An Alternate Theory about the Root Cause of the Current Economic Crisis
Martin Ford offers further thoughts on where we are headed.
An Alternate Theory about the Root Cause of the Current Economic Crisis
Bernanke’s speech in Atlanta a month ago focused a lot of attention on the debate about the forces that led to the current crisis. Was it primarily Greenspan’s low interest rates, or as Bernanke suggested, was a lack of regulation and oversight a more important issue? Nearly everyone seems to agree that the crisis was brought on by some combination of these factors. In other words, the current situation is viewed almost entirely in financial terms.
While there is no doubt that the financial meltdown was the proximate cause of the current recession, is it possible that a more fundamental cause exists? What if the housing bubble and the financial crisis were merely symptoms of something even bigger—perhaps of a structural shift occurring in the broader economy?
I’ve argued here previously that advancing automation technology is likely to result in structural unemployment in the future. In fact, I think this is a trend that is already well underway. The last decade has been characterized by substantial advances in information technology and fairly dramatic increases in productivity. Average workers have seen stagnant or even decreasing real wages, while health care costs have been exploding. Until the onset of the current crisis, official unemployment numbers were low, but those statistics fail to capture underemployment, such as workers who are forced to work multiple part time jobs with no access to benefits.
Globalization, of course, gets much of the blame for the plight of average workers, but the reality is that advancing technology has a larger impact. Jobs are not just moving to China—they are being automated away completely. This is happening not just in the United States but in low wage countries as well.. And it isn’t just in manufacturing; as I’ve pointed out here previously, service sector and knowledge worker jobs are increasingly subject to automation as well.
As the dual forces of technology and globalization progressed over the past decade, I suspect it became pretty clear to most average workers that holding a job at the prevailing wage offered little hope for getting ahead. Recognition of that reality certainly played an important role in the politics that led to the creation of subprime lending programs. You can make a pretty strong case that the housing bubble was caused not simply by low interest rates but by widespread recognition that investing in a home represented perhaps the only viable hope for a typical American family to achieve any measure of prosperity.
The last decade also saw a massive shift away from consumer spending supported by wages toward spending supported by debt (much of it anchored to inflating housing values). That debt-enabled spending drove economic growth not just in the U.S. but, of course, in China and in the rest of the developing world as well. Was all this really caused by the Fed’s policy? Or was it fundamentally caused by advancing technology (as well as globalization) driving discretionary incomes down to a level where broad-based consumer spending became unsustainable without reliance on debt?
I think that is a very important question. Virtually all mainstream economists are focused on a financial solution to the current crisis involving some combination of monetary policy, additional stimulus and re-regulation. If it it turns out that the root cause of the crisis is really technology, rather than finance, those solutions will simply not be sufficient in the long run. Technology is relentless. Automation will never stop progressing, and no conventional financial or monetary policy can, by itself, address that issue.
In my book, The Lights in the Tunnel, I make the case that a basic shift is occurring in the economy. Technology is becoming autonomous, and job automation will invade virtually every employment sector. The result will be structural unemployment and declining wages for all but a tiny (and shrinking) elite. I think it is very possible that the beginning of that trend underlies the current crisis to a significant extent. I suspect that very few people will agree with me on this, but if I’m right, the implications are scary: it means that virtually everyone is focused on solving the wrong problem.
Martin Ford is the author of The Lights in the Tunnel: Automation, Accelerating Technology and the Economy of the Future and has a blog at econfuture.wordpress.com
What if the control of the distribution of wealth was not in the hands of self-serving individuals? Would the problem be better addressed?
“If it it turns out that the root cause of the crisis is really technology, rather than finance, those solutions will simply not be sufficient in the long run.”
Could one say that the root cause of the crisis is the decline of the labor movement? (Rather than technology per se.) Or that the root cause is increasing inequality?
Are people not addressing the question of increasing inequality? And is financial regulation not one way of doing so, at least in part?
I beg to differ, however, may everyone enjoy this across divides of opinion: I have just added a Reference List to my economics blog with economic data series, history, bibliographies etc. for students & researchers.
Its Women in the Workforce-
Dual income dependant economy- young women wanting to be in the workforce, wanting to bear children at a later age and subsequently wanting to leave the workforce during their later child bearing years. The cost of living rises in relation to dual income model but subsquently doesnt decrease when the female (or male) leaves the employment sector. This model differs from the traditional model in that is now more common (and accepted) to have Mr Mom staying at home in cases were the female is percieved to have the stronger earning power. Or the female is then forced to stay in the workforce against her liking because the family unit is now dependant on that income source to survive. Consumer goods, housing, etc. increases yet salaries paying a livable wage decline. Ladies, maybe your Mother’s advice was not in your best interest after all…
Not a good first impression to advertise this way.
