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Government Caused the "Great Stagnation"

Peter J. Boettke

Tyler Cowen caused quite a stir with his e-book, The Great Stagnation. In properly assessing his work it is important to state explicitly what his argument actually is. Median real income has stagnated since 1980, and the reason is that the rate of technological advance has slowed. Moreover, the technological advances that have taken place with such rapidity in recent history have improved well-being, but not in ways that are easily measured in real income statistics.

Critics of Cowen more often than not miss the mark when they focus on the wild improvements in our real income due to quality improvements (e.g., cars that routinely go over 100,000 miles) and lower real prices (e.g., the amount of time required to acquire the inferior version of yesterday’s similar commodities).

Cowen does not deny this. Nor does Cowen deny that millions of people were made better off with the collapse of communism, the relative freeing of the economies in China and India, and the integration into the global economy of the peoples of Africa and Latin America. Readers of The Great Stagnation should be continually reminded that they are reading the author of In Praise of Commercial Culture and Creative Destruction. Cowen is a cultural optimist, a champion of the free trade in ideas, goods, services and all artifacts of mankind. But he is also an economic realist in the age of economic illusion.

What do I mean by the economics of illusion? Government policies since WWII have created an illusion that irresponsible fiscal policy, the manipulation of money and credit, and expansion of the regulation of the economy is consistent with rising standards of living. This was made possible because of the “low hanging” technological fruit that Cowen identifies as being plucked in the 19th and early 20th centuries in the US, and in spite of the policies government pursued.

An accumulated economic surplus was created by the age of innovation, which the age of economic illusion spent down. We are now coming to the end of that accumulated surplus and thus the full weight of government inefficiencies are starting to be felt throughout the economy. Our politicians promised too much, our government spends too much, in an apparent chase after the promises made, and our population has become too accustomed to both government guarantees and government largess.

Adam Smith long ago argued that the power of self-interest expressed in the market was so strong that it could overcome hundreds of impertinent restrictions that government puts in the way. But there is some tipping point at which that ability to overcome will be thwarted, and the power of the market will be overcome by the tyranny of politics. Milton Friedman used that language to talk about the 1970s; we would do well to resurrect that language to talk about today.

Cowen’s work is a subversive track in radical libertarianism because he identifies that government growth (both measured in terms of scale and scope) was possible only because of the rate of technological improvements made in the late 19th and early 20th century.

We realized the gains from trade (Smithian growth), we realized the gains from innovation (Schumpeterian growth), and we fought off (in the West, at least) totalitarian government (Stupidity). As long as Smithian growth and Schumpeterian growth outpace Stupidity, tomorrow’s trough will still be higher than today’s peak. It will appear that we can afford more Stupidity than we can actually can because the power of self-interest expressed through the market offsets its negative consequences.

But if and when Stupidity is allowed to outpace the Smithian gains from trade and the Schumpeterian gains from innovation, then we will first stagnate and then enter a period of economic backwardness — unless we curtail Stupidity, explore new trading opportunities, or discover new and better technologies.

In Cowen’s narrative, the rate of discovery had slowed, all the new trading opportunities had been exploited, and yet government continued to grow both in terms of scale and scope. And when he examines the 3 sectors in the US economy — government services, education, and health care — he finds little improvement since 1980 in the production and distribution of the services. In fact, there is evidence that performance has gotten worse over time, especially as government’s role in health care and education has expanded.

The Great Stagnation is a condemnation of government growth over the 20th century. It was made possible only by the amazing technological progress of the late 19th and early 20th century. But as the rate of technological innovation slowed, the costs of government growth became more evident. The problem, however, is that so many have gotten used to the economics of illusion that they cannot stand the reality staring them in the face.

This is where we stand in our current debt ceiling debate. Government is too big, too bloated. Washington faces a spending problem, not a revenue problem. But too many within the economy depend on the government transfers to live and to work. Yet the economy is not growing at a rate that can afford the illusion. Where are we to go from here?

Cowen’s work makes us think seriously about that question. How can the economic realist confront the economics of illusion? And Cowen has presented the basic dilemma in a way that the central message of economic realism is not only available for libertarians to see (if they would just look, or listen carefully to his podcast at EconTalk), but for anyone who is willing to read and think critically about our current political and economic situation.

The Great Stagnation signals the end of the economics of illusion and — let’s hope — paves the way for a new age of economic realism.

This post first appeared at Coordination Problem.

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