Saturday, May 18, 2013

Bernanke Isn't Neutral on the Long-Run

When I first started teaching intermediate macroeconomics ten years ago, I decided to consider economic growth in the first part of the class.  Partly my reasoning was tactical - its the most mathematically challenging part of the class for many students, so I thought it was good to get them in the habit of working hard and taking it seriously at the start (and the competing claims on students' time tend to be less severe earlier in the semester).  The more important rationale was motivation - at the time we were in the midst of the "great moderation" and it was hard to get students who had never seen a serious recession in their lives excited about learning about things like how the Fed sets interest rates.  That, of course, has changed, and I think starting in with business cycles would be a good way to get the students "hooked" now - its tempting to change, but I've stuck with my strategy of emphasizing growth at the beginning of the semester.

As I noted in a recent post, long-run economic growth is the most important determinant of how living standards change from generation to generation, and why they vary so much from country to country.  The rise in incomes over decades is much bigger than the disruptions due to any business cycle downturn, even relatively large ones like the slump following the 2007-08 financial crisis.  Economic theory says that the main determinant of growth in the long run is technological progress, though we're still a little iffy on explaining how that technological change occurs.

Robert Lucas famously said: "Once you start thinking about economic growth, its hard to think about anything else."  Actually, that's pretty wrong - its very easy to be focused on short-run fluctuations and policy responses to them (and this is really important, and the negative consequences of recessions are understated by representative agent type models that Lucas tends to favor).

Ben Bernanke used his commencement address at Bard College at Simon's Rock as an opportunity to step back from his usual focus on managing short-run fluctuations and talk about economic growth.   His speech acts as a rebuttal of sorts to Robert Gordon and others who are worrying that the benefits of the information technology "revolution" for productivity growth are already petering out.  The core of his response is:
First, innovation, almost by definition, involves ideas that no one has yet had, which means that forecasts of future technological change can be, and often are, wildly wrong. A safe prediction, I think, is that human innovation and creativity will continue; it is part of our very nature. Another prediction, just as safe, is that people will nevertheless continue to forecast the end of innovation. The famous British economist John Maynard Keynes observed as much in the midst of the Great Depression more than 80 years ago. He wrote then, "We are suffering just now from a bad attack of economic pessimism. It is common to hear people say that the epoch of enormous economic progress which characterised the 19th century is over; that the rapid improvement in the standard of life is now going to slow down." Sound familiar? By the way, Keynes argued at that time that such a view was shortsighted and, in characterizing what he called "the economic possibilities for our grandchildren," he predicted that income per person, adjusted for inflation, could rise as much as four to eight times by 2030. His guess looks pretty good; income per person in the United States today is roughly six times what it was in 1930.

Second, not only are scientific and technical innovation themselves inherently hard to predict, so are the long-run practical consequences of innovation for our economy and our daily lives. Indeed, some would say that we are still in the early days of the IT revolution; after all, computing speeds and memory have increased many times over in the 30-plus years since the first personal computers came on the market, and fields like biotechnology are also advancing rapidly. Moreover, even as the basic technologies improve, the commercial applications of these technologies have arguably thus far only scratched the surface. Consider, for example, the potential for IT and biotechnology to improve health care, one of the largest and most important sectors of our economy. A strong case can be made that the modernization of health-care IT systems would lead to better-coordinated, more effective, and less costly patient care than we have today, including greater responsiveness of medical practice to the latest research findings.  Robots, lasers, and other advanced technologies are improving surgical outcomes, and artificial intelligence systems are being used to improve diagnoses and chart courses of treatment. Perhaps even more revolutionary is the trend toward so-called personalized medicine, which would tailor medical treatments for each patient based on information drawn from that individual's genetic code. Taken together, such advances could lead to another jump in life expectancy and improved health at older ages.

Other promising areas for the application of new technologies include the development of cleaner energy--for example, the harnessing of wind, wave, and solar power and the development of electric and hybrid vehicles--as well as potential further advances in communications and robotics. I'm sure that I can't imagine all of the possibilities, but historians of science have commented on our collective tendency to overestimate the short-term effects of new technologies while underestimating their longer-term potential.

Finally, pessimists may be paying too little attention to the strength of the underlying economic and social forces that generate innovation in the modern world. Invention was once the province of the isolated scientist or tinkerer. The transmission of new ideas and the adaptation of the best new insights to commercial uses were slow and erratic. But all of that is changing radically. We live on a planet that is becoming richer and more populous, and in which not only the most advanced economies but also large emerging market nations like China and India increasingly see their economic futures as tied to technological innovation. In that context, the number of trained scientists and engineers is increasing rapidly, as are the resources for research being provided by universities, governments, and the private sector. Moreover, because of the Internet and other advances in communications, collaboration and the exchange of ideas take place at high speed and with little regard for geographic distance. For example, research papers are now disseminated and critiqued almost instantaneously rather than after publication in a journal several years after they are written. And, importantly, as trade and globalization increase the size of the potential market for new products, the possible economic rewards for being first with an innovative product or process are growing rapidly.  In short, both humanity's capacity to innovate and the incentives to innovate are greater today than at any other time in history. 
In typical Bernanke fashion, the whole speech is very nicely done (he must be a fantastic professor).  Another thing I liked about it is that Bernanke also makes a case for liberal arts education:
Well, what does all this have to do with creativity and critical thinking, which is where I started? The history of technological innovation and economic development teaches us that change is the only constant. During your working lives, you will have to reinvent yourselves many times. Success and satisfaction will not come from mastering a fixed body of knowledge but from constant adaptation and creativity in a rapidly changing world. Engaging with and applying new technologies will be a crucial part of that adaptation. Your work here at Simon's Rock, and the intellectual skills, creativity, and imagination that that work has fostered, are the best possible preparation for these challenges. And while I have emphasized technological and scientific advances today, it is important to remember that the arts and humanities facilitate new and creative thinking as well, while helping us to draw meaning that goes beyond the purely material aspects of our lives. 
I'd been thinking of adding Robert Gordon's paper on the "headwinds" facing economic growth to the reading list for next year.  Bernanke's speech will be a nice counterpoint to go with it.

The speech is also discussed by the NYT's Binyamin Appelbaum and Washington Post's Neil Irwin.

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