Recently there’s been a lot of talk about so-called “secular stagnation.” The term refers to a condition in which an economy isn’t just recovering slowly (say, from a deep financial crisis) but is permanently stuck in a mode characterized by very low growth, low inflation (or outright deflation), and stubborn, high unemployment. The purpose of this and the next few posts is to assess the merit of this idea. But, first, let’s look at its provenance, since that is likely to shed light on the subject.
Secular stagnation grew out of the concept of “underemployment equilibrium,” a condition described by John Maynard Keynes in which economic outputs are suboptimal in terms of both demand and production. Keynes noticed that, in market economies, output tended to equalize at a level below full employment. Since (he theorized) this was undesirable from a social welfare point of view, governments should step in. (More on this below.)
Of course, for Keynes there was no social welfare desideratum that couldn’t be brought about by injecting the dead hand of government, but even by Keynesian standards the notion of underemployment equilibrium is bizarre. Before we move on, let’s pause to consider just how bizarre it is, since the idea of secular stagnation grew directly out of it.
If economies were static, and if they chronically equilibrated at less than full employment, maybe we should think about doing something about it. But market economies are dynamic, sometimes spectacularly so, while us workers are slow-footed, slow-witted and set in our ways. As the economy evolves toward ever more efficient production, it takes us a long time to notice that it’s leaving us – or our children – behind. Eventually, of course, we get the message and get ourselves retrained or better educated or whatever.
In the meantime, though, some of us will be un- or underemployed. But that’s a small price to pay for an ever more dynamic and productive economy that ensures better and better jobs for the greater and greater number.(1) After all, while it’s true that there will always be people who are un- or underemployed, those who are so situated in Year 1 are very different from those who are so situated in Year 10. (And if they aren’t, the problem lies with the people, not the economy.) All this is why most economists (and central bankers) consider “full employment” to be somewhere well above 0%.(2)
Silly or not, underemployment equilibrium found an enthusiastic proponent in Alvin Hansen, a Harvard professor who was the main American proponent of Keynes. In retrospect, the idea that millions of people making hundreds of economic decisions (each) everyday could somehow be stupider than a small handful of over-educated government bureaucrats is too funny for words, but at the time it somehow seemed sensible.
Keynes’ The General Theory of Employment, Interest and Money appeared in 1936, in the midst of the Great Depression (hence Keynes’ skepticism about free market ideas). Most people assumed that the US economy was very slowly recovering from a deep financial crisis (the stock market collapse of 1929), which had been converted into a depression by the foolish actions of the very governments in which Keynes placed such confidence.
Alvin Hansen glommed on to the idea of underemployment equilibrium and, in his 1938 book, Full Recovery or Stagnation?, proposed that the US economy was not just slowly recovering from a deep financial crisis and recession. No, the US economy had, according to Hansen, permanently declined into a mire of low growth and high unemployment from which it could never emerge short of dramatic government action.
The government action Hansen had in mind was permanent and massive deficit spending, and also, if needed, wage and price controls, which he saw as necessary to restore full employment and keep it there. How would such a preposterous policy be paid for? Well, the government could simply print money, of course, but even Hansen recognized that such a practice would eventually lead to skyrocketing inflation, an economic cure far worse that the underemployment disease.
Hansen favored, instead, very high taxation on productive workers, so that those moneys could be passed on to unproductive workers. That would stimulate overall demand so that even unproductive workers would be hired (he thought). Of course, high taxes on productive workers and handouts to unproductive workers is a policy that’s been tried by every Banana Republic in history, to say nothing of the USSR, Maoist China, Cuba, Venezuela… oh, I already mentioned Banana Republics.
Fortunately, the US was spared turning itself into a Banana Republic because, literally as Hansen’s book was coming out, the US was emerging from the Depression. Far from being permanently mired in slow growth and high unemployment, the US economy turned out to be the most productive in the history of the world. In no time at all America, one of some 200 countries on earth, accounted for fully 25% of global GDP, a number it has maintained right up to the present time, as competitor countries have come and gone.
Hansen’s notion of secular stagnation was so embarrassingly wrong that it, and he, were quickly and deservedly forgotten. If he is remembered today at all, it’s for the long parade of students he turned into Keynesian automatons and then sent out into the world, where they caused much mischief. The most famous of these students was Paul Samuelson, whose iconic textbook tried to brainwash college students into becoming blind Keynesian devotees.(3) It nearly worked, too. If it hadn’t been for the Department of Economics at the University of Chicago, the American economy would today be the size of a walnut.
If economists were normal human beings, we could relax in the assurance that we would never have to hear the words “secular stagnation” again. Unfortunately, they’re not normal human beings. Viz.,(4) Larry Summers.
(1) People often make the mistake of observing this process as it operates in only one country. When the steel industry declined in the US because steel could be made better and more cheaply elsewhere, it caused thousands of job losses in the US but created millions of jobs worldwide. And the lower costs of steel created millions more jobs in industries that used steel.
(2) “Full employment” can range from as low as 1% – 2% to as high as 13% to 15% depending, at the extreme ends of the range, on the country and whether the observer is a rightwing nut case or a leftwing nut case. The OECD estimates that full employment in the US is 4% to 6.4%.
(3) I’ve mentioned this before (see “Submerging Markets (Part 3),” post of 8/8/13), but the Samuelson textbook I used in college confidently informed me that the USSR would overtake the US as the world’s largest economy by 1984. Even as late as 1989 (in a much later edition of the book), as the USSR was collapsing before our eyes, Samuelson could write, “Contrary to what many skeptics had earlier believed, the Soviet economy is proof that … a socialist command economy can function and even thrive.”
(4) Not that you care, but the “z” in viz. is, as far as I know, the only remaining use of Tironian notes, a form of shorthand invented by Cicero’s secretary, Marcus Tullius Tiro. The “z” is really a Latinization of the Tironian ⁊, which fell out of common use in the 19th century.
Next up: Slow Recovery or Secular Stagnation? (Part 2)
[To subscribe or unsubscribe, drop me a note at GregoryCurtisBlog@gmail.com.]
Please note that this post is intended to provide interested persons with an insight on the capital markets and is not intended to promote any manager or firm, nor does it intend to advertise their performance. All opinions expressed are those of Gregory Curtis and do not necessarily represent the views of Greycourt & Co., Inc., the wealth management firm with which he is associated. The information in this report is not intended to address the needs of any particular investor.