In Praise Of Heady Growth

By Michael J. Mandel

The U.S. economy grew by 4.9% in the past year, the biggest gain since 1984. The Standard & Poor's 500-stock index is up by 20% over the same stretch, while household wealth has surpassed its 2000 peak. And Americans have plenty of buying power -- consumer spending per person is up by 9% since 2000.

Nevertheless, as the election season heats up, economists and politicians on both the left and the right are raising dire warnings about future prospects for the U.S. economy. Topping the list of reasons for distress: huge budget deficits, ballooning estimates of the future cost of Medicare and other entitlements, the flight of good jobs to India and China, and the burden of increased military activity abroad and security measures at home.

Ultimately, we are faced with the question of whether to be optimistic or pessimistic about our economic destiny. Can the good times of the 1990s -- with its low unemployment, fast wage growth, and soaring stock market -- be repeated? Or was that era just a flash in the pan, the product of an out-of-control bubble mentality? Will we soar or struggle?

Here's the straight answer: The ability of Americans to thrive during the next 10, 20, or even 30 years does not depend on the budget deficit or the potential exodus of a few hundred thousand jobs to other countries. Rather, our economic future is inextricably linked to our ability to come up with more technological breakthroughs that equal the Internet in magnitude. Such large-scale innovations drive growth, create new jobs and industries, push up living standards for both rich and poor, and open up whole new vistas of possibilities. This is what I call "exuberant growth."

How can we be so sure of this? The lessons of history and economic research are very clear. Over the long run, economic progress in a highly developed country such as the U.S. depends mainly on technological advances. It was a succession of innovations -- including electricity, telephones, radio, automobiles, and antibiotics -- that revolutionized life in the first half of the 20th century. By contrast, the drought of economically significant innovations in the 1970s -- including the unanticipated failure of nuclear power as a cheap energy source -- helped pull down growth. It is no coincidence that the rise of the Internet in the 1990s coincided with the biggest rise in household incomes, and the biggest drop in poverty, in 30 years.

Going forward, such technology-driven growth is essential if we are not to drown in our problems. The Internet is terrific, but by itself it can't power long-term growth. Without cost-saving breakthroughs in medical science, it won't be possible to supply health care to a generation of aging Americans without bankrupting the young. Without new industries created by innovative companies, it won't be possible to generate enough good new jobs to replace the ones going abroad. Without breakthroughs in energy production and distribution, it won't be possible to provide inexpensive power for industrialized countries while supplying the energy needed to bring up living standards in the developing world. And without rapid growth, it won't be possible to simultaneously pay for national defense and the retirement of the baby boomers.

Simmering Away

The good news: It is rational to be optimistic about the next decade and the future beyond if we are willing to commit ourselves to innovation-driven, exuberant growth. All the ingredients are in place. There are plenty of potential technological breakthroughs simmering beneath the surface. To name just a few: wireless and broadband connectivity that could potentially revolutionize everyday life, solar power that could compete with conventional energy sources, biotech advances that actually cut health-care costs, nanotechnology -- building useful objects atom-by-atom -- that changes the nature of manufacturing and actually makes it cost-effective to produce things in the U.S. again, and space travel that is commercially viable. None of these new technologies is ready for prime time yet, but there's a good chance that at least one will be ready in the next 10 years.

Another reason to expect strong growth is the expanding commitment to research and development and to education around the world. With more smart people working on new ideas, the global rate of innovation goes up -- and since ideas flow freely across national borders, the U.S. benefits as well.

In the U.S. private sector, R&D spending as a share of gross domestic product was up sharply in the second half of the 1990s. And although private R&D spending has weakened a bit over the past couple of years, it's still near historic highs. In Asia, Chinese R&D expenditures now exceed those of any European country, while India is in the top 10 worldwide. At the same time, the number of college graduates has been rising in Europe and Asia as it has become clear that college is where people acquire the advanced skills necessary to prosper in a fast-changing world.

The nature of the U.S. financial system, too, is a cause for optimism, giving the country a unique competitive advantage. Unlike its rivals, the U.S. has a set of well-developed private markets -- led by venture capital and high-yield bonds -- for funding cutting-edge research and fostering innovative startups and fostering new businesses.

