Department of Economic History Julius Probst

Summer term 2016 900515-6857

julius.probst@ekh.lu.se

Foundations of Economic
History

PART 3: Modern industrial society and the welfare

state

Maria Stanfors
Race against the robots: More of a crawl than a sprint

1. Introduction

The financial crisis of 2008 and the subsequent global economic downturn led
to a massive increase in unemployment around the world. Many major
economies still suffer from inadequate economic growth combined with
increased levels of unemployment. A decade of subpar economic
performance has created populist backlashes, xenophobia, and rising
nationalism in many coutries. There are striking parallels to the 1930s where
similar trends have led to the rise of fascism in several European nations,
Germany being the most prominent example. Back then, just as now,
immigrants are increasingly the target of popular discontent, as they
supposedly steal our jobs (Persaud, 2016).
But foreigners are not the only ones who are singled out. Technological
change has become once again the source of disconcern and fear, as
workers are increasingly worried that they will be replaced by machines. While
these kind of fears are not new, Luddites already protested during the time of
the Napoleonic Wars against labor-saving technologies in the textile industry
(spinning frames), they are not entirely unreasonable either (Mokyr et al.,
2015). U.S. manufacturing output is on an all time high, but employment in the
sector is on an all time low (see graph 1 in the appendix). This is, of course,
due to rising productivity levels. Thanks to modern technologies, real output
per person in manufacturing is constantly growing. This observation has led
many to believe that technological mass unemployment might be just around
the corner (Brynjolfsson & McAfee, 2011).
In this essay I take a contrarian view. I focus mostly on the U.S., but the
arguments are equally valid for other advanced economies. I argue that the
mass unemployment scenario is extremely unlikely. While technology might
have a large impact on the sectoral composition of the economy, the level of
unemployment is mostly determined by macroeconomic stabilization policies.
Furthermore, while technological change might have accelerated in recent
years, its impact on economic growth seems to have slowed down (Gordon,
2016). The second part of the essay will focus on the role of the welfare state.
Low-income workers did not fare well in recent decades in spite of low levels
of unemployment. I discuss to what extent public education and other social
programs can reverse recent trends in inequality in the current low-growth
environment.

2. The growth slow-down

The U.S. economy expanded at an unprecendented rate of 2.4% per capita in

between 1920 and 1970. This growth spurt was followed by the stagflation of
the 1970s, a period of high inflation and lower growth. Subsequently, the ICT
boom (Information and communications technology) of the 1990s provided a
welcome boost, but this effect only lasted for a little more than a decade.
Average per capita GDP growth since 2000 has only been around 1.1%. Not
since the Great Depression of the 1930s has economic growth been so
moribund (Gordon, 2016). The abysmal performance of recent years is partly
due to the aftermath of the Great Recession, but its effect should have died
out by now. Moreover, the growth slowdown started already before the
financial crisis of 2008. Financial markets now predict a long-lasting low-
growth and low-inflation environment for years to come (Summers, 2014). In
fact, this secular stagnation outcome seems to be far more likely than the
mass unemployment scenario imagined by McAfee and Brynjolfsson (2011),
for example. To raise productivity and to increase the size of the pie, we
desperately need more machines and more technological improvements, not
less, but recent innovations have disappointed so far. In the words of Peter
Thiel: We wanted flying cars, instead we got 140 characters., Twitter (Gobry,
2011, July 30).
Economic growth during the first half of the 20th century has been more
spectacular than anything mankind has witnessed in previous centuries
because a few General Purpose Technologies (GPTs) fundamentally
changed the structure of the economy. The adoption of electricity, the
introduction of the automobile and the construction of highways, the invention
of various household appliances that reduced household work to a fraction of
what it was a 100 years ago, all these achievements led to a spectacular
productivity boom that raised living standards at a rapid pace during the first
half of 20th century (Gordon, 2016). The ICT boom of the 1990s, on the other
hand, was short-lived. Recent innovations like Facebook, Whatsapp as well
as all the other smartphone applications have changed the way we allocate
our leisure activities, but have failed to substantially raise productivity. All
these new technologies have clearly raised consumer surplus by a substantial
amount, but they simply failed to make workers more productive. In the words
of Paul Krugman (1997): Productivity isnt everything, but in the long run it is
almost everything. It is the only reliable source of long-run economic growth
and thus crucial for improvements in living standards (Fogel, 2008).
While productivity in manufacturing is still advancing at a healthy pace, the
sector now only acocunts for about 12% of GDP, down from more than 25%
after World War II. Rapid advances in the ICT sector can, as a matter of
accounting, only be mildly stimulative to the economy because the sectors
share of GDP is less than 5%. The main problem lies in the growth of the
service sector, which has been expanding from about 60% of GDP in 1945 to
close to 80% nowadays1. Services are traditionally a low-growth sector. A
laptop today is a completely different animal than a laptop 15 years ago. A
haircut, on the other hand, is exactly the same product as it was half a century
ago. Not even the tools have significantly changed.
Products, such as education and health care, have a high-income elasticity of
demand. With rising per capita income the demand for such services
increases more than proportionally, thus increasing the sectors share of
GDP. The hypothesis that a growing service sector can be associated with
lower economic growth is called Baumols disease and was first put forward
in the 1960s. Some economists have suggested that this phenomenon has
contributed to the recent productivity slowdown the world has experienced in
recent decades (Gordon, 2016).
A new GPT, maybe an alternative and more efficient power soure, could help
the global economy out of its current malaise. Unfortunately, there is no way
of knowing when the next productivity-enhancing technological breakthrough
is going to happen, which could have a transformational impact on the entire
economy for years to come. It might be tomorrow, or in a few generations

