It's that time of year when economists are called upon to provide guidance on likely economic conditions going forward. If properly done it eschews crystal ball gazing and ideology. Economists have a vast toolkit and a rich database.
There are long-term, medium-term and short-term trends of U.S. economic growth. It's comforting to observe that in the long term periodic recessions have always been followed by recoveries; the business cycle has never been banished. However, the trend of growth of U.S. real GDP, portrayed in Figure 1, suggests a step-change in recent decades. In the decades after World War II, growth was of the order of 3.5 to 4 percent. From the 1970s through the 1990s growth of 3 to 3.5 percent was the norm. Yet since the turn of the century the U.S. economic growth dynamic has slowed down to around 2 percent. Is this the new normal, and if so why?
Boiled down to its essentials economic growth is a function of two vital variables: the growth of the labor force and the growth of labor productivity. The annual growth of the U.S. labor force peaked in the 1970s at 2.4 percent. It has declined steadily since then. The U.S. Department of Labor predicts 0.6 percent average annual growth of the labor force from 2014 to 2024.
Academic economists, including Robert Gordon at Northwestern University, have studied the long-term trend of U.S. labor force productivity. It appears to have peaked at 2.5 percent in the 1950s and 1960s, and since then it too has steadily declined. Since the end of the Great Recession, it has only grown at a rate of around 1 percent.
In Table 1, I combine the recent trends of these two variables. This yields a proxy for the trend of potential real GDP growth, and I compare it to the trend of actual real GDP growth. There's a fairly close correspondence between these two data-sets.
What do the data in Table 1 tell us? First of all, regardless of future immigration policy, the slow growth of the U.S. labor force is already locked in. Thus, in order to restore the former growth dynamic of the U.S. economy, we need policies that raise the productivity of our workforce. That means increased investment.
In the long term our priority must be improving the productivity of students emerging from our high schools, colleges, universities and vocational schools. However, in the long run, as John Maynard Keyes once quipped, we'll all be dead. We need more immediate solutions.
How do things stand at the moment? In December the Federal Reserve Board raised the targeted range for the federal funds rate by 0.25 percent. This was purely a symbolic and probably largely ineffectual gesture. On the one hand the Fed should have taken this step long ago. On the other hand it is a bizarre time to be tightening monetary policy when inflation is dormant and economic growth is tepid. It certainly won't stimulate investment.