These capabilities of the U.S. financial system represent a major step forward. The essence of capitalism is how it raises and allocates capital. Today, the U.S. can quickly direct resources to areas of technological ferment. That sucks in new ideas and smart people from all over the world, accelerates technological change, produces jobs, and creates a competitive edge that other countries cannot match -- no matter how low their wages.

The bad news: Enemies of growth are everywhere. Both on the political left and on the right, there is a profound discomfort with technological change. Liberals blame technology for creating inequality and unemployment. Deficit hawks fear that new medical technologies will mean bigger health-care bills. Environmentalists worry about the negative impact of genetically modified crops. Moralists fret that technology has opened the door to potentially immoral and corrupting activities such as human cloning and Internet pornography.

Perhaps most surprising, economists, who should be the biggest fans of growth, have mainly ignored or dismissed the importance of technological change. Textbooks, popular writings, and public pronouncements by leading economists tend to focus on topics such as the budget deficit, savings, and taxes, while giving short shrift to technology, the economy's main engine of growth (box). The result is to undermine public support for R&D funding and other critical policies for innovation. In this sense, the economics profession is, unintentionally, an enemy of growth.

Poor Stepchild

It's also hard to find true friends of growth in either political party. Republicans and Democrats wrangle endlessly about tax cuts and budget deficits, even though there is little solid evidence that either has much effect on long-term growth. By contrast, technology-driven growth is the poor stepchild, receiving a microscopic amount of time, energy, and money from politicians. President Bush's latest budget calls for a decline in government funding for nondefense R&D in real terms over the next five years, according to a recent analysis from the American Association for the Advancement of Science. And reasonable proposals for accelerating the rate of technological change are mainly absent from either the Bush or Kerry Presidential campaigns.

To put it another way, what might be called the Silicon Valley mentality -- favoring experimentation, innovation, and change -- faces a hostile climate today. Perhaps this shouldn't be a big shock. Exuberant, technology-driven growth is upsetting to the status quo -- and to the big companies and political donors that benefit from keeping things as they are. Technology represents a force for change that is profoundly threatening.

Nevertheless, there is no doubt that innovation is absolutely indispensable for productivity, wages, jobs, and international competitiveness. Consider productivity: Over the past 50 years output per hour has risen at an annual average of 2.2%. According to the Bureau of Labor Statistics (BLS), investment in machinery, equipment, and other physical capital accounts for about 40% of those gains. Upgrades to the labor force -- including education and experience -- account for a further 10%.

Where does the other half of productivity growth come from? Mainly technological and business innovation. Without it, the economy would be much smaller, standards of living would be much lower, and there would be fewer resources available for either the military or domestic priorities such as health care.

In addition, periods of innovation have generally boosted wages for the poor and for the working class. In the early 20th century it was innovative industries such as automobile manufacturing that could afford to pay the best wages. Henry Ford boosted his factory's daily wage to $5 per day in 1914, when the going wage for factory workers was less than $2.50. More recently, the fast-growing tech sector led the way toward rapid wage growth in the 1990s.

Job growth, too, is closely tied to innovation. Typically, big technological breakthroughs create new and profitable industries that need a lot of workers and are willing to pay good money. Indeed, it's possible to go down the list of industries published by the BLS and identify what past innovations led to which jobs. Perhaps 9 million Americans hold jobs making, selling, or servicing autos and airplanes. An additional 4 million are directly engaged in making high-tech equipment, selling it, or helping people deal with it. The list goes on and on.

A big part of the weakness of the labor market today is that there hasn't been a new job-creating, technological breakthrough in the past few years. The tech sector is still recovering from the roller coaster of the 1990s, and no other leading sector has yet stepped forward to take its place.

Moreover, it's hard to forecast which technology is going to be the Next Big Thing. There are plenty of candidates -- biotech, telecom, nanotechnology, energy, space -- but in each case tremendous economic potential is balanced out by equally daunting obstacles. Biotech has seen rapid scientific advances, but it has proved much harder and more expensive than expected to develop blockbuster products. The need for new energy technologies is obvious to everyone, but neither solar power nor fuel cells are yet economically viable. The commercial exploitation of space offers tremendous opportunities, but the cost of putting objects into orbit is still too high. And the telecom industry, while growing rapidly, is still suffering from regulatory and economic obstacles that have slowed broadband penetration and left the U.S. with a fragmented wireless system.

