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Thursday, January 7, 2016

Back to Basics: What Drives US Economic Growth?

I like to say that the formula for economic growth is simple: it's a mixture of more workers, improved human capital, increases in physical capital, and better technology--all operating in an economic environment that provides incentives for efficiency and innovation. Rebecca M. Blank fleshes out this framework in "What Drives American Competitiveness?" which was delivered as the 2015 Daniel Patrick Moynihan Lecture on Social Science and Public Policy and published in the Annals of the American Academy of Political and Social  Science (January 2016, 663, pp. 8-30).

Blank carries out a "growth decomposition"--that is, looking at the actual rise in real GDP during the 45 years from 1970 to 2014, and attributing it to the following causes: "GDP growth = growth in hours worked (25%) + growth in labor quality (10%) + capital deepening (39%) + TFP (26%)." The phrase "capital deepening" refers to a higher amount of average physical capital per worker. "TFP" stands for "total factor productivity,"  a measure of the growth of productivity over time.

How are these building blocks of economic growth expected to evolve in the next 10-20 years? The answer will imply how US growth will evolve.

For example, the total hours worked in the US economy was actually a little lower in 2014 than it was back in 2000. Blank writes:
"Sheer growth in the number of workers has explained 25 percent of economic growth over the past 45 years. But the three big elements that drove this growth—immigration, the baby boom population bulge, and increases in women’s labor force involvement—are now either growing more slowly or moving in the opposite direction. The result is recent small declines in the work hours of the population. It is hard to see how work hours will grow substantially in the years ahead." 
What about future trends in human capital? A standard method for estimating the amount of human capital is to look at education levels and job experience. Blank focuses on education levels. She points out that at the lower end of educational achievement: "[H]igh school graduation has largely stalled out at around 88 percent of the population for both men and women. This means that a substantial share of the population is still entering the workforce without even a high school degree. Furthermore, a growing share of high school graduates hold GED degrees, which may not provide even the same skill level as a high school degree. From everything we know about the labor market, these young adults will face low wages and higher unemployment throughout their working lives, as job opportunities for the least skilled continue to deteriorate."

At the higher levels of education, US college completion rates are on the rise, but not as quickly as in many other countries. Blank writes: 
While the U.S. population has shown relatively slow growth in the share of the population with a college degree, other countries have made very rapid progress on this front in recent decades. As a result, while this country had one of the most educated populations in 1970, other countries are rapidly surpassing the United States in educational attainment. In 2011, the United States ranked fourteenth among the thirty-six OECD nations in the percentage of 25- to 34-year-olds with associate’s degrees or higher. Even more concerning, this percentage is virtually the same among 25- to 35-year-olds as it is among 55- to 64-year-olds in the United States, while virtually all other countries have seen substantial gains in higher education for the younger age group ... 
Blank doesn't discuss the work experience of the average US worker, but with the retirement of the baby boom generation subtracting large numbers of high-experience workers from the US economy, this isn't likely to be a growth area for human capital, either. 

What about expanded physical capital and innovation? Blank discusses these together, on the grounds that new technologies are one of the main reasons why businesses would expand their physical capital per worker. But for some years now, business investment has been sluggish, in a way that has led some to predict a future of "secular stagnation" for the US economy. Overall US government support for research and development, one of the drivers of innovation, has been flat for several decades (as discussed, for example, here and here). 

In short, looking at the basic determinants of economic growth does not paint a pretty picture for long-run economic growth in the US. Thus, the question becomes to what extent at least some of these determinants of growth might be affected by public policy. It's easy to list what the targets of such policies might be, although it's of course harder to be confident about which specific policies would work in meeting these targets. 

For example,  if job opportunities for low-skilled workers expanded in a way that pulled large numbers of them into the labor force,  or if If a very large number of Americans postponed retirement and continued to work later in life, the number of hours worked in the US economy would not keep falling. US human capital would improve with changes in the K-12 school system that both increased the proportion and the quality of high school graduates, followed by methods of financing more higher education for those for whom acquiring more skills in college makes sense. More government spending on R&D makes sense, but much more important is a business environment that has the incentives and ability to use the results of government R&D--in combination with the firm's own innovative efforts--to grow and expand. 

Blank notes: "Innovation, when it leads to new products that consumers and businesses demand, creates new companies and new jobs. Most job growth comes from rapidly growing new companies that are expanding in high-demand markets. We need that innovation to continue to occur at a high rate in this country if we are to reap these economic benefits." She also writes of the need "to ensure that the United States is an excellent place to start and grow businesses, with modern infrastructure, strong intellectual property protections, a reasonable tax regime, reasonable regulatory structures, and
so forth." 

She adds: "I optimistically note that support for many of these actions should be bipartisan,
although there will be partisan disagreement on how to achieve them." I would add that one way to judge candidates for political office in 2016 is whether they have a detailed and at least somewhat plausible plan--not just a slogan or an expression of good intentions--for improving the main determinants of economic growth.