Sunday, February 17, 2013

It's All About Growth

I attended an investment symposium a couple of weeks ago and had the opportunity to see several of the leading academics in the field of economics and finance.  The speakers included Robert Merton, Professor of Finance at MIT and winner of the 1997 Nobel Prize in Economics and Eugene Fama, Professor of Finance at the University of Chicago.

Another speaker at the seminar that I was not familiar with before the event was Kevin Murphy who is a Professor of Economics at the University of Chicago.  Murphy puts most of his focus on microeconomics doing research in the areas of economic growth, unemployment, relative wages and  medical research.  His speech at the conference was "Investments in People: Education, Health and Growth.

I am a chart guy and I thought several charts in his speech were very interesting and insightful as were his comments on what are the necessary elements for a growing economy in the future.

The first is a chart of the growth in real U.S. per capita GDP.  The red line indicates the growth trend over the years 1889-2012 and the blue line is actual growth.

As you can see, over the last 100+ years we have enjoyed an inexorable increase in our GDP and wealth.  This growth has given us a standard of living that is the envy of the world.

What is fascinating in looking at this visual is even though we hear so much about our recent economic downturn it barely shows up as a blip on the chart.  Compare the current downturn with the 1930's.

The challenge for the future is to keep the blue line moving onwards and upwards with the red line.  If we do that we will continue to prosper.  If we fail to do that, we have a lot of trouble ahead.

Murphy stated that improvements in life expectancy have contributed about as much overall to our overall welfare as as have improvements in our material wealth.  In fact, improvements in longevity from 1970 to 2000 were worth roughly an extra $95 trillion (or $3.2 trillion per year) to U.S. citizens.  That is why health is such an important factor in our growth and is really an investment in human capital over the long term.

Murphy displayed the cumulative value of longevity gains since 1900 in this chart.

You might ask what happened in 1918-1919 to set us back so far?  Those were the years of the so-called Spanish Flu pandemic that claimed over 500,000 lives in the United States most of which were healthy, young adults.  Worldwide the flu killed 50-100 million.  The cost of these deaths carried a very high economic cost. Who knows what might have been produced or invented by this young talent over their lifetimes?   There is no greater loss than that of unrealized potential.

The deaths from this pandemic are also a cautionary tale for the future.  Are prepared for dealing with something like this again?  It is something we need to be planning for.

So how do we keep growing our economy?  Murphy points to three primary sources for increased productivity and wealth.

  • Investment in physical capital
  • Investment in human capital
  • Improvement in technology (knowledge)
Productivity grows as new technologies are introduced and widely adopted.  This is not limited to just high tech.  The same applies for manufacturing, agriculture, rail transportation etc.

However, new technologies will inevitably displace low skilled workers, require higher skilled workers and require increased and new varieties of physical capital.  Continued progress depends on getting a balance of all three inputs: technology, physical capital and human capital.

Murphy spent most of the time in his speech focusing on the effects of how the growth in technology has played out in the labor market.  The increasing demand for highly skilled workers has resulted in an increasing wage premium for college graduates over the last 40 years.  This trend is even more pronounced for graduate school degrees.

The reality of the situation is that real incomes for those with high school education and below have been essentially flat in real terms for a number of years. This has resulted in a disproportionate amount of the wealth produced by the productivity gains going to the higher educated and skilled in the workforce.  

These trends can be seen in this chart of the overall rise in wage inequality for men where those in the 90th percentile (the top 10% of wage earners) have seen increasing wage growth that began in the early 1980's (introduction of the personal computer) and accelerated in the mid-1990's (internet revolution).

From these charts you can also see the effects of supply and demand on the labor market.  During the late 1960's and early 1970's college enrollments rose substantially with the first wave of Baby Boomers going to college.  The result was a tremendous increase in the supply of those that were college-educated that actually depressed relative wages for those with college degrees.  This began to change in the early 1980's with technology advancements. 

I have written before about how I believe technology has had a big impact on the growth of income inequality.  This is what I wrote almost one year ago in my post "1% + 99% Should Be Greater Than 100%".

The technology industry began to take off in the mid-1980's.  We entered the information age from a manufacturing age.  Manufacturing spreads income in a much broader swath in an economy.  You need to pay a lot of workers to build an automobile.  You only need a couple of computer programmers to develop a video game that might sell millions.  For example, the Call of Duty: Modern Warfare 3 game that was released last year grossed $1 billion in the first 16 days it was for sale. 
No where was this more apparent in the last year than the Instagram story in which a 20-something age kid and 12 others developed a photo sharing program that netted them over $1 billion when Facebook bought them out 18 months after it was developed.  I wrote about this as well in this post last April.

The Instagram story underscores the point.  In the manufacturing age you would need millions of invested capital in plant and equipment and thousands of workers to build a business worth $1 billion.  It is unlikely that it could be done in 18 months no matter what the resources were.  There is little doubt the world has changed.
Two final charts in the Murphy presentation show education premiums by gender and race.  In case you are wondering, supply and demand also does matter here.  Women and blacks with college degrees both do better than whites compared to their non-college counterparts when it comes to relative wages.

What should our primary policy goals be to insure that growth continues according to Murphy?

  • We must maintain the incentive for physical investment
  • We must provide an environment that fosters that growth of human capital
  • We must provide rewards to innovation
I hope President Obama is paying attention and our policymakers are paying attention.  We are not going to continue to prosper by penalizing and punishing those who have succeeded.  We need these people to innovate and invest.  We need to continue to make the pie bigger and see that more people have the skills needed to compete in the 21st Century workplace.  

We need to get more people interested in their own personal growth if we are to get future growth in our economy.  That will not happen if  40% of those entering high school do not graduate and men make up less than 40% of recent college graduates.  These should both be national priorities as should passing an immigration reform policy that allows more highly educated immigrants with technical talents in science, technology, engineering and math to get expedited paths to work in this country and become citizens.

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