In a new analysis of the slow growth of the US economy post the Great Recession, the Congressional Budget Office produced a result that might surprise you: the underlying growth rate of the economy has significantly slowed.
If you have an historical perspective on this sort of thing, you know that in past recoveries we’ve grown a lot faster than we’ve been growing of late, and you may have concluded that we’re just stuck in a period where weak demand is preventing us from a faster bounce-back. But the CBO says that’s the least of it—two-thirds of the difference between real GDP growth now and the average for past recoveries is due to “sluggish growth in potential GDP” meaning the underlying, or structural, growth rate of the economy consistent with potential employment growth, capital investment, and our productive capacity, extracting the effects of the business cycle, shocks, and recessions.
That leaves one-third of the growth in recent years attributable to weak demand—that’s the cyclical part.
To be clear, no one’s saying that we’ve closed the GDP or unemployment gaps that opened up over the recession. In fact, the cumulative gap between actual GDP and CBO’s potential GDP since the recession began is almost $4 trillion, and the jobless rate is about three percentage points above full employment. So we’ve still got a lot of slack to absorb.
But as the first figure below shows, the year-over-year growth rate of real GDP is now tracking the potential growth rate, if not beating it a bit (the latter of which would explain the decline in unemployment over the past year). The second figure shows quite clearly how potential GDP has slowed over the past decade, which begs the question, why and what does this mean?
Sources: CBO, BEA
The CBO explains that each of the three factors that go into their calculation of potential GDP have contributed to its slowdown, with potential employment and capital investment—basically the supply of inputs into the production, or growth, process—as the biggest factors. See their cool infographic on these points—very impressive, CBO!
But the key question is what does this mean, and the key answer is that it means slower growing living standards and particularly in an era of higher inequality, a tougher outlook for those with less bargaining power.* These two factors—slower potential growth and a less equitable distribution of that growth—are excellent candidates for why middle class incomes did particularly badly in the 2000s.
The second key question is, of course, is this slowdown inevitable? Some would argue that complaining about slower potential GDP growth is like complaining about someone’s height—they can’t help it if they’re short. Cyclical shortfalls are amenable to monetary and fiscal policy, but structural ones are a function of demographics, resource constraints, and technological limits.
But I’m not so sure…not at all. Some people are short because they didn’t get enough nutrition—their lack of height is not purely structural. What are we doing that’s depriving our economy of the productive inputs it needs to boost our potential growth rates?
It is a well-known problem in American labor economics, for example, that the employment rates (share of the group employed) of prime-aged men (25-54) has trended down for decades, particularly for non-college grads. That’s a waste of inputs, a drag on potential GDP, and pretty sad to boot. Immigration can also be a positive contributor to labor force growth, though I understand that’s not a solution that makes sense at 7.9% unemployment.
Our ideological tilt against investment in public goods, from infrastructure to education, is hurting our productive capacity, and measures to impose budget austerity—e.g., caps on outlays as a share of GDP—threaten to enshrine such underinvestment is perpetuity.
Then there’s the relation of cyclical to structural. Decompositions of the type by CBO here are necessarily arbitrary, and there’s no question that persistent cyclical weakness in demand reduces potential growth. Bad cyclical begets bad structural. For example, workers who experience long-term unemployment due to a harsh cyclical downturn can find themselves much less employable due to skill deterioration once the market picks up (some claim this dynamic is in play now but careful research does not support that contention). Lack of cyclical demand also dampens forward looking investment that has a longer term impact of the supply of capital inputs.
The figure below, from these same data, shows the ratio of real actual GDP to real potential GDP, and the result is pretty remarkable as regards this demand question. I drew a vertical line in 1979 that divides the figure into two periods. In the earlier period, the ratio was often greater than one; in the latter period, it almost never was. The ratio in the figure was equal to or greater than one in 74 quarters, 1949-1979, and only 37 quarters—precisely half—since.
Source: CBO, BEA
I fear we’re into a negative loop where persistently weak demand is chipping away at the inputs and productivity advances that we need to boost our potential growth rates.
Why is that? Again, lousy public policy is a culprit: for years the Federal Reserve thought full employment was consistent with jobless rates that were too high. Supply-side, deregulatory zeal has deprived the economy of public good investments, innovative research, and the oversight necessary to prevent shampoo cycles (bubble, bust, repeat).
Inequality may also be a factor—certainly the post-1979 period is associated with both the rise in income equality and fewer quarters where real GDP beat potential. The mechanisms here may relate to both weaker consumption among the have-nots, underinvestment in productive capacity, and money-driven politics, ideas explored to great effect in Joe Stiglitz’s recent book and CAPs work relating weaker macro outcomes to inequality.
The point is we should not blithely accept the decelerating trend in the second figure above, at least not without a fight. Better, more growth-oriented policies that paid attention to the demand side of the economy, distributional outcomes, productive investments in public goods, and deepening and upskilling of the labor force could reverse that trend.
*Actually, for this to be the case, you have to check that real per-capita GDP follows the same pattern as the 2nd figure above. Alas, it does.