Potential growth and phony budgeting

May 16th, 2017 at 10:29 am

The WSJ has a piece out this AM making an argument that’s become common from economists who think about growth, myself included: there’s no good reason to expect team Trump to achieve their 3 percent GDP growth goal. Many previous pieces have made this case, based on the limits we observe to the two additive components of GDP growth: labor force and productivity growth.

I’ll get to those in a moment, but to me, the important and timely line in the WSJ piece wasn’t so much the analysis of why 3 percent is probably an unrealistic goal (though good for the Journal for amplifying this point). It’s this one sentence, with a factoid you need to know (my bold): “If the economy expands at around a 3% rate over the next decade—a projection Mr. Mnuchin says the administration will make in its budget proposal later this month [next week, actually]—government revenue over the time should be $3.7 trillion more than currently forecast, according to estimates by economists at Goldman Sachs Group Inc.” And those dudes know their trillions.

So that’s the play here. They’re going to pretend to get the extra revenue they need to offset their big tax cut by making an unrealistic growth assumption. The official revenue scorekeepers won’t buy it, so eventually we’ll see a more plausible score with lots of red ink, but when you hear administration officials claim otherwise, you’ll know why they’re wrong.

That said, people who have very reasonably come to distrust economists’ proclamations about growth forecasts might well ask, “how do you know what’s possible re future growth rates?” Fair point. One of the key drivers, as noted, is productivity growth, and economists failed to forecast both the mid-1990s speedup and the subsequent slowdown.

On the labor force—the other growth component—we’re on much more solid ground. Our aging demographics are baked in the cake, so, absent a bunch more immigration, which is possible but unlikely, that’s going to account for 70 percent of the slowdown, as shown in the table below from CBO projections (1% of the 1.4% growth deceleration).

On productivity growth, like I said, we just don’t really have a great bead on what makes it speed up or slow down, so our best move is to assume the long-term trend persists. Over the past 50 years, productivity growth has been around 1.5 percent, about where CBO is in the table above. No one can be too confident in that prediction, but you can be sure that there’s absolutely nothing in the Trump agenda—or anyone else’s agenda—that would justify a predicted jump in that growth rate.

One final point designed to encourage a healthy dose of skepticism about these forecasting exercises. The WSJ includes the figure below, showing the potential growth rate, the same topline variable in the CBO table above. Note how it wiggles up and down over time, suggesting movements in maximum labor force and productivity growth.

Source: WSJ

While there’s definitely some rich analysis that goes into this measure—CBO does the best work one can do on it—it ends up being pretty close to a simple trend extraction. That is, for all our number crunching and forecasting of what’s going to happen, we’re pretty much looking in the rearview mirror and saying, “the future will be a lot like the past,” especially regarding productivity growth.

Let me show you what I mean. The figure below plots the same potential GDP growth line from the WSJ figure against a smooth trend extracted from actual GDP growth. They’re not the same but they’re close. Interestingly, they diverge significantly at the end, but even if the trend is right, it’s still just about 2 percent, which is, in fact, the underlying GDP growth rate since 2000.

Source: BEA, CBO, HP trend

Summing up, economists’ productivity predictions tend to be off the current trend, which is as it should be, but admits that we’re lousy at catching turning points. Certainly, if you’re budgeting for the future, that’s by far the only prudent play. Any assumption of significantly faster growth should be treated with as much respect as magic beans. Aging demographics, on the other hand, are slowing growth in a way we can somewhat reliably predict. And most of all, fully discount BS revenue projections off of phony growth forecasts.

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6 comments in reply to "Potential growth and phony budgeting"

  1. William Monette says:

    A question I haven’t seen addressed. If we did hit the 3% growth rate would it pay for the proposed tax cuts?


  2. spencer says:

    Over the last 5 years while rgdp growth has averaged 5%, real non-farm output growth has averaged 2.75%
    The difference was that government’s net contribution to growth was about minus 0.5% annually — farm output was also a negative.

    But if the business trend of 2.75% can be sustained all Trump has to do to achieve 3% growth is let government grow. Of course the results could be an acceleration of inflation and interest rates– we would just have to wait and see. We just might be worse off if growth is 3%.


  3. Nick Batzdorf says:

    Respect (without intending obsequiousness 🙂 ). This is such a great blog.


  4. Bob Palmer says:

    Piketty found that 2% GDP growth has been about the average for mature economies like ours. Let’s call 2% ‘Piketty’s constant’. If ‘Piketty’s constant’ holds, then our GDP growth in excess of or less than 2% must be due to some temporary abnormal factor: a big war, a massive government deficit spending spending splurge, technological breakthrough. . . . etc. Or maybe a unicorn.

    If Trump and the Republican majority project a 50% increase in real GDP growth (from 2% to 3%) then the onus is on them to say what anomaly they expect will cause such a phenomenal increase, especially in the face of aging demographics as Bernstein explains.

    And I just don’t see how “productivity” through technology can be the Republican’s unicorn. First, productivity has been in the doldrums recently. No one appears to quite know why or how to revive it’. And Second, productivity is value produced per hours worked. If a technological breakthrough makes it possible for one worker to do the work previously done by one hundred workers, productivity skyrockets. But ninety nine pink slips will be issued. The economy may be able to absorb the ninety nine, but that hasn’t been the experience of coal miners, Iron Range miners, steel mill workers. We are just not very good at that.

    Workers are also consumers who spent nearly all, or more than all, of their paychecks. Our economy is about 70% consumer related (way too high, but that’s the way it is.) The unemployed or under employed ninety nine will be a drag on GDP. This will offset the gain from the technological breakthrough that cost them their jobs, to what extent I don’t know. So, no, productivity isn’t the unicorn.

    Republicans will cut government spending and support programs, which is the opposite of a government spending program. So government spending will not be the unicorn.

    That leaves a big war, and that is definitely doable and in the Republican wheelhouse.


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