The "recovery" is about to enter its fifth calendar year, and despite consumer optimism and steady -- if slow -- job growth, deeper, structural problems linger. And those problems may not go away anytime soon.
The pace of growth of gross domestic product is slowing to a stall, rising at an annual rate of just 1.3% last quarter. The employment-to-population ratio is mired at early 1980s levels. Business confidence is in the dumps, as are spending and hiring plans. And the Federal Reserve's new "QE3" initiative -- ongoing monthly mortgage purchases of $40 billion to stimulate the economy -- is having a limited impact on borrowing because of the dysfunctional banking system and overly indebted households.
Let's go even deeper. Here are three measures that explain much of the malaise still being felt by average, middle-class Americans:
Because of skills mismatches and other issues, one Fed official believes the "natural unemployment rate" has risen as high as 6%, suggesting additional drops in joblessness will be slow and could encourage painful jumps in inflation.
The economy's potential growth rate or speed limit -- that is, how fast it can grow without causing inflation -- is slowing from above 3% before the recession to around 2% now as businesses withhold new investment -- something that will pressure living standards, should it continue.
The growth rate in labor productivity and GDP per capita has slowed dramatically -- explaining the stagnation in middle-class wages.
New research by economist Robert Gordon at Northwestern University (.pdf file) suggests the sluggishness could be permanent as a lack of meaningful technological innovation is compounded by head winds from demographics, education, economic inequality, environmental concerns, globalization, and the debt/deficit problem. (If he's right, we're destined to return to a pre-industrial revolution rate of growth, which is essentially nil.) So is this economy a lost cause, or can we still turn things around?
Anthony Mirhaydari
Lots of heat but no light
Gordon argues that the per capita economic growth we've seen over the past 200 years -- which transformed Western society from a collection of subsistence peasant farmers -- has been the exception rather than the rule. Throughout most of history, living conditions remained more or less static. Annual growth in real GDP per capita was around 0.2%. Life was essentially as the philosopher Thomas Hobbes described: nasty, brutish and short.
Then came three waves of transformative innovation. The first, between 1750 and 1830, featured steam power and railroads. Between 1870 and 1900 there were huge advances in electricity, industrial engines, indoor plumbing, communications, chemicals and energy. And from 1960 to now, we've had the information technology revolution.
The problem is that much of our modern-day prosperity is tied to the second wave, which featured one-time gains in the speed of travel, life expectancy and urbanization. People went from traveling by horse and wagon to traveling by jumbo jet. But then, things stopped moving faster. The space shuttles and the Concorde are museum pieces now. Mourning the death of the first man to walk on the moon after riding the Saturn V rocket, today we get excited when someone jumps from a hot air balloon at the edge of space.
Thus, per capita growth slowed after 1970. Americans, with the help of policymakers, used asset price inflation and debt accumulation to compensate for the wage stagnation that resulted. That gave us the illusion of maintaining the prior pace of increase in living standards.
That fantasy is now being laid bare.
The problem, according to Gordon, is that productivity gains from the third wave -- which peaked in the late 1990s -- proved fleeting. Since then, the focus of this so-called "new economy" has turned from using technology to enable advances in a wide variety of fields to simply improving entertainment and communications devices. We're seeing intense innovation and investment in a very narrow area of questionable benefit. The voyeurism of Facebook (FB) and the ability to watch snarky YouTube videos on your smartphone pales in comparison to the miracle of human flight.
The growth crash
You can see the result in the chart below, which illustrates the stagnation in GDP per capita.
This one chart shows all that is wrong with the economy and the middle class, and the task that will be faced by either President Barack Obama or Mitt Romney over the next four years.
Americans' idea of what their standard of living should be is based on the growth seen in the years following World War II through the early 1970s; that's the blue line in the chart. If that rate of growth had continued -- it averaged nearly 2.4% a year during that period -- GDP per capita (a proxy for wages) would be $63,500, 32% higher than it is now.
Instead, since 2001, average annual GDP per capita growth -- the red line in the chart -- has clocked in at a measly 0.7%. That returns us to a pace of growth not seen since just after the Civil War. What's worse, because of the impediments to the economy listed above, the growth rate could drop as low as 0.2%, a level last suffered in the 17th century, Gordon says.
For the middle class to prosper again, labor productivity and GDP per capita must reaccelerate.
Can the rich save us?
Last week, in "Vote for the Romney economy?" I talked about supply-side measures needed to boost capital investment and labor productivity. The discussion above underlines the importance of encouraging CEOs and small-business owners to take risks, buy new equipment, hire new workers and spur innovation by lowering the cost of growth efforts and the potential tax burden when new initiatives succeed.
Government can play a role -- not by giving cheap loans to companies like A123 (AONE) so it can try to sell its taxpayer-funded battery technology to China when things don't work out but by rewarding successes by fostering competition and buying the results. Why not emulate the strategy of the X Prize Foundation, which offers prizes for private-sector successes in fields like space travel.
Human ingenuity remains undiminished. Consider this year's Nobel prizes for work in quantum physics and adult stem-cell research. Quantum computing holds great promise, given the ubiquity of microprocessors, including self-driving cars and humanoid robots that can finally cross the "uncanny valley" and become true human proxies. Stem cells could advance regenerative medicine as the populations of rich world economies gray.
A trickle-down solution?
But what about demand?
While most people are suffering because of the stagnation outlined above, the wealthy are doing just fine as we regress toward the stratified social structure of the pre-industrial era. Consider the latest Federal Reserve survey of consumer finances. Between 2001 and 2010, the wealth of the median middle-income family fell by more than 20%. For the median family in the upper 10% of income, wealth increased 17% to $1.2 million.
Globally, Credit Suisse expects global wealth to increase 50% over the next five years. Most of this will accumulate to the elites, since just 0.6% of the global population controls more than 39% of overall wealth. According to its estimates, 18 million new millionaires will be created.
The ugly truth is this: The only solution I see, outside of a wealth tax and a rewriting of the social contract between the moneyed and the rest, is encouraging businesses to push the boundaries of possibility to satisfy the desires of the ultrarich. They'll want new organs and cybernetic servants. They'll want first-class seats for travel into space. Hopefully, thanks to the trickle-down of technology and the new jobs created along the way, the middle class will come along for the ride.
At the time of publication, Anthony Mirhaydari did not own or control shares of any company mentioned in this column in his personal portfolio.
Be sure to check out Anthony's new money management service, Mirhaydari Capital Management, and his investment newsletter, the Edge. A free, two-week trial subscription to the newsletter has been extended to MSN Money readers. Click here to sign up. Mirhaydari can be contacted at anthony@edgeletter.com and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.
Stock mentioned on the previous page: Facebook (FB).
