I have been struggling to articulate why I feel quite so concerned about the economy but in a dinner conversation last night I had a kind of Eureka moment.  It is now well understood that for at least two decades or so we had economic growth that was fueled (at least in the US) by consumer debt, which in turn was made possible by a housing bubble.  

Much of the political discussion today seems premised on the idea that once we are done with de-leveraging, households will return to spending and eventually growth and employment will follow.  But let’s examine how the economy grew when it was not fueled by consumer debt.  For many decades (arguably since World War II and possibly even further back) we had a successful loop working: consumers wanted to buy new things, companies made those new things and in the process paid out wages that allowed consumers to buy those things.  This is a virtuous cycle.  Make more stuff, have more income, buy more things which you or someone else makes, who then has income, and so on.

What happened though is that technology has gotten in the way.  In particular, we have gotten so good at making things (i.e., productivity has gone up so much) that how much we need to pay to labor has started to decline.  This breaks the virtuous cycle.  Yes we make more things but it no longer results in higher wages and so we can no longer afford those things.  We were able to hide this breakdown using debt.  Now that the debt is disappearing, the breakdown is becoming obvious.  We have had the least jobs created in any recovery from a recession.  And I believe that this is just the beginning.  My former thesis advisor at MIT, Erik Brynjolfsson, has really been digging into this.  It is worth reading “Race Against the Machine” co-authored by Erik with Andrew McAfee, which lays out the case that technology is rapidly displacing labor.

So just to restate my epiphany: the technology-induced break in the virtuous economic growth cycle didn’t just happen but goes back maybe as far as two decades.  We simply used debt to hide it.  If that is indeed the correct explanation then the employment situation is going to continue deteriorating. 

PS I have made a fair number of assertions in this post that I should really link to data for but I am on the road in London and a bit pressed for time.  It would be great if anyone reading this wants to provide some links as part of the comments.

PPS Globalization also plays a role here.  Apple yesterday announced the iPhone 5, which will generate billions in US sales and even profits to Apple.  But very little of this will go towards paying US domestic wages.