1
Data from FRED
from now. Furthermore, it takes a long time until new technologies are
adopted, even in todays world. The diffusion of ideas and the acceptance of
new methods is not an instantenous process. Thomas Edison set up the first
electrical power station in New Jersey in the 1880s. However, only in the
1930s electricity finally started to have a transformational impact on the
economy. It took a substantial amount of time to build up a national grid and
to connect more and more businesses and households (Gordon, 2016).
Even in todays economy, technologies spread much slower than what is
commonly assumed. The struggle of the UberPop service to expand to
European markets shows how regulations can stifle technological change.
There are many barriers to the adoption and diffusion of new technologies,
regulations and vested interests just being a few out of many.

3. Unemployment and the sectoral composition of the labor force

The mass unemployment scenario as a result of technological change has

certainly gained some traction in the media in recent years. Uncertainty for
ordinary workers has increased. Unemployment went up and wages
stagnated in the aftermath of the financial crisis. Employment in
manufacturing is shrinking as workers compete with robots and China.
Nevertheless, one should be extremely sceptical about the proposition that
the future will hold technological unemployment for a majority of workers.
Indeed, graph 2 displays the U.S. unemployment rate over the last 50 years.
There is no apparent long-run trend visible in the data. The financial crisis led
to an extremely high unemployment rate in its immediate aftermath because
of macroeconomic mismanagement. The economic concensus is that more
aggressive fiscal and monetary stimulus could have brought down
unemployment much faster in the aftermath of the crisis (Summers, 2014).
The natural rate of unemployment is determined by structural factors, but the
actual rate of unemployment historically follows the business cycle. It is
ultimately the Fed and not technology, which determines how many people
are out of labor. It is true that the labor force participation rate has been going
down for more than a decade (graph 2). However, this can be partly attributed
to an ageing population while some of it clearly was the consequence of the
financial crisis (Gordon, 2016). The U.S. unemployment rate is currently at a
low of 4.7%. Some economists think that at least a fraction of the displaced
workers will join the labor force again as the economy continues to recover
(Rothstein, 2015).
While the Fed roughly determines the total level of employment in the
economy, the sectoral composition is determined by structural factors,
technological change maybe being the most important. Manufacturing
employment has declined from about 17 to 12 million over the last 20 years.
Total real output in the sector, on the other hand, has been increasing by
about 45%. This was only possible because productivity has roughly doubled
over the same time period, which corresponds to an annual growth rate of
about 3.5%2. It seems like technological progress and not China is the real
culprit of the decline in manufacturing employment in the U.S.
Despite the disappearance of so many jobs, U.S. unemployment actually
declined significantly during the 1990s and is now again at a very low rate as
the U.S. economy has finally recovered from the financial crisis. The key to
this puzzle is, of course, structural change. Jobs in manufacturing were
replaced by jobs in the service sector. This phenomenon is not very
surprising. The demand for services rises more than proportionally as per
capita income increases. The sector expands as a share of GDP because the
consumers demand for education, health care, restauration, transportation,
etc., goes up. Many jobs disapppeared in the car manufacturing industry, for
example, as production chains became more and more automated. But the
economy usually adjusts and creates other employment opportunities. New
sectors like the high-tech industry created numerous new occupations that did
not exist previously. However, one should note that these new sector jobs
were not abe to replace old-fashioned manufacturing jobs one for one.
General Motors was the most valuable U.S. company in the 1960s. In 1955, it
had about 580,000 emloyees, compared to just a little more than 200,000
today. It was indirectly responsible for about 3 million American jobs if you
include the entire supply chain. Todays most valuable companies are all in
the high-tech industry. Facebook and Apple are among the top 10 companies

