The Big Trend: The World is Getting Wealthier

A macroeconomist says that despite the risks, long-term growth patterns should make you optimistic about the future.

March 29, 2013

| by Kathleen O'Toole

In your rush to understand today’s stock market numbers or tomorrow’s tax and debt debates, you might be blinding yourself to two important long-term economic trends: the tripling of income over three generations in the United States and the way poor countries are finally also raising their standards of living.

American adults are, on average, three times richer than their grandparents, and their grandchildren will likely be three times richer than they are. That’s in real dollars with inflation removed, says macroeconomist Charles Jones of Stanford GSB.

Furthermore, people in most developing countries are now also increasing their standards of living.

“Historically, poor and rich countries grew at roughly the same rate, but in the last decade we’ve seen a bunch of poor countries growing rapidly — not just China and India, but also Africa and other places. This is an incredibly wonderful accomplishment that the rest of the world is catching up with the advanced countries,” Jones says.

These optimistic messages are part of an hour-long lecture that Jones has condensed from his quarter-long MBA course Growth and Stabilization in the Global Economy. It’s a course designed to give students a longer-range view to supplement the immediate perspective of daily news.

In the spring 2013 version, Jones conceded not all economic trends are coming up roses. Potential growth-stunting pests include the Euro crisis and the political fighting over budget, tax, and debt limits between Democrats and Republicans in Washington, D.C. Anecdotal reports of a housing bubble in China, however, don’t show up in hard data as a threat to China’s growth or to the global economy, he said, when asked about a 60 Minutes news feature on that topic. According to data provided by the Economist magazine, Chinese housing purchase prices compared to rents do not indicate a bubble. “You hear anecdotes about China’s overbuilding with housing, empty roads, and office buildings, but you wait two or three years and those roads are really crowded, those office buildings are full, and the newest ones are empty.”

Some Americans worry needlessly that China’s gain will be America’s loss, Jones said. He cited work by economist Paul Romer that concludes new ideas have been the key ingredient fueling greater standards of living in rich countries over the last 100-plus years, and new ideas will continue to be the engine of growth for the world.

“You might think electricity, cars, and jet airplanes were great inventions and now all we are inventing are Angry Birds on an iPhone, but the growth is still 2%” per year, he said. Compounded over 50 years, even with periodic recessions, an average of 2% has tripled Americans’ income.

“People produce ideas, and ideas lead to economic growth no matter where they occur,” Jones said. Therefore, as China expands its production of PhDs in science and engineering, it will also be contributing more ideas. Competition among businesses might increase because of more new ideas, he said, but consumers will be better off because “ideas are not scarce in the same way that tractors or other economic goods are scarce.”

One potential shock could be inflation in the United States due to the liquidity that the U.S. Federal Reserve has pumped into the economy since 2008. Jones praised Fed chairman Ben Bernanke as “the right guy at the right time” for dealing with the financial crisis and the resulting long-lasting recession. Having earned his doctorate studying monetary policy and the Great Depression, Bernanke was most likely quicker than any other economist would have been to drop interest rates in order to head off a bank run by banks on banks and to keep business projects running, Jones said. Bernanke has more than tripled the Fed’s balance sheet, which Jones compared to tripling the water in a mountain lake above a valley. “The worry you have is that water could spill over the dam, and flood the valley,” he said, meaning runaway inflation. Forecasters, however, indicate they believe the Fed can keep inflation under control.

Macroeconomists “were caught by enormous surprise,” by the 2008 financial crisis and the depth of the recession that followed, Jones said, because during the 20th century, they had seen economic downturns getting shorter and further apart. Only one published study before 2009, by Carmen Reinhart and Kenneth Rogoff, hinted at the fact that there might be two very different types of recessions. It now seems that those caused by excessive lending and borrowing may linger longer than those caused by standard business cycles or natural disasters or political shocks such as the one leading to high energy prices in the 1970s. Business and banks are perhaps not as quick to spend their way out of a recession if its cause was overspending and overborrowing, Jones said. This is why banks have been reluctant to relend the money the Fed has made available to them at low rates.

Another worry is the Euro crisis. The financial bubble in countries like Spain, Italy, and Greece led to wages rising in those countries ahead of productivity, he said, and now it’s difficult to bring those wage rates down to address the fiscal problem. Normally, when country leaders control their currencies, they can print more money to cause inflation, which can reduce the value of wages compared to prices. The European Union’s unified currency makes that strategy infeasible. “So the adjustment is occurring by having high unemployment rates and waiting for that to drive wages down or hope that productivity rises,” Jones said. “That’s a 10- or 15-year proposition.” In the meantime, unemployment rates around 25% make elected leaders subject to voter wrath and therefore less likely to implement better long-term reforms.

Overall though, Jones said, he is optimistic. “The overwhelming fact of economic history for the last 150 years is, on average, incomes were growing at 2% a year, and that growth is inexorable. As bad as the Great Depression was, it was temporary.”

Charles Jones is the STANCO 25 Professor of Economics at Stanford GSB.

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