** Rational Exuberance by Michael Mandel

Mandel is the Chief Economist at Business Week and he skewers current dogmatic economic theory which tends to unbelievably ignore innovation in its models as a primary driver of economic growth. He uses data and examples to stake his case, and then extends his arguments to forecast the near future.

If the US shifted to cautious (slow growth), the most pernicious and surprising effect would be the popping of the educational bubble. During the 1990s, college educated workers thrived because the fast pace of innovation demanded workers who could learn and adapt quickly to new technologies. That drove up pay for educated workers… But if the pace of innovation slows, there will be much less need for college educated workers. Jobs will be routinized (and automated), and companies will replace high paid college educated workers cheaper workers with associate degrees or even less (or outsource to other countries). Falling demand and rising supply means a sharp downturn in the incomes and fortunes of the college educated. P10

Periods of innovation and exuberant growth also seem to be the periods with the lowest unemployment… Why should this be? During period of cautious growth, companies have only 1 way to boost productivity and profits – by cutting costs and trimming workers… However during period of exuberant growth, both companies and workers have other options. Innovation enables companies to compete by using new technology to make existing workers more productive. And even if workers are laid, there are innovative new industries that are hiring… Workers have something to aspire to – there’s unclaimed territory where smart and hardworking Americans can make their mark. P39

Exuberant growth builds on the real competitive advantage that the US has – not in capital, not in education, not in infrastructure but in risk taking. Other countries don’t have the resources to take a chance on an expensive new technology the way the US does. At the same time, exuberant growth in the US turns out to be beneficial to other countries… Such growth allows the US to keep moving to higher and higher rungs on the economic ladder. Technological change creates new products and new markets that can be exploited for a time before other countries catch up…And as the US moves onto new markets, it opens up the lower rungs for other nations. P41

2035 Forecast: Exuberant Growth could save us
Between 2005-2035, the US population will increase by 27%, but in the prime working age group of 25-64, it will increase by only 12%. That means each worker must be 13% more productive to maintain a constant per capita income in 2005 dollars… A cautious growth economy of only 1.1% productivity growth per year will yield a compounded increase of 39% by 2035. 13% of this must be committed to compensate for the increase above, that doesn’t leave much for everyone else… By contrast, exuberant growth powered by technological change will yield a 92% increase by 2035. It then becomes possible to pay for the baby boomer retirement and rising medical costs and still have plenty left over. P45

The uncertainty of innovation has been responsible for all of the big economic forecasting failures of the past. Fore example, nobody expected the sharp slowdown in productivity growth in the 1970s and early 1980s. What was the cause? It wasn’t low capital investment. It wasn’t education as the percentage of Americans with a college degree was rising sharply. Nonfarm productivity grew at a meager .5% per year… One simple explanation that economist dismissed too easily was technological failure. In particular, 2 leading innovations of the 1960s – nuclear power and space travel – unexpectedly turned out to be major disappointments… Similarly it was the unexpected success of the internet that confounded economic forecasters in the 1990s, when many forecasters consistently expected Europe to grow faster than the US, when the US grew faster every year between 1992 and 2000. In the end technological change turned out to be more important than any other factor. P66

The Next Breakthrough?

Communications: Advanced telecom

Materials: Nanotechnology

Health: Biotechnology

Energy: Fuel cells, solar

Transportation: Space

Why biotech won’t help the economy?

To help the economy a breakthrough biotech drug/therapy it has to satisfy 2, not necessarily compatible objectives. 1^st it would have to be successful treating an important disease, which would make it profitable for the company producing it. At the same time, it must reduce the total health care spending in the economy, or it merely means taking dollars from an older therapy and applying it to a new one. What about increased lifespan? That merely increases the population, and at older ages, it may even increase the overall health care spend since everyone dies of something eventually. P104

Bet on telecom – but not on the existing players

Telecom has several advantages. The technology works and it doesn’t have any big safety considerations to worry about. And there are applications for all the new capabilities. There are 2 big hurdles that telecom faces. 1^st is the uneven state of broadband access [this seems likely to be fixed with new/cheaper technology]. The 2^nd is the ever increasing hold of the large telecoms on the market… Without innovative energies from new firms, the process of change goes much more slowly. That negates one of the main competitive advantages that the US has. [Again if the technology is much cheaper the capital costs to deploy will be reduced, removing this hurdle as well].

Keep an eye out for an energy breakthrough

Energy innovations have been an absolutely critical part of every industrial revolution in the past… Our high tech civilization could be derailed without a breakthrough in either energy distribution or generation… It should be a very good time for the financial markets and VCs to start funding energy start ups. Unfortunately the 3 main candidates for igniting an energy revolution – solar, fuel cells, and nuclear are immature or problematic… None of them leaps up as an immediate candidate for driving the next revolution without some dramatic improvements. P108

Nanotech: Don’t hold your breath on this one until you see a ‘Shockley Event’, where a technology can get on a Moore’s law like exponential progression.

Space: Who needs it? Don’t invest here.

If and when a financial crisis comes in China, no one knows whether the political system will end up performing like the US in the late 1980s after the S&L bailout, or more like Japan’s, where in the 1990s it was paralyzed by bad debt… The danger is that China will not be able to act effectively in the event of crisis. It will have to bail out banks and companies that are overextended, while forcing consolidation at the same time. P141

2010s: Back to the 1970s?

What happens after most businesses have been computerized, networked, web-enabled? If there are fewer must have technologies, then we slip back to the 1970s again… It will become harder to justify paying a college grad 60% more than someone with an associate’s degree who can do the same job… It is precisely the routination of technology that poses a deep and hidden danger for the educated classes… The set of routine tasks expands over time… Educated workers are in danger of seeing their jobs deskilled… In such a world, programmers will worry about being replaced by cheaper labor in India and the Phillipines. Professors will worry about being replaced by distance education. The educated classes will no longer feel immune from economic downturns. ‘The idea that technological advances favor more skilled workers is a 20^th century phenomenon’. P164

Pop goes the education bubble

People who received college diplomas in 60s, 70s, & 80s had an unfair advantage they didn’t realize at the time. They grew up in a world in which there was very little competition from overseas for type of cerebral, organizational, persuasive activities. Of hat generation of 60s to 80s, 30% of them got college degrees. In Japan and Germany, the percentage in that generation was only 15%. In France, it was only 10%. That was no way to run a modern economy (ouch to France!). Today, the surge in college enrollment overseas is creating an enormous overhang of low cost college graduates, which can potentially replace more expensive US graduates. P167

The full impact of a growth crisis does not usually hit until well after the recession is over. For that reason, the beginning of a growth crisis is hard to identify at the time. 1974-5 recession marked the onset of the last growth crisis, despite a strong recovery – growth of 5% over the next 3 years. P174