[NYTr] Booming Economy: Alan Greenspan Book Excerpt

[All the News That Doesn't Fit]

Newsweek - Sep 24, 2007 issue
http://www.msnbc.msn.com/id/20789997/site/newsweek/


Exclusive Book Excerpt from Alan Greenspan

Greenspan charts our economic course in 'The Age of Turbulence.' 

An excerpt:

People have always been enthralled by the notion that it is possible to
peer into the future. Ancient Greek generals sought audiences with the
oracle at Delphi to guide their military adventures. Fortune-tellers
thrive to this day. Modern Wall Street employs phalanxes of very smart
people to read what the entrails of market performance say about future
stock prices. To what extent can we anticipate what lies ahead?
Fortunately for policymakers, there is a degree of historical
continuity in the way democratic societies and market economies
function. There is indeed much that we can infer about the U.S. economy
and the world at large in the decades ahead, especially if we adopt
Winston Churchill's insight: "The further backward you look, the
further forward you can see."

What, then, can we reasonably project for the U.S. economy for, say,
the year 2030? Little, unless we first specify certain assumptions. I
need affirmative answers to the following questions to get started.
Will the rule of law still be firm in 2030? Will we still adhere to the
principle of globalized free markets, with protectionism held in check?
(By protectionism, I mean not just barriers to international trade and
finance but governmental restrictions against competition in domestic
markets as well.) Will we have fixed our dysfunctional elementary and
secondary school systems? Will the consequences of global warming
emerge slowly enough so as not to significantly affect U.S. economic
activity by 2030? And finally, will we have kept terrorist attacks in
the United States at bay? Unsaid are those possibilities, such as a
wider war or a pandemic, that could upset any forecast.

But the long list of caveats does not inordinately tie our forecasting
hands. After all, such a list has always existed in one form or
another, and yet the record of long-term forecasting of the U.S.
economy overall in my experience has been reasonably impressive. What
is the most likely level of overall activity we can expect in our
arbitrarily chosen 2030 forecast year?

Given our assumptions and the economy's historical record, it is
difficult to imagine the employment rate of the civilian labor force
being outside the rather narrow range of 90 to 96 percent (that is, an
unemployment rate between 4 and 10 percent). America's fifty-year
average is more than 94 percent, with nonrecession years (the
assumption for 2030) near 95 percent. Combining labor force
participation rates, population projections, a near 5 percent
unemployment rate, and a stable workweek yields an annual growth rate
in hours worked in the United States through 2030 of 0.5 percent.

If we smooth through the raw data on output per hour, a remarkably
stable pattern of growth emerges, going back to 1870. Annual growth of
nonfarm business output per hour has averaged close to 2.2 percent.
Even without adjusting for the business cycle, wars, and other crises,
the range of overlapping consecutive fifteen-year averages of the
annual increase in output per hour stays consistently between 1 and 3
percent. Our historical experience strongly suggests that as long as
the United States remains at technology's cutting edge, annual
productivity growth over the long run should range between 0 and 3
percent.

But why not higher—say, 4 percent per year or more? After all, in much
of the developing world, annual output per hour has been averaging
growth of far more than 2 percent. But those nations have been able to
"borrow" the proved technologies of the developed world and have not
themselves had to undertake the slow step-by-step effort to advance
cutting-edge technologies.

U.S. productivity in 2005 was 2.8 times higher than in 1955. That is
because we knew so much more in 2005 than a half century earlier about
how our physical world operates. Every year, millions of innovations
incrementally improved overall productivity. This process has become
particularly evident since the discovery of the exceptional electrical
properties of silicon semiconductors following World War II. Yet why
hasn't productivity growth been even faster? Couldn't what we knew in
2005 have been figured out by, say, 1980, thereby doubling the rate of
productivity gains (and increases in standard of living) between 1955
and 1980? The simple answer is that human beings are not smart enough.
Our history suggests that the ceiling on the productivity growth of an
economy over the long term at the cutting edge of technology is at the
most 3 percent per year. It takes time to apply new ideas and often
decades before those ideas show up in productivity levels.

Which brings us to our bottom line. Coupled with the projected 0.5
percent annual increase in hours worked between 2005 and 2030 that
follows from the demographic assumptions cited earlier, a slightly less
than 2 percent annual average growth in GDP per hour implies a real GDP
growth rate of slightly less than 2.5 percent per year, on average,
between now and 2030. That compares with 3.1 percent per year, on
average, over the past quarter century, when labor force growth was
considerably faster.

