USA: Smith on Economics - Don't be seduced by 'new agers'.

USA: Smith on Economics - Don't be seduced by 'new agers'. - Is stronger, sustained growth evidence of a new age for the US economy or, as David Smith suggests, is this just a particularly rosy phase of an inevitable cycle?

Last Updated: 31 Aug 2010

Is stronger, sustained growth evidence of a new age for the US economy or, as David Smith suggests, is this just a particularly rosy phase of an inevitable cycle?

Perhaps the biggest economic talking point of this year was sparked off recently by Alan Greenspan, chairman of the US Federal Reserve Board, the American version of the Bank of England. In testimony to Congress, Greenspan, probably now the world's most influential economic policy maker, accepted that the evidence in favour of a 'new age' for the US economy was becoming more convincing by the day.

What is this 'new age'? It is nothing to do with Glastonbury hippies.

Instead, says Greenspan, the US economy is enjoying a new lease of life because it is able to grow more strongly and for longer, without running into inflationary pressures. There are two reasons why this may be so. The first is the increasing flexibility of labour markets. Removing restrictive practices, new agers argue, has allowed unemployment to fall to much lower levels before those people in work start feeling secure enough in their jobs to ask for more money. The second component is new technology - and information technology in particular, which is having a decisive impact on productivity growth.

Labour markets improving

Should we believe the new agers - and is their creed relevant for the UK? I have long believed in the first strand of the UK version. Labour markets are clearly working better and there is now a better trade-off here between unemployment and wages growth. As the months have passed, the evidence for this as become increasingly compelling. Currently unemployment is lower than at any time since the early 1980s, but pay settlements are rising at just 3%. The last time unemployment was at or near present levels, in the late '80s, earnings growth was double the present rate.

There is much more difficulty in extending this first strand to the wider world economy. Although we have always looked to America as a nation with a flexible labour market, continental Europe is operating under a considerable handicap, with only slow progress towards flexibility being made there. Whether the unemployment-earnings trade-off has improved in Europe is exceedingly difficult to say - growth is so poor and European unemployment so high at 11% that wage claims are not at present the burning issue for the average worker.

For new agers, this particular circle is squared by globalisation. Even in some older industrial economies with the most rigid labour markets, they say, the forces of global competition and pressure from the newly industrialised countries means that there will always be a permanent lid on wages. I am sceptical of this argument. Even if it is true that competition from low-cost producers is more competitive than before, it is also true that in the mature economies most workers are now sheltered from this effect because they work in the service sector.

Better use of technology

The second plank of the new-age argument - the influence of new technology - is even more problematical. This claims that a prolonged period of high investment in information technology and computer-aided machinery is producing substantial growth dividends. Thus, the dramatic increase in, say, computer processing power means that a given investment has a much bigger impact on productivity now than, say, five years ago.

And firms have learned how to use technology better, not merely to replicate the old processes in a less labour-intensive way, but to change those processes entirely. The first motor cars, for example, were just horseless carriages - they were slow and unreliable. Then they developed into something recognisably different and with capabilities undreamed of in the days before the internal combustion engine. The same thing is happening with computers.

Economists have long debated the role of new technology in economic growth.

For Austrian Joseph Schumpeter, technological innovation was the central factor in preventing advanced economies from becoming economically stagnant.

A theory for the good times

More recently, other economists have given greater emphasis to the role of human capital - the education and skills of the workforce - but the problem with new-age economics, whoever believes in it and for whatever reason, is that it keeps going in and out of fashion. It is all the rage when we have been waiting for the next recession for so long that we start to believe that it won't come along at all. Then, when it does, the new agers go a little quiet.

So when influential thinkers start to boast of reinvention and reinvigoration, it is time to start worrying, because we all know we have been here before.

The air was thick with talk of Britain's productivity miracle in the late '80s, when the true picture was one of an overheated economy in the latter stages of an unsustainable boom. Paul Krugman, an American economist, argues that for advanced industrial countries, growth settles down at 2% or so, and there is not much that anyone can do about it. Perhaps the new age, with labour market flexibility and information technology, is necessary simply to allow the older economies to carry on growing at even this rate. So we should be wary of those new agers. It is far more likely that sooner or later the harsh reality of the economic cycle will walk up and smack us right between the eyes.

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