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January 24, 2011

How much technology driven growth would have been needed to avoid the financial crisis

Peter Thiel believes that an important factor in the financial crisis is that technological progress hasn’t been so impressive in the last 15 years (H/T Michael Anissimov Accelerating Future

President Obama will emphasize the desire to increase technological innovation in the State of the Union address tomorrow. However, there is a gap between the stated desires for more innovation and GDP growth and actual effective pro-growth policies.

SHAFFER: You once said that the tech bubble of the ’90s migrated into an entire financial-services bubble. What does that mean?

THIEL: There’ve been a whole series of these booms or bubbles in the last few decades, and I think it’s a very complicated question why there have been so many and why things have been so far off from equilibrium. There’s something about the U.S. in the last several decades where people had great expectations about the future that didn’t quite come true. Every form of credit involves a claim on the future: I’ll pay you a dollar on Tuesday for a hamburger today; I’ll buy this house, and I’ll pay off the mortgage over 30 years; and so you lend me money based off expectations on the future. A credit crisis happens when the future turns out not to be as good as expected.

[blaming lenders... blaming borrowers]

My orthogonal take is that the whole thing happened because there was not enough technological innovation. It was not really the fault of the borrowers or the lenders; the problem was that everybody had tremendous expectations that the country was going to be a much wealthier place in 2010 than it was in 1995, and in fact there’s been a lot less progress. The future is fundamentally about technology in an advanced country — it’s about technological progress. So a credit crisis happens when the technological progress is not as good as people expected. That’s not the standard account of the last decades, but that’s the way I would outline it.



People were expecting house prices to go up 8 percent a year. That would be quite possible in a society where the GDP was growing tremendously and where there were tremendous gains in efficiency and technological innovation. But we’re not having that much innovation and, because of that, the housing bubble was unrealistic. It’s also possible that the housing bubble was very deeply linked to the tech bubble. The tech bubble was about extrapolating technological gains; it turned out that the gains didn’t materialize as quickly, or at all, and then people went back to housing and back to credit to get the 8 percent returns. But housing and credit still depend on an underlying society that is progressing, and that sort of progress was not actually happening. So, if the tech bubble was fake, then the housing bubble would almost certainly have to be fake. The real root of the problem is always technology.

History of US GDP growth

1995 2.515 
1996 3.741 
1997 4.457 
1998 4.355 
1999 4.826 
2000 4.139 
2001 1.08 
2002 1.814
2003 2.49 
2004 3.573 
2005 3.054 
2006 2.673 
2007 1.947
2008 0 
2009 -2.633
2010 2.639


Sustained 4.4 to 4.8% gdp growth (from 1997 to 2000) from 2001 to 2007 would have meant about 14-16% larger economy in 2007 and 2008 when the financial crisis hit.

This would have meant 14-16% more taxes for all levels of government based on the government taking taxes on the overall economy.

A larger economy would also mean more jobs and higher salaries if the ratio of income to the overall economy remained constant. This would have meant higher demand for residential and commercial real estate. Higher demand would have meant higher prices unless there was an increase in construction that exceeded the increased demand.

This would have meant budget surpluses for the federal government in 2007

Total revenue           $2.54 trillion
Total expenditures      $2.78 trillion
Deficit                 $244.2 billion
14% more revenue        $2.90 trillion  ($120 billion surplus)
16% more revenue        $2.95 trillion  ($170 billion surplus)

A similar analysis would apply for current budget problems, that if pro-growth policies were adopted and able to achieve a sustainable 4.4-4.8% gdp growth then over 15 years there would be $500 billion per year more federal tax revenue. This would not be enough by itself to bring down $1 -1.5 trillion dollar deficits but the growth of the debt would be more manageable. Also, the ratio of debt to national GDP would also be improved as the GDP demoninator would be bigger.


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