I’m not all that sure that investing in personal ownership of a single asset (a house) is superior to renting a house and investing in companies that own rental houses.
There are certainly benefits to owning your house/flat versus renting, such as being able to decide on your own about renovations or building an annex, but that’s not really an economic benefit. This especially relates to poorer sections of the public who do not have the high income to build up assets to deal with unexpected events (not everything is insurable).
I’d also argue that a sizable rental market can also improve labor mobility.
Hat tip to Martin for at least bringing up a possible negative regarding technology which is very rare given the religious standing technology has in modern life. While an argument could be made that the political class wanted to blunt the effects on employment due to automation,rising energy cost and globalization by allowing the banking system to run wild it certainly didn’t work. Having retired from the manufacturing sector it has been clear that little thought has been given to the rate of technology change and its impact on business life. No one has yet provided me with a good explanation of how a business can purchase machinery for millions of dollars and have it become obsolete in a few years or whole sectors of the economy simply disappear and expect a viable social order to follow. I realize that risk and change are part of the human experience but we have understood that excess credit creation has negative consequences and as a functioning society we will have to understand the limits of rapid technology change.
Hat tip to Martin for at least bringing up a possible negative regarding technology which is very rare given the religious standing technology has in modern life. While an argument could be made that the political class wanted to blunt the effects on employment due to automation,rising energy cost and globalization by allowing the banking system to run wild it certainly didn’t work. Having retired from the manufacturing sector it has been clear that little thought has been given to the rate of technology change and its impact on business life. No one has yet provided me with a good explanation of how a business can purchase machinery for millions of dollars and have it become obsolete in a few years or whole sectors of the economy simply disappear and expect a viable social order to follow. I realize that risk and change are part of the human experience but we have understood that banking requires regulatory controls and over time we may come to realize that having a functioning social order may require similar control over the rate of technology change.
Wealth distribution is only a symptom, but it is a good starting point, it is imperative though to see this globally. Not to be hyperbolic, but instead to establish a bench-mark, the earnings at the top of the global spectrum are about $1bn per year; the earnings at the bottom are about $300 per year; put simply, one investor equals 3,333,333 workers. And obviously, the value of a person’s contribution was lost somewhere along the way. This is of course the most extreme example possible but it serves the point, I could then compare this to the US economy in the 1950s, which if I remember correctly was a ratio of about 25 to 1, but instead of wasting anymore time on this I’ll just say 50 to 1 and take the lazy way out here, 3,333,333 to 1 is so far out of balance that it pretty much stands alone anyway.
Another symptom of the problem has to do with the interdependent relationship between growth via lending and upward mobility rates. Compare an economy with a 50 to 1 ratio to an economy at 3,333,333 to 1 and there is a hint of what this means in regards to upward mobility. Naturally, there there is a multi-dimensional upward mobility factor involved here, but, that leads to China now having the World’s 3 largest banks and their producing more autos than the US etc., and my macro lacks ‘pop’ even when I avoid being redundant, so maybe that is enough about upward mobility just now. What is worth repeating though, is that the formula of earning, saving, and investing those savings, is what keeps asset values tied to incomes. It might also be worth noting that if economists intend to succeed in their field, this simple formula is best ignored, it is not a popular concept among the string-pullers. So in a way, the problem is about the incentive dynamics of the field of economics — but the problem can be defined in many ways.
The latest super recession is like other recessions but is worse for various reasons. Most come from excesses in the economy of one sort or another. Did the 1929 recession stem from technology? Or the 1958 one? Or the 1974 one? Or the 1980/81 one? Or the 2001 one? If not why would one think this one stems from technological change…which is an ongoing process in any case? I smell someone with an idea to sell and an ax to grind.
I wonder whether the root metaphor helps in thinking about a network of variables that interact and feed back and get trapped in eddies. Lots of factors seem important. None looks like a prime mover.
All of these technology changes were going on in the 90s, yet employment increased dramatically and wages did, too. Manufacturing employment declined significantly under Bush I (down 7%), by huge amount under GW (down 25%), and by a little under Reagan (down 3%), and yet it increased by 2% under Clinton.And didn’t James Galbraith pretty much eviscerate these technology change explanations for workplace phenomena that happened to fall disproportionately on middle and lower income people?
That kind of explanation always looks like a way to defelect attention from what really matters: government policy. Restrain the power of the rich and you get higher unemployment and higher wages for ordinary Americans; loosen it and they decline. The irony is that the rich come out better when government restrains their power (which really means restraining the power of the worst of them): they may have a somewhat lesser share of the pie, but the pie is much bigger and their total amount is bigger than it would have been.
