## Friday, August 15, 2014

### What's the Difference Between 2% and 3%?

If you calculated that the difference between 2% and 3% is 1%, you are of course arithmetically correct, but in an economic sense, you are missing the point. Herb Stein explained the difference in an 1992 essay about the work of Edward Dennison on economic growth. Stein wrote:
The difference between 2 percent and 3 percent is not 1 percent but 50 percent. That, of course, is not the result of research--at least, not Dennison's--but it is an often-neglected and important proposition that he emphasized. Its significance is that what seems a small increase in the growth rate--say, from 2 to 3 percent--is really a large increase. As a first approximatino, such an increase in the growth rate would require an increase of 50 percent in all the resources, effort, and attention that went into generating the 2 percent growth rate.

Dennison had died in 1992, and Stein's short remembrance, "Memories of a Model Economist," was published in the Wall Street Journal, November 23, 1992. It was reprinted in On the Other Hand ... (pp. 235-239), a 1995 collection of Stein's popular essays and writings published by the AEI Press.

One of the challenges of teaching basic economics is to explain why small differences in the annual rate of economic growth are so important. Stein's comment from Dennison is one way to focus attention on these issues. In the short run of a single year  the difference between 2% and 3% is indeed 1%, but when the issue is how to bring down the unemployment rate, raising the number of workers needed is a big deal. In the longer run of a decade or two, the key point to remember is that economic growth accumulates, year after year, so losing 1% every year means losing (approximately, not adjusted for compounding of growth rates) 10% after a decade and 20% after two decades.

When a nation falls behind in productivity growth over a sustained period of time, it is a matter of decades to make up that foregone productivity growth. (If you doubt it, consider the experience of the United Kingdom or Argentina during the earlier parts of the 20th  century, or think about a quarter-century of lethargic growth has affected perceptions and reality of Japan's economy.) No matter what your public policy goal--more for social programs, tax cuts, deficit reduction, rescuing Social Security and Medicare--the task is politically easier if the growth rate has been on average higher and the economic pie is therefore substantially larger. In the last few years,  U.S. economic policy has for good reason been focused on the aftereffects and lessons of the Great Recession. But looking ahead a couple of decades, the single most important factor for the health of the U.S. economy is whether we create an economic climate so that the rate of per capita growth can be 1 or 2% faster per year.