2 Data from the Federal Reserve Economic Data: FRED
by market capatilization in the U.S., but only employ a tiny fraction of the
workforce. Facebook, for example, has less than 13,000 employees3.
As of 2014, there were about 4.6 million workers in the IT sector (information
technology). This is a sizeable number, but it only represents 2.9% of the total
workforce. While the IT sector has been adding about a million jobs in
between 2000 and 2014, it is other industries, especially the service sector,
that have been expanding at a more rapid pace. Professional and business
services, healthcare and social assistance, and leisure and hospitality have
created in between 2004 and 2014 a total of 3 million, 4 million, and 2 million
jobs, respectively4.
It is thus a fallacy to believe that manufacturing jobs were mostly replaced by
occupations in the IT sector, the so-called new economy. Not only did high-
tech fail to create a sufficient amount of jobs, but its skill content is also
fundamentally different. High-tech companies in Sillicon Valley attract the
most talented and most skilled individuals from all over the world. Some
economists point out that technological change has been extremely skill-
biased in recent decades (Goldin and Katz, 2009). While modern technologies
and high-skilled labor are complementary in most cases, low-skilled labor
certainly seems to be substitutable to a much higher degree in many
industries, especially manufacturing. The service sector might be an
exception to the rule. The average Joe, formerly working at the production line
for General Motors, did not simply become a Google employee. Instead, he
became a barrista at a Starbucks or an Uber driver.
It is thus services and not modern high-tech that has assumed the role of the
main job creator in the U.S. over the last decade and there is no reason to
believe that this will change any time soon. Projections by the Bureau of
Labor Statistics (BLS) assume that the fastest growing industries in between
2014 and 2024 are in the service sector, such as healthcare and educational
services (Henderson, 2015). There is nothing fundamentally wrong in itself
with the current decline of manufacturing and the growing importance of
services in our modern economy. This shift simply indicates a structural
transformation. As incomes grow, the share of expenditures spent on services

3
Data from Fortune 500
4
Data from the Bureau of Labor Statistics: BLS
tends to rise, thus explaining the growth of the sector. However, there are a
few reasons why this structural change might be somewhat worrisome for the
middle class as well as for the economy as a whole. First, service sector jobs
are probably associated with less job stability than long-term employment in
manufacturing. Furthermore, salaries in manufacturing are likely to be higher.
Indeed, the recent hollowing of the middle class might be the result of
manufacturing jobs being replaced by lower-paid employments in the service
sector.
Finally, since the economy has shifted increasingly towards services in recent
decades, economic growth might be harder to generate because productivity
increases are usually much lower in the service sector. Because of this
compositional effect, other sectors like manufacturing would have to grow
faster than they used to in the past in order to achieve the same amount of
GDP growth. Unfortunately, this is not what we observe. The recent growth
slowdown cannot just simply be attributed to such a compositional effect.
Instead, productivity seems to have slowed down across the board, affecting
all major sectors of the economy, including manufacturing (Gordon, 2015).

