CBO: Slower Growth is Baked in the Cake…(But it shouldn’t outta stay that way)

November 17th, 2012 at 10:32 pm

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.



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5 comments in reply to "CBO: Slower Growth is Baked in the Cake…(But it shouldn’t outta stay that way)"

  1. John Dila says:

    Hi Jared–

    I’ve recently started following your posts, which are insightful and have great analysis. Thanks for sharing your contributions.

    I’m also in the middle of reading Michael Lewis’ books about what caused the mortgage/economic crises (Liar’s Poker, The Big Short, Boomerang). Many of the characters in his books represent the few who depart from status quo thinking, and ask tough questions where most have become complacent and complicit. Had more people done so, and had more people listened, the crises may have taken different turns.

    In the vein of trying to understand something that seems basic about economic growth in our capitalistic environment, I have a question that follows on your CBO post:

    It’s always seemed to me that if you look at the world as a finite place with finite dimensions (notwithstanding our sundry capabilities to innovate and become more efficient), with a finite number of people vying for finite resources, why do we expect and–maybe more importantly–why to we message the American population that continuous year-over-year growth (GDP) is possible or even desirable?

    A thoughtful and analytical post about this conundrum–around our collective desire for constant “growth” vs. focusing on any number of other national/global indicator–would be most welcome.

    As we think about the way forward over the next four years, and the next 40 we must find new, more appropriate ways of leading in this world—in politics, economics, education, and health care. We have to create ways to cooperate with our growing neighbors around the globe.

    What if US leaders started placing heavier emphases on things like quality of life, corporate value, and collaborative economics? The younger generations are starting to think this way and more bridges need to be built around this topic that span our generations.

    What are your thoughts about this and how we could move the conversation to a less capitalistic-cetric place?

    • Jared Bernstein says:

      Good questions and good points.

      The answers, to my thinking are a) true, there are resource constraints that we must consider–and here too policy can help a lot, b) the big issue for me here is efficiency–doing more with less, and c) some simple arithmetic of growth.

      Re a) we must recognize not only the constraints on growth, but the damage unconstrained growth powered by fossil fuels does to the environment. A tax on carbon use is not only a no-brainer–it’s a classical economics solution (internalizing an externality) that pols would support were they not bought and paid for on this issue.

      b) As I stress in the blog, there’s a lot of waste/slack going on that we should squeeze out. Maybe a third of health care spending in the US is wasted; too many are underemployed; we’re leaving efficiency gains on the table all over the place! That implies more growth by using existing, or even fewer, resources. (and ftr, we are using energy a lot more efficiently than we used to).

      c) Since output (GDP) divided by hours worked equals productivity by definition, take natural logs, move things around, and think in terms of growth rates and you get that GDP growth equals productivity growth plus labor force growth (really, hours, but they’re obviously related). So, improving efficiency, or productivity (as in ‘b’) boosts growth as does faster growing labor force. And visa versa.

      Your penultimate paragraph is interesting–sometimes I think/hope we’re moving in that direction, but most often, I must say, I fear that it’s congenitally hard for humans to move forward that way. Much more to say about that, and I’m obviously all about WITT vs YOYO, but history is pretty clear that we’ve got a bit of screw loose in this regard.

  2. urban legend says:

    What I have seen very little of is quantitative historical data that dramatizes the presumed under-investment in infrastructure and public goods and services. I believe it, can see it in falling bridges and decrepit mass transportation systems, hear about it in (admittedly self-interested civil engineers telling us we need $2 trillion in infrastructure investment), but have had a hard time finding simple data to make it clear — data like a steadily declining percentage of GDP in national infrastructure ever since the anti-tax crusade caught hold. It would also help to be able to say that, say, $200 billion in additional public goods investment annually for x number of years would create two million new jobs directly and 3.5 million in total, thereby bringing unemployment down to 5% in two or three or four years.

    It would also be good to be able to show where the greatest needs are so that people could begin to see their self-interest: how they are being short-changed today and how their lives could be better. Bridges not falling down is just a start. I would love to see the Chicago CTA modernized to eliminate the eyesore of rusting structures, and bring beautiful, comfortable, well-lit stations, (much) quieter wheels, quicker trips, etc., all to encourage higher usage. How many thousands of workers could be put to work for several years just doing that one project? How many more such projects — yes, including projects that improve auto travel — could we find around the country?

    Unfortunately, what we get are generalizations and platitudes. We who do believe it, who even suspect that short-changing infrastructure employment made the employment generated by bubbles necessary to keep unemployment to politically defendable levels, need help. We need well-founded data and graphs to spread the message.

  3. mike shupp says:

    Three points occur to me:

    (1) a shortage of infrastructure spending — our “physical plant” is getting older, and no one wants to spend money on repairing streets and burying electrical lines and replacing decrepit buildings

    (2) a slowdown in R&D spending, coupled with aiming much of our national R&D at “safe” low-payoff activities rather than breaking new ground — i.e., the “new” industries that ought to be soaking up the unemployed and new college graduates aren’t getting started

    (3) the USA as a whole is being hollowed out. We’re filling up the coastal cities with people, and the great bulk of the interior is becoming depopulated, being used for farming and some natural resource extraction, but nothing more. We’re turning the American heartland into something like a great Gobi desert — and deserts don’t contribute much to national wealth.