How fast can the economy grow?
Alan Greenspan, Ayn Rand disciple and self-appointed economic Caesar, is dedicated to serving bondholders by making control of inflation his only priority. His chosen mechanism is periodic imposition of recessions to keep wages at or below the subsistence level. Paul Volcker, Greenspan's predecessor as Federal Reserve Board chair, tried to keep inflation at zero when the oil cartel raised prices in the 1970's by imposing a recession intended to drive down the prices of everything else. He raised interest rates to bring this about and got his recession, but prices of everything went up even faster and the combination of high interest rates, unemployment, and rising prices destroyed Jimmy Carter and produced Ronald Reagan. Ideologues are impervious to history, though, and Greenspan learned nothing from the debacle.
Up until 1970, the American economy grew at about four per cent a year. Like Greenspan, most academic economists now think that anything over three per cent cannot be sustained. Neo-classical arguments against the possibility of faster growth in the Gross Domestic Product are reasonable given neo-classical assumptions. The assumptions, however, are open to question.
Inflation is assumed to stem from excess demand in auction-like
markets, demand caused by wage earners having too much money, but in our
economy perhaps half of the prices in the GDP are administered by sellers-
health care alone now accounts for more than seventeen per cent of national
spending. Anything protected as intellectual property is allowed monopoly
pricing. Many services, like those of lawyers and auto repair shops, are
priced after they are delivered. And it is my observation and experience
that price increases in the administered sector tend to be inverse
to demand. Businessmen price on the income statement- if profits as
a percentage of sales fall, it is seen as a "need" for a price
increase. Because accounting profits rise and fall disproportionately to
sales, it's not surprising that inflation is currently low- earnings
are growing sharply. Nor was it surprising that businesses in the Volcker
years dealt with higher oil and interest costs and falling sales by raising
prices, curtailing investment, and laying off workers.
It is also assumed that industrial sales are limited by a theoretical capacity,
an element in demand-induced inflation. But employee expenses in many modern
corporations are mostly overhead that does not vary with unit demand. A
pharmaceutical company could double its unit sales with perhaps a five
per cent increase in the work force. When unit output grows faster than
the number of employees, measured productivity goes up.
Productivity-- output per worker-- is assumed to be a limiting factor,
one that grows only with additional schooling and a slow contribution of
technology. A few years ago for a forum on productivity, I examined manufacturing
productivity among countries and among American industries over time. (I
excluded service industries because of their notorious resistance to productivity
gains.) I found a near perfect correspondence between growth in output
and growth in productivity, across industries and countries. My explanation,
derived from decades of experience with a manufacturing multinational,
is that firms do not add capacity when demand is slack (regardless of interest
rates), but they invariably add plant to satisfy sales growth. The new
additions incorporate technology accumulated since the last expansion,
and are therefore more productive. When sales are growing and earnings
margins are rising, moreover, firms are more willing to spend on R &
D. Add the arithmetic consequence noted above of growth alone improving
the per-worker output of overhead employees, and one should expect
rapid growth in unit demand to increase productivity. This is a
far cry from assumptions derived from increased cultivation of less productive
land when demand for corn is high.
The currently low unemployment figures are also alleged to be a limit on
growth, but they don't take into account the excessive use of minimum-wage
workers in redundant fast food, retailing, and similar enterprises that
contributes nothing to the GDP-- fewer locations could easily supply the
demand. If faster growth were to shift some of these employees to manufacturing
industries, the wages and productivity of the remaining service workers
and locations would rise and growth in sales and earnings in the service
sector would be unaffected.
If continued growth in the GDP scares Alan Greenspan into
raising interest rates to head off an imagined inflation threat, the stock
and bond markets will fall, businesses will be frightened into cutting
new investment, unemployment will rise, and falling profits will cause
businesses to raise prices. Greenspan will not be blamed, though,
since the inflation will be seen to demonstrate his foresight.
Art Hilgart , October 9, 1997