What Greenspan Doesn't Know. ... about Today's High-Tech, Global Economy Could Fill a Large Book (and He's Not Alone)
Samuelson, Robert J., Newsweek
The dirty secret of today's economy is that no one truly understands it. Not Alan Greenspan. Not Larry Summers. Not Abby Joseph Cohen. We listen to these and other oracles, examining their every utterance for enlightenment. They're the experts. They know more than we do. But what they don't know may well be more important than what they do.
Ignorance can be a powerful force. It may help explain the erratic daily swings in stock prices. Stories about the economy's future alternatively elevate or depress the market with bewildering regularity. The stories may be contradictory. But if people don't know what to believe, any story can be believable--at least momentarily.
To say that Greenspan et al. don't truly understand the economy doesn't mean they know nothing. Economists pour out reports bulging with tables and charts. These often brilliantly illuminate some past economic trend. What they've consistently failed to do is anticipate the big economic upheavals of our time, including--most prominently--America's present low-inflation boom.
One reason is the gradual breakdown of the standard "model" (or theory) of how the economy operates. Simplified a bit, the model goes like this. At any moment, the economy has a given productive capacity, based on the number of workers and overall efficiency ("productivity"). People and corporations use up this capacity by spending, which is based on their wages, salaries, dividends and profits. Ideally, total spending ("demand") always matches the economy's productive capacity ("supply"). If spending grows too rapidly, inflation may result. The economy "overheats." This can cause a recession, because the Federal Reserve has to raise interest rates to suppress inflation.
By this model, the economy's stability depends on keeping demand and supply roughly balanced. The trouble now is that we're having a harder and harder time gauging either spending (demand) or productive capacity (supply). Consider the forces that obscure our vision:
Technology: Computers and communications technologies (it's said) have dramatically increased productivity growth. The economy can expand more rapidly without encountering inflationary scarcities. Great. Unfortunately, we don't know how much productivity growth has improved--or whether the gain is permanent. The old model recognized that productivity growth (based on technology, education and management) might shift from time to time; but the assumption was that, once a change occurred, it lasted for a while. But suppose that technology advances occur in irregular spasms. Sometimes we get torrents; sometimes we get trickles. What then?
Unemployment: The old model assumes that, below some unemployment rate, tight labor markets generate inflationary wage increases. As late as the mid-1990s, this threshold was widely thought to be between 5.5 and 6 percent. But the unemployment rate has been at or below 4.5 percent since early 1998 without--as yet--triggering a wage explosion. Where is the dangerous threshold, and is it stable? …