Overcoming Obstacles

Any one of these technologies is a long shot to become the Next Big Thing over the next 5 to 10 years. But unlike any other country, the U.S. can put substantial resources into all these areas at once -- funding research, startups, and new product development -- while absorbing the financial pain of failures. It's like putting down bets on more than one number at the roulette wheel -- the odds of at least one becoming a big success go way up. More than that, the flexibility of the U.S. financial system means any promising technology or product can get funding, even if it threatens existing companies. Once any of these technologies gets close to commercial viability, the resources will be there and its economic impact will be accelerated.

But the triumph of exuberant growth over its enemies is not inevitable. Throughout history, the foes of innovation have often dampened technological change. As economic historian Joel Mokyr writes in his 1990 book, Lever of Riches: "Technological progress is like a fragile and vulnerable plant, whose flourishing is not only dependent on the appropriate surrounding and climate, but whose life is almost always short. It is highly sensitive to the social and economic environment and can easily be arrested by relatively small external changes."

To increase the odds in favor of exuberant growth, we need new goals for running economic policy -- and politicians brave enough to support them. First, we must encourage technological change by paying far more attention to encouraging basic and applied research, the formation of innovative new startups, and the development of a skilled workforce. Conversely, we need less debate about the budget and trade deficits, and more of an understanding that America's greatness has always rested on its ability to embrace technology and change.

A different sort of macroeconomic policy is also needed. For the past 50 years, macroeconomists have focused on smoothing out the ups and downs of the business cycle. That's still paramount to avoid deep recessions. But technology-driven booms, like the one of the 1990s, should be encouraged. Although running the economy "hot" does carry dangers -- the possibility of a bust afterward -- the benefits of providing better conditions for innovation and risk-taking more than outweigh the downsides.

But such growth-oriented policies are unworkable without an equally intent focus on providing more economic security as well. Rapid technological change is inherently scary to people, because it has the potential to destroy their jobs and overturn their way of life. Therefore, exuberant growth must go hand in hand with economic security. Fairness and transparency are crucial. If we want people to support technological change -- as investors, as workers, as consumers, as voters -- they must feel there is a level playing field and that no critical information is hidden from them.

Next, we have to ease the pain for Americans who are hit by financial or technological turbulence. What's needed is some form of income insurance, which would go beyond unemployment insurance and offer protection against drops in income. One way to provide such protection is to modify the tax system to allow people to utilize income averaging over several years for tax purposes. Such a strategy means that someone who did well one year and poorly the next could average over two or three years and end up paying a lower tax rate. In 1997 the tax laws were changed to include such a provision for farmers, but it needs to be broadened to everyone. The result would be a big tax refund for people -- especially middle- or high-income taxpayers -- who lose their jobs or are forced to take a lower paying one.

Above all, we must strengthen the safety net to allow Americans to support technology-driven growth without worrying that it will rob them of jobs and benefits. In particular, a fast-growing, exuberant economy can afford to provide at least a minimal level of health-care coverage for everyone.

In this new world, a political coalition built around both pro-growth policies and policies promoting economic security and fairness is needed. The coalition will cut across party lines, encompassing all groups who benefit from technology-driven growth: investors with money in the stock market; educated managers and professionals who thrive in periods of rapid change; less-skilled workers who can ride a boom to a better life.

Finally, and perhaps most important, we must embrace the exuberance brought on by new technologies and renounce the ethic that too much growth is bad for us. Exuberance is not a character flaw that has to be rooted out. Rather, it's the essential motive force for a technologically vibrant economy.

Economists who thought that the U.S. economy had reached a mature state in the 1980s were proven wrong by the Internet and the technology boom. We do not know what lies beyond the next hill. It cannot be proven that there are new opportunities beyond the horizon. But embracing exuberant growth helps ensure that our children live not in the Age of Uncertainty but in the Age of Possibility.

Adapted from Rational Exuberance: Silencing the Enemies of Growth and Why the Future Is Better Than You Think by Michael J. Mandel. Published by HarperCollins, May, 2004. Copyright 2004 by Michael J. Mandel. Michael J. Mandel is BusinessWeek's chief economist. His previous book, The Coming Internet Depression, came out in September, 2000.

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