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ECONOMICS ON THE TRAIL

The Stagnation Thesis Is Back!

Macroeconomic Policy Changes Would Increase Economic Growth and Productivity

DECEMBER 01, 1995 by MARK SKOUSEN

“. . . the economy cannot on its own generate enough steam to provide our full potential of growth.”
—Alvin H. Hansen,
“The Stagnation Thesis” (1954)[1]

“. . . we no longer have a fertile frontier to exploit or a monopoly on the fast-growing mass-production and distribution industries that spearheaded growth.”
—Jeffrey Madrick,
The End of Affluence (1995)

Remember Alvin Hansen’s “stagnation thesis”? The Harvard economist first proposed this quasi-Keynesian proposition in the late 1930s when the U.S. economy was “stuck” in a never-ending depression. Unless the government engaged in massive federal spending, he asserted, the economy was doomed to lackluster performance due to declining population growth, the disappearance of labor-saving technology, and the closing of new frontiers.

Fortunately, Hansen’s stagnation thesis was repudiated both in theory and practice.[2] A booming population, advanced technology, and new frontiers (computers, electronics, telecommunications, etc.) propelled the U.S. economy to a period of rapid economic growth following World War II.

Now, a generation later, a prominent economic journalist has declared that the U.S. is going through another round of stagnating growth. According to Jeffrey Madrick in his new book, The End of Affluence, the nation’s economic growth has slowed to 2.3 percent a year on average since 1973. Before that, it grew at an average annual rate of 3.4 percent. The decline of 1.1 percentage points represents $12 trillion in lost wealth since 1973. “Twelve trillion dollars is more than enough to have bought each of America’s homeowners a new house, or paid off all our government, mortgage, and credit-card debt, or replace all of our nation’s factories, including capital equipment, with new ones.”[3]

Not only does Madrick paint a bleak picture of falling real wages, eroding markets, closed factories, and rising poverty, but, worse, he contends that there is virtually no way for America’s economy to regain its old ways of high performance.

Madrick blames a new form of global capitalism, not government, for this disastrous “slow growth” development. “The main reasons for this decline are not inflation, government budget deficits, low levels of investment, faltering education, the irresponsibility of Democrats or Republicans, excessive spending on the military, the aged, or the poor. . .” (p. 3). Rather, the cause is the permanent loss of America’s capacity for mass production, which has been replaced by “flexible” production by the Asians, Europeans, and other foreign competitors. No longer do companies produce a single mass product, but a wide variety of products in a single factory. This new intensive form of international competition has made economies of scale and big business obsolete. The result is a sharp curtailment in productivity growth, which is both permanent and worldwide. According to Madrick, even higher education and training don’t pay like they used to. In short, we are doomed to slower growth, both here and abroad.

Of course, Madrick’s fatalistic argument is as fallacious as Hansen’s old stagnation thesis. There is no reason why the United States can’t grow 3 percent or 4 percent or even 5 percent a year over the next decade—if the right actions are taken. To suggest that fiscal and monetary policy has little to do with economic performance is preposterous. And to assert that increasing competition and innovation reduce productivity is absurd. But that’s the kind of thinking that comes from a former NBC economics reporter and graduate of Harvard Business School.

Recent evidence contradicts Madrick. In fact, the day I bought his book, Business Week (Oct. 9, 1995) came out with a cover story on U.S. productivity. Due to restructuring and innovative production methods, U.S. productivity posted a remarkable 3.5 percent gain over the past year, higher than all other industrial nations. “Technology is transforming the American economy into the most productive in the world,” the magazine reported. “The result: higher living standards seem inevitable.”

Moreover, American business could do even better if the government adopted the right kind of macroeconomic policies. What Joseph Schumpeter said about the stagnation thesis could well apply to Madrick’s theory: “Though there is nothing to fear from people’s propensity to save, there is plenty to fear from other factors. Labor unrest, price regulation, vexatious administration and irrational taxation are quite adequate to produce results from income and employment that will look exactly like a verification of the stagnationist theory.”[4]

Imagine the favorable effects the following policy recommendations would have on American industry and wage growth:

—reducing or eliminating the capital gains tax;

—adopting a flat tax with generous exemptions for low-income workers;

—replacing Social Security with a genuine private pension system;

—curtailing wasteful spending, selling off federal assets, and privatizing government services, resulting in a budget surplus.

Despite Madrick’s claims to the contrary, such macroeconomic policy changes would cause a sharp drop in real interest rates and a dramatic increase in economic growth and productivity.

Skeptics who question the benefits of a “supply side” revolution should take a look at the recent success story of Peru. For decades, Peru experienced a form of secular stagnation, suffering from high taxes, hyperinflation, bureaucracy, and corruption. Then unexpectedly an outsider, Alberto Fujimori, was elected president. His administration transformed the economy. Inflation was cut from 7,650 percent in 1990 to 13 percent this year. Peru imitated Chile by creating its own alternative private Social Security pension plan. It engaged in extensive privatization, including Telefonicas del Peru. Even better than Chile, it abolished taxes on capital gains, dividends and inheritance. The maximum tax rate on income was cut to 30 percent. And there are no foreign exchange controls.

Not surprisingly, stagnating Peru became the fastest growing economy in the world, with a real economic growth rate exceeding 13 percent this past year. President Fujimori was re-elected recently with 64 percent of the vote.

The United States could see a dramatic rise in its fortunes if it followed a similar path. Its growth rate may not reach 13 percent, but it could easily double to 5 percent or more. To paraphrase Adam Smith, there is much potential in a nation. Don’t sell America short. []


1.   Alvin H. Hansen, “The Stagnation Thesis,” Readings in Fiscal Policy, ed. by Arthur Smithies and J. Keith Butters (Irwin, 1955). Hansen first raised the specter of secular stagnation in Full Recovery or Stagnation? (Norton, 1938).

2.   Hansen’s theory was dealt a deathblow by George Terborgh’s The Bogey of Economic Maturity (1954). Economists as diverse as Paul Samuelson and Mark Blaug agree that Hansen was proven wrong.

3.   Jeffrey Madrick, The End of Affluence (Random House, 1995), p. 6.

4.   Joseph Schumpeter, Capitalism, Socialism and Democracy (Harper & Row, 1950), p. 398.

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