(This essay was published in South China Morning Post on 10 May 2017.)
The emergence of outsiders Donald Trump and Bernie Sanders in last year’s presidential election reflects the rise of right wing and left wing populist reaction to poor economic performance – both low productivity growth and high economic inequality. Economic factors may not be the only reason for the rise of populism in the US and around the world, but it is certainly a major part of the explanation.
It is not without irony that the president of communist China is now championing a liberal world economic order and telling the president of capitalist America the benefits of free trade. The irony is perhaps not surprising since China sees itself as still rising economically and a beneficiary of a liberal economic order, while America worries about economic decline and being a victim of the open global economic order it once championed.
Ever since the 2008 financial market meltdown, it has been customary to blame global economic integration and free market capitalism for failed economic performance. This accusation has gained widespread popularity in the media and public policy debates. But is it justified?
I do not think so and here is why: the wave of global economic integration and free market capitalism did not really start until after 1980, and mostly towards the latter part of the 1980s. But economic performance in the West, particularly in the US, started to weaken in the 1970s. The forces behind this slow weakening have remained in place up to the present time.
Research by Professor Kevin Murphy shows that the real wage rates of men grew by 19.4 per cent in the 1940s, 29.7 per cent in the 1950s, 24.1 per cent in the 1960s, and only 5.0 per cent in the 1970s and -7.8 per cent in the 1980s. In other words, labor productivity growth had started to decline rapidly in the 1970s and turned negative in the 1980s.
Robert Gordon’s work The Rise and Fall of American Growth (2016) reconfirms these results and shows that US labor productivity was at its peak during 1920-70, but fell off significantly during 1970-2014.
Gordon shows that the change in labor productivity is due mainly to changes in total factor productivity, which represents innovation and technological change.
Most technological advances since the 1970s have tended to be channeled into a narrow sphere of human activity involving entertainment, communication, and the collection and processing of information. This explains why the new technological advances have not had a big economy-wide impact in lifting productivity. They have benefitted only a small number of industries and a limited, highly-skilled fraction of the workforce.
The economic slowdown in the US preceded the shift to ‘right of center’ pro-market economic policies advocated by Milton Friedman and the Chicago School by more than a decade. Global economic integration and free market capitalism in all likelihood prevented productivity growth from declining faster.
Could the concentration of technological advances since the 1970s in a small number of sectors have worsened inequality? In the period 1979-90 when global economic integration had barely taken off, the wage premium for college graduates over high school graduates increased from 42 percentage points in 1979 to 71 percentage points in 1990. Consequently, overall wage inequality for men grew dramatically between 1979 and 1990.
As with wages, Professor Murphy has showed how the pattern of economic inequality in the US has changed due to technological advances.
During the 1970s and 1980s, technological advances demanded more skilled workers so labor markets paid them a premium, thereby increasing wage inequality. In the 1940s technological advances demanded more unskilled workers so they received the premium, thereby decreasing wage inequality. In the 1950s and 1960s, technological advances did not favor either skilled or unskilled workers so wage inequality remained stable.
The changing pattern of technological advances provides a more convincing explanation for the patterns of wage inequality and productivity growth over the past five decades than blaming it on global economic integration. Failure to appreciate the true forces at work will lead to the adoption of wrong policies that will not solve the problems society faces. They may even worsen them.
It is unlikely we can control the bias of technological advances. So the best policy is to influence the supply of skilled versus unskilled workers to support productivity growth and mitigate the effects of wage inequality.
The ideological debates will continue, but it is important we bring scientific analysis and empirical evidence to illuminate the questions we wish to resolve. In the age of social media, where communications channels are echo chambers for the convinced and converted, shouting matches add no value and only reinforce prejudice.