The economic decline of a lifetime

When I google long-term economic decline, most of the results focus on recession. A few focus on depression. After three sittings, I found one search result that actually considers long-term decline:

"Recessions are difficult, but stagnant growth could prove more challenging, Stanford economist warns", by Melissa De Witte, dated 7 December 2022. Almost current. From Stanford News. The article is an interview with John Cochrane. I know of him from The Grumpy Economist.

De Witte's opening:

While recessions are painful, they are only temporary interruptions to the economy, says John Cochrane, an economist at Stanford’s Hoover Institution, arguing that people should be paying more attention to long-term economic growth, which in the U.S. is currently stagnating.

Yeah. But I wouldn't say "stagnating". I'd say declining. And not just "currently".

But wait, this is a good observation:

Rather than focus on quarterly changes to growth rate, which is how recessions are currently gauged, the long-run growth of the economy matters more.

Most. Definitely. Yes. Long-run economic decline is like a weak, permanent recession that slowly gets worse and only gets worse.

 

Here's something. Cochrane says:

Currently, stagnant growth is our big problem. Long-run growth of the economy matters much more than year-to-year growth rates. Recessions are painful interruptions, but we should be paying much more attention to long-run growth.

"Currently" again? What does he mean to say? Only just now? Or for quite some time? For how long? Dunno, dunno, dunno. Plus, Cochrane needs more emphasis on "big problem".

But hey: If long-run growth is what matters, then maybe long-run growth is what we should look at. Let me start with a quick look at three graphs. We can dwell on the third one.

Graph #1: Up, Up, and Away! (Or so it appears)

Graph #1 shows Real GDP for the US in dollars, millions of dollars, from 1790 to 2021. Data from MeasuringWorth. "Real" means inflation has been taken out of the numbers, so we see the growth of output without the increase of prices.

Graph #2: The same data. A different glance.

Graph #2 shows "percent change" from the year before, for each year. Cochrane calls it the "year-to-year growth rates". The plotted line is jiggy as can be. And I don't see any definite pattern in it, so I don't know what the graph is telling me.

Graph #3: Again, the same data, but 20-year averages

Now we are looking at long-run growth. This graph shows long-term (20-year) average growth rates. Each point on the graph shows the average for the 20-year period that ends at that point.

A pattern begins to emerge in the third graph: 

• Increasing growth from 1820 to 1863
• Decreasing growth from 1890 to 1933
• Increasing growth from 1933 to 1954
• Decreasing growth from 1954 to 2020

Consider the decrease that ends in 1933. I am reminded of Milton Friedman in Free to Choose, saying "the economy hit bottom in 1933." Graph #3 shows long-term growth hitting bottom the same year, 1933. Coincidence, you think? Not entirely.

The graph shows sharp increase after 1933, rising to a peak in 1954. Recovery from the Great Depression feeds into that sharp increase. So does the second World War.

After the 1954 peak the graph shows persistent decline, from more than 6% growth to less than 2%. What was it Cochrane said?

Long-run growth of the economy matters much more than year-to-year growth rates. Recessions are painful interruptions, but we should be paying much more attention to long-run growth.

Cochrane said, and I can only agree that

Currently, stagnant growth is our big problem. 

But the problem is bigger than we think. If nobody's happy with our economy currently, maybe it is because long-run growth has been in decline now for seven decades.

Seven decades. It's a lifetime.

Why the long decline? Finance is the problem. Excessive finance. This graph is from Thomas Philippon:

Graph #4: from "Has the U.S. Finance Industry Become Less Efficient?"
by Thomas Philippon (2011)

Philippon's high points match up with the lows on Graph #3, and Philippon's low points correspond to the highs on Graph #3. I'm not comparing the years before 1890. But since 1890, Philippon's graph goes up, down, up while my graph goes down, up, down. Since 1890.

Finance goes up-down-up while Real GDP growth goes down-up-down. Economists might call that a negative correlation. You might think they would want to spend more time looking into excessive-finance-as-the-cause-of-slow-growth. Cochrane in the interview, for example, fails to mention finance as a possible cause of the stagnation.

Philippon describes his graph:

The cost of intermediation grows from 2% to 6% from 1870 to 1930. It shrinks to less than 4% in 1950, grows slowly to 5% in 1980, and then increases rapidly to almost 9% in 2010.

His turning points: 1930, 1950, 2010. My turning points: 1933, 1954, 2020. The big discrepancy, 2010 versus 2020, arises only because I'm using Philippon's ten-year-old graph. The other differences are rounding errors.

His graph shows two reversals of trend. My graph (again, since 1890) also shows two reversals of trend. There are only two reversals in 130+ years, and those reversals are almost simultaneous on the two graphs. That's gotta be significant!

I took Philippon's graph and erased the background, then "flipped" the graph to make the low points high and the high points low. Then I overlaid it on my Graph #3 and fitted his graph to mine to make the dates line up. Now we can look at the pattern since 1890 and see how the growth of finance compares to long-run economic growth:

Graph #5: Philippon's graph overlaid on my Graph #3
with dates aligned (note alignment at 1880 and 1980)

Remember: finance is flipped for figure five.

• From 1890 to the early 1930s, 20-year average RGDP growth shows decline. So does flipped finance.
• From the early 1930s to 1950 or so, 20-year average RGDP growth shows increase. So does flipped finance.
• From 1954 to end-of-data, 20-year average RGDP growth shows decline. So does flipped finance.
  

Flipping Philippon's graph makes it easy to see the similar pattern in the two graphs.

Philippon's original, un-flipped graph shows that the size of finance runs opposite the long-term growth of Real GDP. The more finance we have, the less economic growth we get. The less finance we have, the more economic growth we get. Since the late 1800s this is true. The graph shows it.

"Long-run growth of the economy matters much more than year-to-year growth rates," Cochrane says, and "we should be paying much more attention to long-run growth." Indeed it does, and yes we should.

Since 1890, as finance increases in size, Real GDP grows less. Why? Because finance is a cost, and more finance means more cost.

Hey -- We need finance for growth, yes. But we shouldn't be using finance for everything. We need just plain money -- money that doesn't cost money -- to maintain our existing economy at its existing level. 

We can use credit for growth. That's fine. But after the economy grows, the economy is bigger. So then, instead of the credit, we need more "money that doesn't cost money" to maintain the bigger economy. This solution, obvious as it may be, is not part of economic policy.

Under existing policy, old, well-used credit continues to exist as debt, public and private. The financial cost of debt interferes with the cost of living. As Vladimir Simkhovitch said of ancient Rome, things eventually get to the point where labor cannot support life. This is where we are today: Labor can no longer support life. So we live on credit, and our debt just grows and grows. This cannot end well. Policy must change.

Central bankers don't see anything wrong with the cost of finance, probably because the cost of finance is income for bankers. For the rest of us, the cost of finance is a cost. 

As long as economic policy continues to promote credit use and the accumulation of debt, we will continue to see the decline of long-run economic growth. 

 

The comparison of Finance to long-term Real GDP growth is not a good match before 1890. I did not research this discrepancy. But finance was small before 1890. Perhaps it was small enough, then, that finance was still beneficial, rather than harmful to growth. If so, the discrepancy is further evidence that excessive finance is harmful -- and that finance has been excessive since 1890.