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Is 1.8% Economic Growth the Best We Can Do?

11 May 2018

Alan Reynolds

Economists who treat economic progress as a matter of
bookkeeping rather than human action have a bad habit of treating
“productivity” as a mysterious deus ex machina that causes
economic growth to slow down or speed up.

By extrapolating the past 10 years’ dismal productivity growth
and labor force participation into the next 10 years, the
Congressional Budget Office (CBO) concludes the U.S. economy can’t
possibly grow faster than 1.8% a year. Since the economy is stubbornly outgrowing its lowball forecasts,
the CBO felt obliged to lower GDP “projections” to
1.5-1.6% in 2021-2023 just to keep the
2018-2028 average under their magical 1.8% lid. This apparently
makes sense to one prominent economist.

“Even 2% Growth Will Be Hard to Sustain” was the headline of a
Feb. 14 Wall Street Journal article by the former chairman
of President Obama’s Council of Economic Advisers, Jason Furman. Real GDP per hour worked, he
noted, rose at a “1% annual pace over the past decade. If that
average continues, overall economic growth in coming years will
average only 1.5%” — assuming (as he does) the labor force
grows at the slow 0.5% pace it did for the past 10 years.

To declare that the next
10 years will be like the last 10 years does not require a
sophisticated economic model. It’s just naive

To declare that the next 10 years will be like the last 10 years
does not require a sophisticated economic model. It’s just naive
extrapolation. And it conveniently blames the disappointing Obama
recovery on unlucky productivity and labor force trends.

The most optimistic alternative scenario Mr. Furman can bring
himself to imagine is a growth rate of 2.1%, leaving us stuck
somewhere between 1.5% and 2.1%. The CBO’s 1.8% projection is right
in the middle of that miserable range, for similar reasons.

Growth, CBO Style

The CBO’s 10-year projection of 1.8% growth is critically
important. If economic growth is even 1 percentage point higher,
the CBO is grossly exaggerating long-term budget deficits. That is
not only possible, it is typical of CBO forecast errors after
income or capital gains tax rates were reduced. From 1983 to 2000,
the CBO’s two-year forecasts of real GDP growth were
repeatedly 1 percentage point too low, on average.

We are not at the mercy of blind fate or past trends. If business
output grows more quickly, output per hour will too. Productivity
in the nonfarm business sector rose by 3% a year from 1996 to
2005 because business output rose by 3.9% a year.
Economic growth raises productivity, not the other way

Nonfarm business productivity slowed to only 1.2% a year from
2007 to 2017 mainly because business output grew by only 1.7% a
year, but also because hours worked grew by only 0.4%. It is this
unusually feeble “trend” in productivity over the past 10 years
that Furman and the CBO ask us to project forward for the next 10

Furman expands the concept to total GDP per hour, but his
suggestion that we’re doomed to repeat the 2007-2017 aberration
(which would require another Great Recession) still fails. The OECD
calculates U.S. real GDP per hour in 2010 dollars. Real GDP per hour
rose from $62.35 in 1984 to $93.83 in 2007 — a gain of 2.3% a
year. Since then, as Furman notes, the increase slowed abruptly to
just 1% a year.

Why should we expect that the unusually weak productivity gains
since 2007 constitute an inexorable trend? That same question
applies to Furman’s projection that the labor force will also keep
rising at the depressed 0.5% rate of 2007-2017, when there was
unprecedented shrinkage in the number of working-age Americans
willing to work. Furman speaks of a “steady decline in labor force
participation … since around 2000,” but that is misleading.

Where Did The Workers Go?

It was no surprise that the labor force participation rate dipped slightly
from a record high of 67.1% at the 2000 peak to 66 in the 2008
recession. The mystery is why it kept falling after the
recession to 62.7% by 2015 despite falling unemployment
and rising wages.

A new Mercatus Center study finds the rising number
of young male labor force dropouts appears “connected to the rising
accessibility and generosity of government benefits.” Similarly,
The Redistribution Recession by University of Chicago
economist Casey Mulligan identified many new taxes, regulations and
benefits, including ObamaCare, that “reduced incentives for people
to work.”

If labor force dropouts can be incentivized to return to the
workforce, the labor force could rise substantially faster than the
working-age population. Average hours can also grow faster than the
labor force if involuntary part-timers get full-time work.

Adding the unusually low productivity growth of the past 10
years to the unusually low labor force growth is a fine way to
predict that past, but it’s not a serious way to predict the future.

The defective reasoning that leads Jason Furman and the
Congressional Budget Office to “project” a decade of 1.5%-1.8%
economic growth turns out to be an excellent reason for optimism,
because it implies that the CBO is grossly underestimating
long-term tax revenues and (depending on spending) future budget

is a senior fellow with the Cato Institute.

Click here to view the full article which appeared in CATO Journal