The US economy underwent a fundamental shift in the early 1970s. The cause of that shift is still elusive. But it's a good bet changes in energy technology probably had something to do with it — with lessons for our economic future.
A new website called "WTF Happened In 1971?" is getting an increasing amount of attention. The site is incredibly simple — just a huge series of charts showing how economic statistics seemed to dramatically change in the early 1970s. For example, real wages rose steadily throughout the 60s, but plummeted after 1973.
Part of this was probably because productivity growth, one driver of wage increases, slowed down around the same time. But productivity and pay also began to diverge, even when worker benefits such as health care are included.
A series of other changes followed around 1980 — rising inequality, soaring budget deficits, ballooning trade deficits, falling savings rates, and so on. These are often attributed to the laissez-faire economic policies of President Ronald Reagan. But some of them, including trade and budget deficits, show hints of beginning a decade earlier.
So what did happen in the early '70s to cause such a large and enduring structural shift in the US economy? One obvious candidate is the oil shock of 1973. A coalition of Arab nations, angry at Western support for Israel during a recent war, organized an oil embargo, sending what had been very stable oil prices suddenly skyrocketing.
The oil crisis is one of the chief suspects in the productivity slowdown that began in the early '70s and ended in the mid-1990s. Nobel prize-winning economist William Nordhaus, writing in 2004, found oil-intensive industries accounted for two-thirds of the slowdown.
Even more fundamentally, the oil shock probably had an effect on the types of innovations scientists and companies generated. The crisis didn't just mean a rise in oil prices; it meant innovators could no longer rely on cheap, easily portable energy to be available forever.
Oil had represented a big improvement over coal. It was much cheaper to extract and transport and had a higher energy density. That permitted vast and rapid improvements in transportation technologies such as airplanes, internal combustion cars, and so on.
But after 1973, that energy bonanza was no longer a sure thing. The smooth progress of industrial technology toward bigger, faster, and more powerful machines, already in trouble due to the failure of nuclear power to supplant oil, crashed to a halt in 1973. Instead of finding new ways to use ever-more-abundant energy, manufacturers shifted toward finding ways to do more with less. Manufacturing productivity kept increasing, but the sector became less and less important to the economy.
The oil shock also probably helped fuel inflation. Prices had been rising in the late '60s, but after 1973 inflation soared to new heights.
The leading theory is that the Federal Reserve responded to the oil shocks by shifting to an easier monetary policy, which caused a self-fulfilling upward spiral of inflationary expectations.
Workers may not have been prepared for this accelerated inflation. When one looks at a graph of nominal hourly earnings — that is, unadjusted for inflation — it's astonishing how little the growth rate changes from year to year.
This suggests workers aren't very good at negotiating cost-of-living increases, allowing an unexpected surge of inflation to send real wages plummeting and keep compensation growing more slowly than productivity. And the eventual remedy for inflation — Fed Chair Paul Volcker's interest rate hikes in the early 1980s — created sharp recessions that increased unemployment and also helped hold wages down.
So the oil shock must be the prime suspect in the economic shift that began in the early 1970s. Of course, there are other potential culprits. One is shrinking union membership, which probably reduced workers' bargaining power.
But even here, the oil crisis could have exacerbated the trend, by shrinking heavily unionized manufacturing and mining industries and by weakening labor's bargaining power via the Volcker recessions. Similarly, the increasing importance of the financial sector, which accelerated after 1980 and is widely believed to have exacerbated inequality, could have been caused partly by companies looking for more profitable activities after expansion stagnated in transportation and heavy industry.
If the end of the age of cheap oil was truly responsible for many of these negative structural shifts in the US economy, then one obvious remedy is to find an energy source better than oil. That alternative may already be available: Solar power is becoming startlingly cheap. But to truly replace oil, solar energy will have to be not just cheap to gather but easy to transport from place to place. That means we need much more progress in batteries or other storage technologies. Governments should push hard to make big leaps in these technologies, so that the era of cheap energy can return — and with it, hopefully, widely shared prosperity.
Disclaimer: This article first appeared on bloomberg.com, and is published by special syndication arrangement.