Arriving at a credible forecast for the level of real GDP for 2030 is a
start, but it doesn't tell us much about the nature of the dynamic that
will be driving U.S. economic activity a quarter century in the future,
or about the quality of our lives. For superimposed on these powerful
trends will be the consequences of an inevitable completion of major
aspects of globalization. At some point, globalization's vast economic
migration—the epoch-making shift of fully half of the world's
three-billion-person labor force from behind the walls of economies
that were centrally planned, in part or in whole, to competitive world
markets—will be complete, or as complete as it can possibly get. The
continuing acceleration of the flow of workers to competitive markets
during the past decade has been a potent disinflationary force. That
acceleration has depressed wage growth and held down inflation
virtually uniformly across the globe. Leaving aside Venezuela,
Argentina, Iran, and Zimbabwe, inflation during 2006 in all developed
and major developing nations was clustered between 0 and 7 percent.
Similarly narrow ranges describe long-term interest rates. Such
globally subdued price and interest rate pressures are exceptionally
rare in my experience.

The rate of flow of workers to competitive labor markets will
eventually slow, and as a result, disinflationary pressures should
start to lift. China's wage-rate growth should mount, as should its
rate of inflation. The first signs are likely to be a rise of export
prices, best measured by the prices of Chinese goods imported into the
United States. Falling import prices from China have had a powerful
ripple effect. They have suppressed the prices of competing U.S.-made
goods and contained the wages of the workers who produce them—as well
as the wages of any who compete against the workers who produce the
goods that vie with the Chinese imports. Accordingly, an easing of
disinflationary pressures should foster a pickup of price inflation and
wage growth in the United States. It should be noted that import prices
from China rose markedly in spring 2007 for the first time in years.

How the federal reserve responds to a reemergence of inflation and
expected falling world saving propensities will have a profound effect
not only on how the U.S. economy of 2030 turns out but also, by
extension, on our trading partners worldwide. The Federal Reserve's
pre-1979 track record in heading off inflationary pressures was not a
distinguished one. In part, that earlier history was a consequence of
poor forecasting and analysis, but it also reflected pressures from
populist politicians inherently biased toward lower interest rates.
During my eighteen-and-a-half-year tenure, I cannot remember many calls
from presidents or Capitol Hill for the Fed to raise interest rates. In
fact, I believe there was none. As recently as August 1991, Senator
Paul Sarbanes, in response to what he considered intolerably high
interest rates, sought to remove voting authority on the FOMC [the
board that controls the federal funds rate, the primary lever of
monetary policy] from what he perceived were the "inherently hawkish"
presidents of the Federal Reserve banks. Interest rates declined with
the 1991 recession, and the proposal was shelved.

I regret to say that Federal Reserve independence is not set in stone.
FOMC discretion is granted by statute and can be withdrawn by statute.
I fear that my successors on the FOMC, as they strive to maintain price
stability in the coming quarter century, will run into populist
resistance from Congress, if not from the White House. As Fed chairman,
I was largely spared such pressures because long-term interest rates,
especially mortgage interest rates, declined persistently throughout my
tenure.

It is possible that Congress has observed the remarkable prosperity
that emerged in the United States and elsewhere as a consequence of low
inflation and has learned from this happy circumstance. But I fear that
containing inflation through higher interest rates will be as unpopular
in the future as it was when Paul Volcker did it more than twenty-five
years ago. "You're high on the hit parade for lynching," Senator Mark
Andrews told Volcker bluntly in October 1981.

This brings us back to globalization. If my suppositions about the
nature of the current grip of disinflationary pressure are anywhere
near accurate, then wages and prices are being suppressed by a massive
shift of low-cost labor, which, by its nature, must come to an end. A
lessening in the degree of disinflation suggested by the upturn in
prices of U.S. imports from China in spring 2007 and the firming of
real long-term interest rates raise the possibility that the turn may
be upon us sooner rather than later. So at some point in the next few
years, unless contained, inflation will return to a higher long-term
rate.

