BREAK THE OLD WINDOWS:

The Economic Mega-Worry (Robert Samuelson, 1/03/07, Real Clear Politics)

A century ago, Americans spent 43 percent of their incomes on food and another 14 percent on clothing. By 2002, those shares were 13 percent and 4 percent. Meanwhile, family incomes (after inflation) had tripled. Filling the spending gap are all the things we take for granted--cars, TVs, travel, telephones, the Internet. Home ownership has zipped from about 20 percent to almost 70 percent of households.

This triumph of mass consumption is usually credited to technological breakthroughs, from the assembly line to computer chips. But the whole process is also described as productivity improvement. In 1900, 41 percent of Americans worked on farms. If mechanization, new seeds and fertilizers hadn't meant that fewer people could produce more food, we'd still be paying two fifths of our income to eat. Labor productivity is measured as output per hour worked. Whatever enables people to produce more in a given time (machinery, skills, organization) boosts productivity.

That in turn raises our incomes--or gives us more leisure. It also promotes domestic tranquillity by muffling the competition between government and personal spending. Slow future productivity growth virtually ensures a collision between the heavy costs of retiring baby boomers--mostly for Social Security and Medicare--and younger workers' living standards. Higher taxes will bite deeply into sluggish incomes. The reason: what seem to be tiny productivity shifts have huge consequences.

Consider. In 2005, the U.S. economy produced $12.5 trillion of goods and services, or gross domestic product (GDP). Per capita income--the average for individuals--was $35,000. If productivity growth averages 2.5 percent a year, the economy reaches $34 trillion in 2035 (in constant "2005 dollars"), estimates Moody's Economy.com. Per capita income rises to $73,000. Now, suppose productivity growth averages 1 percent annually. Then GDP in 2035 is only $23 trillion, and per capita income is $48,000. That $13,000 gain ($48,000 minus $35,000) may look large, but it occurs over three decades, and for workers part of the gain would be taxed away to pay baby boomers' retirement costs. Typical take-home pay would rise less than 1 percent annually.

Unfortunately, productivity growth has recently decreased. In the past year, it's been only 1.4 percent. By contrast, it averaged about 3 percent from 2000 to 2005. The fall-off partly reflects a mature business cycle. As the economy slows, so do productivity gains. But some long-term forecasts project that the poor performance will continue. In Moody's Economy.com's outlook, productivity growth averages 1.4 percent a year from 2005 to 2035. The main reason: stunted business investment in new machinery, technologies and buildings, says chief economist Mark Zandi.

Basically, the benefits of the Y2K hysteria have worn off. But we can force another round of investment in modernization by adopting tough emission standards -- under the pre-text that they're to combat global warming -- and taxing carbon so heavily that alternatives become economical.

Posted by Orrin Judd at January 3, 2007 8:53 AM