose in raising the economic growth issue is not to figure out who is most right about it, or about the many other threats we face. It is rather to lay out yet another serious, threatening issue that will demand the very best of our elected political leaders: their ability to access the best knowledge and thinking, to sort out the possibilities and probabilities, the values, costs, and options, and then make the best choices for America.
I'm simply placing the economic growth issue beside the challenges of intelligently and timely reducing the deficit, reforming social programs, and reducing the cost of health care in America while providing access to preventative and basic health care to all. And we also have to address market and regulatory reform, investment in education and infrastructure, global warming, depletion of natural resources, and the social and economic implications of changing demographics, among many other things. The tolerances and costs for error and delay on our part are finer and less forgiving than ever. We need to start getting things right sooner rather than later.
Let's now return to Mr. Zakaria for his concluding remarks:
Perhaps [a remedial] response to today's challenges is just around the corner -- perhaps Washington will be able to summon the will to pass major, far-reaching policy initiatives over the next few years, putting the United States back on a clear path to a vibrant, solvent future. But hope is not a plan, and it has to be said that at this point, such an outcome seems unlikely.
The absence of such moves will hardly spell the country's doom. Liberal democratic capitalism is clearly the only system that has the flexibility and legitimacy to endure in the modern world.
The danger for Western democracies is not death but sclerosis. The daunting challenges they face -- budgetary pressures, political paralysis, demographic stress -- point to slow growth rather than collapse. Muddling through the crisis will mean that these countries stay rich but slowly and steadily drift to the margins of the world. Quarrels over how to divide a smaller pie may spark some political conflict and turmoil but will produce mostly resignation to a less energetic, interesting, and productive future.
We can only hope that is the worst case; certainly, more dire circumstances and effects come to mind when reading some of these reports and analyses. But let's go back to where we now are after the recent 2012 elections, and think about the possibilities.
So, in our misdirected self-interest and misunderstandings, we voters responded as dysfunctionally as our politicians to our 2012 election leadership needs. The Left returned their rascals just as predictably and happily as the Right returned theirs. And they all continue to mark to the expectations of their constituencies in a totentanz, a dance of death, to reason and good governance. It has provided rich material for comedians, late-night TV, and laughs at parties and gatherings. But there is so much at stake at such a critical juncture that is not the time for levity; nor is it the time for ideological agenda's and uncompromising zealotry of any kind.
It is time to weigh our full range of American values—economic, societal, political, and national security—and sort out and prioritize what an advancing 21st-century nation needs to assure effective leadership and make progress as a society, one supported by a strong economy and an able defense capability, as well. Then, to make that happen, they have to craft a fiscal plan, a budget, that is solvent and has integrity. And that includes reforming all those public and social programs and our defense apparatus—and setting tax policy to responsibly fund it all. Then they have to explain it to the American people and implement it.
It's not about party or ideology; it can't be. It's about building common cause around the things that matter most (which will be difficult) and employing pragmatic, professional analysis by those most qualified and best informed (which may be politically unwelcome). The long discussion we've engaged here has many moving parts and offers many possibilities, but unless we are ready to embrace reform and change writ large, the research, analysis and data offered above offer a very sober and unsettling view of our economic future.
The continuing failure of our elected representatives to get us on a solvent, balanced and accountable budgetary path will only make things economically and financially more difficult for most Americans—and more difficult for government to sustain the kinds of social programs you and I know we need for a strong society and economy.
But most Americans do not have the time, interest or ability to sort out these increasingly complex issues and problems, or to separate the facts from political misdirection, over- or understatement, and lies that come from multiple directions. And often, it appears, neither do many of our political leaders. I've read that in China, a significant majority of their leaders have engineering and science backgrounds. America's elected national leaders, like most Americans, are troublingly short of science and math education, and therefore are poorly prepared to understand and make decisions on issues that relate to those areas. And so many issues now facing us do require understanding and command of those subject areas.
All that just strengthens the case for changes to how our democracy, politics, and the role of professional analysis must be reformed or changed, and converge on a decision-making and implementation process that is well informed, time- and cost-efficient, and accountable to the people's best interests, if not their views. Mr. Zakaria's observation about the need for an independent infrastructure bank was moving in the direction of trying to merge the best capabilities of government and the private sector to reform and make effective the process for assessing the need and the condition of infrastructure, and for recommendations and financing that aren't based on politics.
Thinking like that is what is needed to competently, responsibly face our future. The best data, analysis and recommendations of the best professionals in areas that bear on resolution of an issue must be required to be submitted and considered openly in making those decisions. But how much confidence can we have that anything like that can happen? Not much, if we are to be coldly realistic—and certainly not before a lot more pain is endured by many more of us. And how much confidence do we have that elected political leaders and their constituents will return to a patient, compromising spirit, one that demands those leaders lead by exercising their best judgment, well-informed, in serving the best interests of the country and its people? That, I believe, is where our hope lies: restoring a stronger, more resilient and accountable representative democracy, and thereby a stronger, more enduring republic. But that too will likely demand more pain visited on all until it is clear that the only thing left to them is to make the difficult decisions and carry out the necessary reform and change measures.
Until then, we will all look for more agreeable answers and affirming views, as Mr. Grantham reminds us we all subconsciously do. But it is most discouraging to hear some of the shallow voices of political leadership, like this one from Europe. In a recent Boston Consulting Group report, "Ending the Era of Ponzi Finance" (January 2013), they quote Jean-Claude Juncker, prime minister of Luxembourg and president of the Euro Group saying, "We all know what to do, we just don't know how to get re-elected after we've done it." The BCG authors, most all from their German offices, take it for granted that politicians will be unable to face up to their responsibilities and embrace the difficult changes that must be made—at least without the support of business and "other stakeholders." And so far, that is the way Eurozone political leadership has conducted itself as it fails to take the kind of decisive action needed to successfully address their budgetary woes.
At this point, our elected leaders in the U.S. appear to be no more willing to shoulder their responsibilities than those in Europe. But my more cynical instincts are tempered by the fact that we are the American republic that has always met our leadership challenges and patriotically made the necessary sacrifices to prevail and move forward as a nation, sooner or later--but too often later, as Sir Winston Churchill famously chided us. Said Mr. Churchill, "We can always count on the Americans to do the right thing, after they have exhausted all the other possibilities."
So now as much as ever, we look to that historical identity to surface and buoy our hopes. Even now with the narrower tolerances and decreasing room for error, now when the passage of time is a more unforgiving factor, don't we still expect the American leadership and people to rally, to do what must be done, even if only just in time to avert disaster? Even if it still dictates a lesser future among a world community of nations who may all have to accept a lesser future?
So, practically, ultimately, we likely have no better option than trusting that our untidy, often misguided, irresponsible and unaccountable group of elected leaders will eventually find no alternative left to them but responsible action. Only when that ungainly accumulation of feckless leaders gets frightened and despairing enough for themselves and the country will they give up their political and personal self-interest, make common cause with each other and the American people, and do the right thing—and do it just in the nick of time. The best we can hope for may be summed up in the old adage, "Better late[r] than never." But, as Mr. Zakaria observed, that may only be good enough to allow us a "muddle-through" future, one where we are unlikely to maintain our place of societal and economic distinction in the world.