4. Education and the skill premium

As growth has been on a downward trend during the last decades, wages for
low-income workers have fallen and wages for the middle class have
stagnated. It is only high-income workers who have recently enjoyed robust
wage growth. Real hourly wages for the 10th percentile have fallen by 5% and
for the 50th percentile they have only increased by 6% in between 1980 and
2012. Meanwhile, the 95th percentile has experienced a staggering increase
of 41% (Bivens et al., 2014). These numbers are to be taken with a grain of
salt because of the price index that is used to deflate nominal wages. There is
some evidence that suggests that statistics offices overstimate the annual
inflation rate by up to 1% (Boskin et al., 1998). Furthermore, low-wage
workers have a different consumption basket than high-wage workers, which
would further distort the accuracy of the calculated real wageof different
income groups. Nevertheless, it is clear that individuals at the bottom part of
the wage distribution have significantly fallen behind since the 1980s. As
mentioned previously, the adoption of technologies that are complementary to
high-skilled labor seems to be one factors that is driving this trend.
However, Goldin and Katz (2009) have a slightly different interpretation of
recent events. They argue that technological change has been skill-biased for
more than a century. Already the inventions of the 2nd Industrial Revolution,
such as steam power and electricity, increased the demand for skilled-labor.
What matters more for the wage premium is not so much technological
change per se, but more importantly the relative demand and supply of skilled
workers. Goldin and Katz (2009) argue that for a very long time the supply of
skilled workers has kept up with demand, thus keeping the wage premium in
check.
They have labeled the 20th century the century of human capital. High income
countries started to educate the masses. The U.S. established itself as a
global leader in secondary schooling already at the beginning of the 20th
century, a few decades prior to similar developments in Western Europe. The
human capital stock of the American workforce increased from an average of
almost 8 years of schooling in 1915 to 13.5 years of schooling in 2005 (Goldin
and Katz, 2009). High school graduation rates in the U.S. were merely about
10% in 1910. The high school movement really took off in the 1930s as
schools cropped up all over the country. The fraction of students enrolled in
high schools increased from 18 to 71% in between 1910 and 1940. The
amount of skilled workers thus increased rapidly during the deacades when
some of the key technologies of the 20th century started to become part of
everyday life (Goldin and Katz, 2008).
The introduction of automobiles and the adoption of electricity in the beginning
of the 20th century was clearly highly transformative to the economy and
increased the demand for skilled labor. The demand for education is highly
dependent on the pecuniary reward of additonal schooling. Secondary
schooling for the masses was thus to some extent an endogenous response
to the state of the economy, conditions in the labor market, and the increased
demand for skilled workers. Goldin and Katz (2009) note that the skill
premium actually declined during the 1930s and 1940s. The increased
demand for skilled labor was thus more than offset by the supply response
created by the high school movement, leading to a massive rise in graduation
rates.
College is to the second part of the 20th century what high school was to the
first. For cohorts born in the year 1930, college graduation rates by the age of
30 were about 10% for females and roughly the double for males. For the
cohort born in 1975, the college graduation rate for females increased to 35%
while that for men had gone up to 30%. The college wage premium did not
change significantly from the 1950s to the 1980s (Goldin and Katz, 2009). The
increased demand for skilled labor was satisfied by a rapidly rising supply of
college graduates during that period. Skill-biased technological change did not
have the expected effect on the wage premium because higher education
turned out to be a countervailing force. Ever since the 1980s, however, low-
wage workers have increasingly lost ground. Wages in the upper tail of the
distribution have risen rapidly while median wages have stagnated (Goldin
and Katz, 2009). The demand for skilled workers certainly seems to have
outpaced supply in recent decades.
Goldin and Katz (2009) offer a very natural solution to the problem. They note
that the average educational attainment of the workforce only increased by
one year from 12.5 to 13.5 years of schooling in between 1980 and 2005, a
much slower rate of progress than what one could observe in prior decades.
Consequently, they suggest to expand the human capital stock of the
workforce by increasing college graduation rates even further.
Education is a public good and there are substantial economic rewards from a
more educated populace. The cost of tuition has increased more than
twelvefold since 1978 whereas the CPI has risen less than threefold over the
same time period 5. There is no question that the U.S. government could
subsidize college to a greater extent. A system that relies on more moderate
tuition fees would not only reduce the substantial amount of debt U.S.
students have accumulated in recent years, but also increase college
attendance rates.
However, there are a few caveats. College attendance rates are already quite
high. It is questionable to what extent it makes sense to push that rate even