I should have said more about automated production etc. The problem is in part downward pressure on wages on a global scale. So the mechanization trend is clearly adding to that pressure, but not nearly so much as the fact that billions of people are unemployed, and the subsidizing of ag goods, by all of the developed nations, is keeping labor markets in a constant state of vast oversupply. But it is how this downward pressure is being expressed through upward mobility rates that is the key to understanding the whole mess. Consider for instance what would have happened without the excessive leverage ratios of 40 to1,, and then subtract the illusionary gains from sub-prime loans and all of the other ‘innovations’, and what remains is an economy that lacked enough borrowers, and an economy with household debt maxed out, and an economy that would have simply collapsed sooner. This first became apparent in the late 1990s when lenders were out knocking on doors and signing folks up for second mortgages. Another way to define the problem is to say the US economy became too dependent on the financial services sector, and that includes a little hint of the health-care facet, but as I said before, the problem can be defined in many ways. But the popular definition, whether one includes interest rates being too low with a lack of regulation, with a GSE twist or whatever combination thereof, that is like saying that the Great Depression was caused by a run on banks — nonsense!
I’ve been thinking of having a seminar on the importance of writing readable sentences, and on how rude it is not to support claims. I don’t have a website but there is park near my house and I was wondering if I might post the directions on your site? I live near the middle of the country and I think everyone should be more like me, I am exemplary because….
The fiscal and monetary policies of the United States for the last thirty years have been geared toward rewarding capital investment at the cost of real wages. This was intended to increase capital investment, eventually resulting in a bounty trickling down to all.
In a world filled with examples of unintended consequences is it so hard to accept that these policies have actually worked too well producing more capital than could be absorbed by traditional investments?
This explains much of what we have seen in the last thirty years. The poor wealth distribution. The bubble markets, where the excess capital in turn chased stocks and then real estate. The increased derivatives makets, financial instruments that in truth were nothing more than zero sum gambling. The flow of money pushing the mortgage market to make risky loans.
You’ve left out targeting price inflation. I believe what you are trying to ask is if positive productivity growth and cheap labor produce price deflation, what should happen?
The fed wanted lower reserve requirements, lower capital requirements, and lower interest rates so that more debt could be used to fight price deflation. It worked until most average people ran out of savings and the ability to make the interest payments.
From bernanke’s speech “
Deflation: Making Sure “It” Doesn’t Happen Here “
“The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand–a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers.1 Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending–namely, recession, rising unemployment, and financial stress.”
1. Conceivably, deflation could also be caused by a sudden, large expansion in aggregate supply arising, for example, from rapid gains in productivity and broadly declining costs. I don’t know of any unambiguous example of a supply-side deflation, although China in recent years is a possible case. Note that a supply-side deflation would be associated with an economic boom rather than a recession. Return to text “
If you are disagreeing with bernanke, GOOD!!!!!!!!!!
Oops! Forgot the link.
Actually, it looks not to be a bad site. The advertiment here might be a bit clumsy and not too appropriate. But the site itself looks to be worth a visit assuming that it’s not loaded with malware or some such. It didn’t inundate me with banner ads or try to sell me stock in Bolivian coconut planatations or anything. I tracked through it enough to find lots of links to serious material. I bookmarked it and probably will return to it in the future.
And how would one explain Japan? Aggregate demand has been dropping for 20 years?
Is it just possilble that sources of deflation are more of a mystery than we think? Gee, maybe we really don’t understand econmics very well?
In short, Japan’s deflation problem is real and serious; but, in my view, political constraints, rather than a lack of policy instruments, explain why its deflation has persisted for as long as it has. Thus, I do not view the Japanese experience as evidence against the general conclusion that U.S. policymakers have the tools they need to prevent, and, if necessary, to cure a deflationary recession in the United States.
Bernake says political constraints explains Japan’s persistent deflation. So there are cures, they just never implemented them.
The steadily (and rapidly) increasing length of “jobless recoveries” since the rise of Reaganomics is yet another nice demonstration of what Martin suggests.
Picture and numbers:
According too Keynes, by now we should not be working more than 3 hours a day, because of the increases in productivity. That prediction seems to fit this storyline. So why don’t we all live happily off our technological conquests, instead of muddling through all this stress?
No doubt the American worker has become destabilized in extremely large numbers. This has threaten
the standard of living in the US. But anyone could have seen this coming starting in the early 1990’s. It’s obvious. Outsourcing, NAFTA, accelerated immigration, staffing agencies, etc. I believe increases in productivity shows a shift in accounting methods such as overseas productivity integrated into US
productivity. Many companies do not tell the truth. They want to show increased profits by way of efficiency for their stock holders. There has to be constraints on increased productivity and a decline in
employees. Hard to tell without looking at an operation. However, without looking. I believe that
companies have boosted their productivity earnings by using overseas labor in some sort of accounting trick.