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Kurzweilomics

By Arnold Kling - October 18, 2005 12:00 AM

"I close with an anecdote from Simon Kuznets. He used to give a one-year course in growth economics, both at Johns Hopkins and Harvard. One of the points he made was that if you wanted to find accurate forecasts of what happened in the past, dont look at what the economists said. The economists in 1850 wrote that the progress of the last decade had been so great that it could not possibly continue. And economists at the end of the nineteenth century wrote that the progress of the last half century had been so great that it could not possibly continue during the twentieth century. Kuznets said you would come closest to an accurate forecast if you read the writers of science fiction. But even the writers of science fiction were too pessimistic."
-- Robert W. Fogel

"The law of accelerating returns is fundamentally an economic theory. Contemporary economic theory and policy are based on outdated models...largely overlooking computational capacity, memory, bandwidth, the size of technology, intellectual property, knowledge, and other increasingly vital (increasingly increasing) constituents that are driving the economy."
-- Ray Kurzweil, The Singularity is Near, p. 96

 

The publication of Ray Kurzweil's latest book is a major (dare one say singular?) event. His views are worth considerable discussion and debate. This is the first of three essays that I plan to write on topics raised by Kurzweil. Here, I deal with the economic forecast implicit in the book. In the next essay, I will sketch a vision of the future that differs somewhat from Kurzweil's, based on my skepticism about artificial intelligence. The third essay will look at what I think might be the new outlook for military power, based on technology trends.

 

Forecasting Productivity

 

Labor productivity is perhaps the most important statistic in the economy. Over time, output per worker is what drives wage rates and the standard of living.

 

Economists routinely forecast annual growth in U.S. labor productivity of roughly two percent for the next several decades. For example, the Trustees' Report for the Social Security Administration assumes productivity growth of 1.6 percent in its "intermediate" scenario.

 

To Kurzweil, this forecast would be ludicrously pessimistic. He would see it as an example of what he calls "intuitive linear" thinking, in which people forecast the future on the basis of a linear extrapolation of the past. For example, from 1960 through 1992, productivity growth in the nonfarm business sector averaged 1.6 percent. Accordingly, that may seem to be a reasonable rate of increase to project going forward.

 

However, since 1992, productivity growth has sped up. As this article from the Federal Reserve Bank of San Francisco points out, "The performance of productivity in the U.S. economy has delivered some big surprises over the last several years. One surprise was in the latter half of the 1990s, when productivity growth surged to average an annual rate of over 3%, more than twice as fast as the rate in the previous two decades. A bigger surprise has been the further ratcheting up...productivity growth averaged around 3.8% for the 2001 through 2004 period."

 

This good news on productivity rarely surfaces in the media. In part, this represents a general pessimistic bias in the media and among the population at large. In part, it reflects the inability of people to grasp nonlinear thinking.

 

Technological innovation is what drives productivity growth. Kurzweil argues that the rate of technological innovation is doubling every decade, which to me would imply that the rate of productivity growth will double every decade. If annual productivity growth was 3.5 percent in the decade ending in 2005, then it will be 7 percent in the decade ending in 2015 and 14 percent in the decade ending in 2025. By that time, productivity would be more than 7 times what it is today. Thus, if average income per person is $35,000 today, then it will be over $250,000 per person (in today's purchasing power) in 2025.

 

At a growth rate of 14 percent, output per person "only" doubles at a rate of about every 5 years. Using a more elegant mathematical model of technological change, George Mason University economist Robin Hanson arrives at an even more striking forecast. He writes, "we might see yet another transition to a much faster mode, if such faster modes are possible. The suggestion is fantastic, namely of a transition to a doubling time of two weeks or less sometime within roughly the next century."

 

The Equity Premium Puzzle

 

As an aside, Kurzweil's analysis may contain a solution to a problem in economics known as the equity premium puzzle. Historically, shares of stocks, which grow with the economy, have earned a much higher return than securities that simply pay a fixed rate of interest. Economists wonder why the owners of interest-bearing securities did not shift more of their portfolios into stocks, which would have reduced the equity premium. Edward Prescott, who received the 2004 Nobel Prize, co-authored one of the papers that drew attention to this puzzle.

 

If Kurzweil is correct that we mistakenly apply linear models to forecasting in a nonlinear world, then investors would consistently under-estimate the long-term growth rate of the economy and of the stock market. That might explain some of the persistent equity premium. If investors were to apply a more accurate nonlinear forecasting model, stock prices would jump to a higher level, beyond which the excess returns from holding shares would be minimal. Instead, using linear thinking, investors are continually surprised.

 

Economic Problems Vanish

 

In The Great Race, an essay that reflects the influence of Kurzweil's earlier writings, I pointed out that a question going forward is whether the economy can grow faster than Medicare. I argued that Moore's Law favors the economy, but demographic and political considerations favor Medicare.

 

If output per person in 2025 is more than 5 times what it is today, then the economy will have won the race. That means that all of the concerns that economists raise about the middle of this century, such as the external debt of the U.S. economy (the cumulative trade deficit), the fiscal implications of Social Security and Medicare, or gloomy scenarios for global warming, will be trivialized by the sheer heights that economic wealth will have scaled by that time. If Kurzweil is correct, then the mountain of debt that we fear we are accumulating now will seem like a molehill by 2040. We will pay off this debt the way someone who wins a million-dollar lottery pays off a car loan.

 

I hope that the lottery-winning Kurzweil scenario materializes, but I am still not comfortable watching our government accumulate obligations to future entitlement recipients at the current rate. As of now, however, the data on average productivity growth over the past decade is reasonably consistent with the hypothesis that the economy is winning the Great Race.

 

Arnold Kling is author of Learning Economics.

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