5 Data from the Bureau of Labor Statistics: BLS
higher, not everybody can be college material, and at what cost one can do
so. Finally, there is some doubt to what extent providing more education will
help low-income workers. Moretti (2012) estimates that for every job created
in the high-tech sector, five additional jobs are created in the local service
industry in the long-run, from Yoga instructors to Uber drivers. There is a case
to be made that workers in such occupations simply do require advanced
degrees. Pushing for more higher education might not bring many additional
benefits if a substantial part of the new jobs require a low skill content
because they are occupations in the service sector. Note thay this argument
is very different from the lump of labor fallacy. I do not argue that there is only
a fixed amount of jobs in the economy because that statement has never
been true. Instead, I claim that the sectorial composition is pinned down by
structural factors, technology being the most important determinant.
Consequently, I am more sceptical about the benefits of additional higher
education than Goldin and Katz (2009), for example. An Uber driver with a a
more advanced degree does not earn more money than his peers with slightly
lower education. More education might not be helpful if it does not change the
ratio of skilled to unskilled jobs in the economy, and there is no fundamental
reason to believe why it would do so.

5. Migration as en engine of growth

From a theoretical point of view, it is not quite clear whether migration is

growth-enhancing or not. In the basic Solow model, an increase in the
population growth rate temporary depresses output per capita because the
capital per worker ratio decreases. New endogenous growth models, on the
other hand, allow for a positive effect of population growth for two reasons. It
increases the supply of potential innovators and it also increases the size of
the market, which is crucial for the profitability of any given innovation (Aghion
& Howitt, 2008).
The U.S. population has grown by a factor of 4.2 from 76 million in 1900 to
325 million in 2015. By comparison, France has seen its population increase
by a factor of 1.6 over the same time period. The U.S. has historically always
been an immigrant country and has historically benefitted from this status.
The first wave of global migration occurred at the turn of the century. The U.S.
received more than 600,000 migrants on an annual basis in between 1900
and 1930, a total of 19 million6. Most of them came from poorer countries in
Southern and Eastern Europe (Hatton & Williamson, 2005). From a global
welfare point of view, it is highly desirable to allow workers to move from low-
productivity to high-productivity countries. However, such substantial
movements of labor represent a large shock to the domestic economy. Even
though immigrants and natives are often complements in the labor market, the
evidence suggest that low-skilled natives are in direct competition with
migrant labor and that their wages suffer as a consequence (Hatton &
Williamson, 2005).
The world experienced several decades of low migration flows in the middle of
the 20th century because many advanced economies, even the U.S., started
to erect barriers to limit the inflow of foreign labor, partially a result of domestic
anxiety (Hatton & Williamson, 2005). The immigrant share of the U.S.
population reached an all time high of 15% in 1910, decreased to 5% in 1970,
and subsequently increased to 13% in 20137 . Immigration has picked up
again in recent decades. The U.S. has become the most popular destination
country for migrants from Latin America. While a large pool of the migrant
stock is low-skilled labor, the country has also attracted a substantial amount
of talent and ingenuity from all around the world. More than 40% of the
Fortune 500 companies were founded by immigrants or their children
(Anderson, 2011, June 19).
But higher immigration rates do not only increase the pool of potential
entrepreneurs. The U.S. will inadvertently face demographic headwinds
because of an ageing population and a lower fertility rates. These two forces
will increase the ratio of non-workers to workers in the economy, which will
have a negative impact on per capita income. A higher migration rate could
thus turn out to be a vital tool in mitigating the non-technology related aspect
of the growth slowdown (Gordon, 2016).