>From 1939 to 1989, the year of the fall of the Berlin Wall and before
the onset of the post-cold war wage-price disinflation, the CPI rose
ninefold, or 4.5 percent per year. The 4.5 percent inflation rate, on
average, for the half century following the abandonment of the gold
standard is not necessarily the norm for the future. Nonetheless, it is
probably not a bad first approximation of what we will face.

An inflation rate of 4 to 5 percent is not to be taken lightly—no one
will be happy to see his or her saved dollars lose half their
purchasing power in fifteen years or so. And while it is true that such
a rate has not proved economically destabilizing in the past, an
inflation projection in that range assumes a generally benign impact of
retirement of the baby boomers, at least through the year 2030. Today's
relative fiscal quiescence masks a pending tsunami. It will hit as a
significant proportion of the nation's highly productive population
retires to become recipients of our federal pay-as-you-go health and
retirement system, rather than contributors to it. Over time, unless
this is addressed, it could add massively to the demand for economic
resources and heighten inflationary pressures.

Thus, without a change of policy, a higher rate of inflation can be
anticipated in the United States. I know that the Federal Reserve, left
alone, has the capacity and perseverance to effectively contain the
inflation pressures I foresee. Yet to keep the inflation rate down to a
gold standard level of under 1 percent, or even a less draconian 1 to 2
percent range, the Fed, given my scenario, would have to constrain
monetary expansion so drastically that it could temporarily drive up
interest rates into the double-digit range not seen since the days of
Paul Volcker. Whether the Fed will be allowed to apply the hard-earned
monetary policy lessons of the past four decades is a critical unknown.
But the dysfunctional state of American politics does not give me great
confidence in the short run. We could instead see a return of populist,
anti-Fed rhetoric, which has lain dormant since 1991.

My fear is that as Washington strives to make good on the implicit
promises made in the social contract that characterizes contemporary
America, CPI inflation rates by 2030 will be some 4 percent or higher.

The "higher" is meant to reflect whatever inflation premium might arise
as a consequence of the inadequate funding for health and retirement
benefits for baby boomers. In the end, I see a positive fiscal outcome.
But I suspect it is likely that to restore policy sanity we will first
have to trudge through economic and political minefields before we act
decisively. I am reminded of Churchill's perception of Americans, who
"can always be counted on to do the right thing—after they have
exhausted all other possibilities." The trip through the minefields is
a major source of risk for my forecast, and it could be manifested in
higher paths for interest rates and inflation.

As awesomely productive as market capitalism has proved to be, its
Achilles' heel is a growing perception that its rewards, increasingly
skewed to the skilled, are not distributed justly. Market capitalism on
a global scale continues to require ever-greater skills as one new
technology builds on another. Given that raw human intelligence is
probably no greater today than in ancient Greece, our advancement will
depend on additions to the vast heritage of human knowledge accumulated
over the generations. A dysfunctional U.S. elementary and secondary
education system has failed to prepare our students sufficiently
rapidly to prevent a shortage of skilled workers and a surfeit of
lesser-skilled ones, expanding the pay gap between the two groups.

Unless America's education system can raise skill levels as quickly as
technology requires, skilled workers will continue to earn greater wage
increases, leading to ever more disturbing extremes of income
concentration. Education reform will take years, and we need to address
increasing income inequality now. Increasing taxes on the rich, a
seemingly simple remedy, is likely to prove counterproductive to
economic growth. But by opening our borders to large numbers of highly
skilled immigrant workers, we would both enhance the skill level of the
overall workforce and provide a new source of competition for
higher-earning employees, thus driving down their wages. The popular
acceptance of capitalist practice in the United States will likely rest
on these seemingly quite doable reforms.

It is not an accident that human beings persevere and advance in the
face of adversity. Adaptation is in our nature, a fact that leads me to
be deeply optimistic about our future. Seers from the oracle of Delphi
to today's Wall Street futurists have sought to ride this long-term
positive trend that human nature directs. The Enlightenment's legacy of
individual rights and economic freedom has unleashed billions of people
to pursue the imperatives of their nature—to work toward better lives
for themselves and their families. Progress is not automatic, however;
it will demand future adaptations as yet unimaginable. But the frontier
of hope that we all innately pursue will never close.

[From "The Age of Turbulence" by Alan Greenspan. To be published by The
Penguin Press, a division of Penguin Group (USA) Inc. ]

© 2007 by Alan Greenspan