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Wednesday, December 23, 2015

Schumpeterian growth and secular stagnation

What is secular stagnation? The "secular" part suggests something that's persistent--in the order of decades (as opposed to the 2-5 year frequency usually associated with a business "cycle."). The "stagnation" part suggests a measure of under-performance. But what measure? Are we talking about lower than average growth in employment and incomes? Or are we talking about depressed levels, instead of depressed growth rates? Are we talking about both? Getting this straight makes a difference in how we want to approach thinking about the phenomenon in question.

In what follows, I'll take the view that secular stagnation refers to prolonged episodes in which growth in real per capita income (GDP) is lower than its long-run average.

Most economists agree that long-run growth in material living standards (real per capita income or consumption) is the product of technological progress. Contemporary business cycle models (at least, those used for monetary policy) assume that technological progress occurs more or less in a straight line. This abstraction may be fine for some purposes, but I never much liked it myself. As a PhD student, I was influenced by Schumpeter's 1939 masterpiece Business Cycles.

Schumpeter (1939) emphasized that there is no God-given reason to expect growth to occur in a straight line. Research and development, and the process of learning in general, can be expected to generate innovations of random sizes and at random intervals. Moreover, any given innovation takes time to diffuse. Economy-wide productivity does not jump instantaneously with the arrival of the internet. I like this quote from his book:
 ‘‘Considerations of this type [the difficulty of coping with new with new things] entail the consequence that whenever a new production function has been set up successfully and the trade beholds the new thing done and its major problems solved, it becomes easier for other people to do the same thing and even improve upon it. In fact, they are driven to copying it if they can, and some people will do so forthwith. Hence, it follows w that innovations do not remain isolated events, and are not evenly distributed in time, but that on the contrary they tend to cluster, to come about in bunches, simply because first some, and then most, firms follow in the wake of successful innovation.’’ [p. 100]
It was this passage that led me to think of a model in which technological innovation drove growth but in a manner that was uneven because of diffusion lags. The notion that a new general purpose technology might spread like a contagion to generate the classic S-shaped diffusion pattern in GDP seemed like a very interesting hypothesis to investigate.

I was also influenced by Zvi Griliches' famous empirical investigation of the diffusion of hybrid corn in the United States:

In my paper (actually, the second chapter of my PhD thesis, published in 1998 with Glenn MacDonald) I saw this:

And so Glenn and I built a dynamic general equilibrium model where firms were motivated to innovate and imitate superior technologies. We estimated parameters so that the model reproduced the smooth but undulating path of GDP depicted in the figure above. I think I see these patterns in more recent TFP data as well (source):

According to this interpretation, episodes of secular stagnation are largely an inevitable byproduct of the process of technological development and growth. Accepting such an interpretation does not, in itself, have any implications for the desirability of policy interventions. But it does call into question the efficacy of certain types of interventions. In particular, do we really believe that more QE will spur future economic growth? Or should policy attention be directed elsewhere?

Now, one might object, as Larry Summers does here, that "If the dominant shock were slower productivity one might expect to see an increase in inflation." The type of reasoning that underpins this view is the simple Quantity Theory of Money equation: PY=VM. Ceteris paribus (holding MV fixed) a decrease in real income Y should induce an increase in the price level P. Maybe the 1970s provides the empirical basis for this view.

But there is no theoretical reason to believe that productivity slowdowns, or indeed, expected productivity slowdowns, should be inflationary. It's very easy to demonstrate, in fact, that "bad news" in the form of a slowdown in productivity leading to depressed expectations over the net return to capital spending can cause a "flight to safety" to government debt instruments (including money). The effect of such portfolio substitution is to depress bond yields and the price-level (see here and here for example).  But even apart from these effects, the behavior of inflation depends critically on the nature of monetary and fiscal policy.


  1. So, recognizing that technological changes & productivity changes display such clustering, and then assuming that we mere mortals are unlikely to know when and where the next big thing will occur, we might conclude that the most important thing is to get the "conditions" right. I put conditions in scare quotes because I'm thinking not of industrial policy or any of that simplistic nonsense, but the much deeper arguments made by D. McCloskey in her latest series of books.

    Her's is a very well developed theory that the great increases in productivity and quality of life in the West were due not to division of labor or capital accumulation. Rather, those were results of a change in how society viewed the merchant class - what she calls the bourgeoisie. I really can't capture her arguments in a comment on a blog post, but her books are very worthwhile.

    The reason I bring it up is to ask you this question. How important is it that right now, in the developed Western countries, business is viewed with great suspicion, and so policies that limit growth and innovation are very easy to pass? Things like occupational licensing, business licenses (esp. in financial services) and the rest all limit business formation and thus eliminate the conditions in which clusters of innovation can take place.

  2. Larry Summers has to be conning us. I don't trust the guy at all. By the way, Summers also probably thinks that inflation would raise interest rates on long bonds. I don't think that is true either, now that there is such massive demand for the long bonds in clearing houses. Also, please let me understand why economists do not want to study the supply and demand of long bonds, as this is a legitimate economic reality?

  3. You think of Schumpeter, I think of Heraclitus: "Every cow is driven to pasture by a blow." Even where new technologies have favorable payback times and other obvious advantages, businesses resist their adoption and it often takes persistent effort on the part of governments and trade groups to catalyze change. I work for private outfits that do this sort of thing for the electric utilities, but our efforts to encourage the spread of such innovations as variable speed electric motors and other power electronics equipment often depend on government help. The classic instance of the adoption of hybrid corn certainly owed a lot to the Department of Agriculture. The role of government action in research is pretty well accepted, but the state's role doesn't end when a new device or drug is developed. Perhaps one reason that technology-driven growth slows down at times is that ideologies hostile to the entrepreneurial role of government prevail, often with the help of old business interests who have every reason to fear creative destruction. If you stop pushing, things stop moving because of the viscosity of the medium, i.e., the innate conservatism of those who already have theirs.

  4. I think of secular stagnation more in terms of the distribution of income than in terms of technological innovation. As the concentration of income increases the ability to sell potential output depends increasingly on the expansion of debt relative to income. When this kind of debt expansion is no longer feasible the economic system stagnates so long as the concentration of income remains. See:

  5. "When this kind of debt expansion is no longer feasible..." If debt expansion is no longer feasible, George, why do we have a shortage of long bonds as Larry Summers and many others have said? Now there is massive demand for the bonds. But, you are right though that there is stagnation.

  6. Very interesting post, thank you !!!
    I recently read Schumpeter's "Theory of Economic development", one of his first major contributions in which he already lays out his ideas about long-term economic growth. Most importantly, his ideas about innovation being the key driver of economic growth (creative destruction) and also that it is a highly uneven process. I actually discuss his work on my blog if anybody is interested and link his ideas to some of the work that has been done recently on endogenous growth models, which can model Schumpeterian waves. Here is the link:
    I start off being rather critical with Austrian economics, but later on highly praise Schumpeter's ideas, which are mostly ingenious.