6. The welfare state as a potential solution to growing inequality

6 Data from the Migration Policy Institute: MPI
7 Data from the Migration Policy Institute: MPI
The social welfare state is pretty much a 20th century creation. While poor
relief existed in countries like England and France before 1900, it only
accounted for a tiny fraction of national product. Other programs, such as
mass public schooling, health care subsidies, unemployment benefits,
pension benefits, and minimum wage policies, are all inventions of the 20th
century (Lindert, 2004). Welfare programs in the U.S. started to expand at a
rapid pace during the 1930s when a large share of the population suffered
from the economic consequences of the Great Depression. As countries
became richer, they could afford an increasing amount of social spending.
The welfare state expanded over the course of the 20th century, as more and
more social programs got introduced over time (Lindert, 2004). There were a
few backlashes though. The expansion of the welfare state came to a halt
during the 1980s under the presidency of Ronald Reagan. The administration
pursued an activist policies against labor unions. Unionization rates in the
U.S. have fallen rapidly ever since and the real minimum wage was eroded
over time as a result of inflation. These policies led to a significant decline in
the bargaining power of labor and low-wage workers have seen their incomes
stagnate as a result.
Previously, I have argued that technological change is unlikely to result in the
mass unemployment scenario that some people imagine. Instead, we have
seen a sectoral shift from manufacturing to service sector jobs. Education
might not turn out to be the one-size-fits-all solution that Goldin and Katz
(2009) make it out to be. Instead, governments will have to turn back the clock
and revert some of the recent trends. Sensible minimum wage policies, the
strengthening of labor unions, the adoption of Earned income tax credits, or
even a universal basic income, are all examples of economic policies that
could give back some bargaining power to low-income workers. Such policies
would strengthen their position in the labor market and could prevent a further
erosion of real wages in the bottom part of the income distribution (Mishel &
Walters, 2003).
Housing policies should also be on the top of the list. Housing prices have
exploded in major metropolitan areas over the last decades because demand
far outstrips supply. Zoning laws and other regulations have prevented
housing construction in the areas where it is most needed. Many low-income
workers cannot afford to live in such areas anymore. The economic costs of
these policies are enormous. High housing prices prevent an efficient
allocation of labor from low-productivity to high-productivity regions. Hsieh et
al. (2015) estimate that U.S. real GDP could increase by more than 4% if
housing construction in metropolitan areas took off and such if a reallocation
of labor then were to take place.
The plight of low-income workers did not have to happen. It was a deliberate
choice of the political system. Since the 1980s, economic policies were
increasingly tilted towards high-income workers and capital owners. But
economies often move in cycles. There has been a slight policy reversal since
the financial crisis. Higher minimum wages were implemented in many cities
in the U.S., but a more systematic approach is needed to reverse some of the
recent trends in inequality.

7. Conclusion

The disappearance of old-fashioned manufacturing jobs has reignited fears of

technological progress. Economic growth and productivity gains, however,
have extremely disappointed over the last two decades. What we see in
reality is not so much a race against the machines, but more of a crawl. In
order to raise living standards, we actually need more technological progress,
not less. We should thus embrace any productivity-enhancing technological
change. Economists, however, do not quite agree upon the right policy-mix
that would lead to more innovative activity. Higher spending on research and
development could be one way forward, but nobody can predict when or even
whether such activities would pay off. In the presence of lower trend GDP
growth, policy makers should also focus on the recent increase in inequality.
Social programs must take a center stage again in the public debate because
otherwise low-income workers will just continue to fall behind in the current
low-growth environment. Not only would such a development be detrimental
to social cohesion, but also it would come at an economic cost because high
levels of inequality seem to be growth-inhibiting (Cingano, 2014).
8. References

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- Mishel, L. R., & Walters, M. (2003). How unions help all workers.
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- Moretti, E. (2012). The new geography of jobs. Houghton Mifflin
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40.
 06
08

03
04
05
07
09
10
11
1960-01-01
1962-10-01

Source: FRED
Source: FRED
1965-07-01
1968-04-01
9. Appendix

1971-01-01
1973-10-01
1976-07-01
1979-04-01
1982-01-01
1984-10-01
1987-07-01
1990-04-01
1993-01-01
1995-10-01
1998-07-01
2001-04-01
2004-01-01
2006-10-01
2009-07-01
2012-04-01

Figure 2: U.S. unemployment rate and labor force participation

2015-01-01

56
58
60
62
64
66
68
Figure 1: Employment, output and productivity in U.S. manufacturing

rate

rate)
Linear
Labor force
participation
Unemployment

(Unemployment