It’s the Economy, Stupid!

Linus Yamane

Professor of Economics, Associate Dean of Faculty

When I try to understand the rise of Donald Trump, I think about macroeconomics first. My favorite political science professor in college, Thomas Ferguson[1], told me that if you want to understand politics, you just have to follow the money. Or as James Carville and Bill Clinton said in 1992, “It’s the economy, stupid!” This is one of the reasons I ended up going into economics.

At first glance the U.S. macroeconomy looks very good. Our standard of living, as measured by per capita GDP, is higher than it has ever been at $56,310, and ranks in the top 10 in the world. The unemployment rate is running at 4.9%, well below the post WWII average of 5.8%. There is no inflation in sight. Over the past year inflation has been about 1% while the average inflation rate since 2000 has been about 2.2%. And American workers are more productive than they have ever been. They can produce more goods and services with an hour of labor than at any other time in history. So you have to look a little deeper to understand the level of dissatisfaction.

In the period from 1947 through 2000, real GDP per capita in the United States grew at 2.25% a year. At this rate, the standard of living doubles every 32 years. Even in the economically difficult period from 1970-1985, real GDP per capita grew more than 2% a year. Americans have grown used to seeing their standard of living improve over time, and to expect their children to have a standard of living twice as high as themselves. This was the experience for multiple generations of Americans throughout the 20th century.

  Growth Rate
Time Period Real GDP Per Capita Productivity Employment
1955-1970 2.32% 2.04% 1.74%
1970-1985 2.08% 1.01% 2.04%
1985-2000 2.21% 1.84% 1.67%
2000-2015 0.87% 1.25% 0.57%

Since 2000, the macro economy feels very different for a broad swath of Americans. Over the past 15 years, real GDP per capita has grown by less than 0.9% a year. The rising tide has slowed down dramatically. We should no longer expect our kids to do better than we are doing. The need to lower our expectations is difficult and frustrating for most people.

The figures above describe the “average” American as opposed to the “median” American. For the “median” American the story is actually worse. The distribution of income has been deteriorating for quite some time. The Gini index[2], one measure of income inequality, has monotonically increased from 0.386 in 1968 to 0.482 today. (Most countries in the world, approximately 70%, have a more equitable distribution of income.) So for the bottom half of the income distribution, only the very lucky have been able to maintain their standard of living over the past 15 years. The bulk of these Americans are extremely frustrated with the state of the economy. The policies which worked from WWII to the turn of the century are no longer working for them, and have not been working for at least 15 years. Consequently they no longer support the status quo, and are looking for something different.

Why is the economy not working anymore? The first place to look is at productivity growth. Productivity is output per labor hour. This is the value of the goods and services Americans can produce in an hour. While our productivity is higher than it has ever been, the growth in productivity has slowed down in this century.

Productivity growth was actually slower in the 1970-1985 period than after 2000. But in the 1970-1985 period we made up for the slowdown in productivity by increasing the number of people in the labor force. The number of people employed increased by more than 2% per year during this period. Thus per capita GDP (output per person) continued to rise.

The problem since 2000 is characterized by both a slowdown in productivity growth and a slowdown in employment growth. In the post World War II period, male labor force participation[3] rates have been steadily falling, from over 87% to 69%. But the decline in male labor force participation has been offset by an increase in female labor force participation. Female labor force participation rates increased from 32% immediately after WWII to over 60% in 2000. But since 2000, female labor force participation rates have been falling. The female labor force participation rate has now fallen to 56.6%. We cannot continue to have both men and women leaving the labor force. Someone needs to be in the labor force. Our overall labor force participation rate has declined from 67.3% in 2000 to 62.4% last year. During the past 15 years about 5% of the population just left the labor force.

We now have an economy where fewer people are working, where the tide is no longer rising as quickly, productivity growth has slowed down, and people cannot expect their kids to do as well as their parents. This is enormously frustrating for a large segment of American society. They are not interested in the same old same old. They want to see some fundamental changes.

Looking forward, there are at least two contrasting views. The pessimistic view comes from Robert Gordon[4]. Gordon believes that the dramatic scale of inventions and innovations between 1870 and 1970 were a one-time occurrence in human history, and that productivity growth will be much slower in the future. Our economy also faces some very strong headwinds in the form of an aging population, stagnating education, consumer and government debt, and income inequality. Thus the younger generation of today will be lucky to match their parents’ standard of living for the first time in American history.

The more optimistic view comes from Erik Brynjolfsson and Andrew McAfee[5]. They observe that general purpose technologies, which lead industrial revolutions, take time to become adopted economy-wide. The steam engine led the first industrial revolution, electricity led the second industrial revolution, and the computer is leading the third industrial revolution. Since these technologies take a few decades to become fully adopted, we are just on the cusp of seeing the productivity advances resulting from the computer.

While their prognosis for increasing productivity is optimistic, Brynjolfsson and McAfee are sanguine about the accompanying social dislocation. Computers can now beat humans in Jeopardy, chess and go, and do most things better than humans can. Thus machines will continue to take on more jobs, and humans will continue to lose those jobs. There will be increasing wealth inequality between those competing with machines and those who work with these machines. These are the growing pains of radically reorganizing our economy. “In medicine, law, finance, retailing, manufacturing and even scientific discovery,” they write, “the key to winning the race is not to compete against machines but to compete with machines.” We need to learn to work with computers as our teammates. In the long run, these advanced digital technologies can make all people more innovative, productive and richer.

So whether you take the Robert Gordon view or the Brynjolfsson and McAfee view, in the short run we can look forward to a period of significant economic and social adjustment. We will need to adjust to the new technological changes or the lack of it. In the process, some people will scapegoat minorities, immigrants, and/or foreigners for this adjustment, and want to follow demagogues. But our standard of living here at home depends first and foremost on our productivity here at home. So hopefully most of us will understand the real technological reasons for our dislocation, and make appropriate electoral and policy decisions.


[1] Ferguson, Thomas (1995). Golden Rule : The Investment Theory of Party Competition and the Logic of Money-Driven Political Systems. Chicago: University of Chicago Press.

[2] A perfectly equal income distribution has an index value of 0 and a perfectly unequal society (where Bill Gates has all the income) has an index value of 1.0.

[3] The labor force participation rate is the percent of the population which is working or looking for work.

[4] Robert Gordon, “Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six Headwinds,” NBER Working Paper #18315, August 2012.

[5] Erik Brynjolfsson and Andrew McAfee, Race Against The Machine: How the Digital Revolution is Accelerating Innovation, Driving Productivity, and Irreversibly Transforming Employment and the Economy, Digital Frontier Press, 2011.


Leave a Reply