Can U.S. Economic Growth Be Speeded Up?

 

It is widely recognized and deplored, see here and here, that economic growth in the U.S. has been very slow, averaging only 2% per year, since the end of the Great Recession in June 2009.
The Federal Reserve has taken unprecedented steps to limit the severity of the recession by holding down both short term and long term interest rates.  But these efforts are only partially working and are, unfortunately, having a number of negative effects as well.
It also has been made quite clear that the problem is supply side and not demand side.  This is because, on the one hand, wages are beginning to rise more quickly and consumers are spending more money but, on the other hand, business investment is shrinking which is leading to slow productivity growth.
Capture38The American Enterprise Institute’s James Pethoukoukis has just provided new data  on the current weakness of business investment as illustrated in the above chart. Furthermore he quotes the economist, Robert Gordon, who has clearly described the many headwinds holding back the U.S. economy to the effect that:

“The American tax code exerts a downward pressure on capital formation and therefore on economic growth. It is now 30 years since the passage of comprehensive federal tax reform in the U.S.  In the intervening years, nearly every developed country has reformed its tax codes to make them more competitive than that of America.  Meanwhile the U.S. has allowed its tax code to atrophy.”

Conclusion. Yes, economic growth can be speeded up. But monetary policy won’t do the trick.  Congress must intervene with the right changes to fiscal policy, i.e. lowering tax rates for both individuals and corporations, paid for by closing loopholes and shrinking deductions.

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Can We Solve All Our Fiscal and Economic Problems at the Same Time?

 

This website, It Does Not Add Up, is devoted to discussing our country’s most serious economic and fiscal problems.  They are:

  • Stagnant Economy. Since the end of the Great Recession in June 2009, the economy has been growing on average at the historically slow rate of about 2.3%. Slow growth means higher unemployment, stagnant wages and less tax revenue.
  • Massive Debt. U.S. public (on which we pay interest) debt is now 74% of GDP (highest since WW II) and projected by CBO to grow rapidly unless strong measures are taken to reduce it. This puts our country’s future wellbeing and prosperity at great risk.
  • Increasing Income Inequality. Incomes for the high-skilled and well-educated are increasing much faster than for the low-skilled and less-educated workers.

The new Republican majorities in Congress are stirring the waters by proposing a ten year plan to shrink the deficit down to zero, i.e. to balance the budget by 2025.  The opposition claims that this would “sharply cut the scale of domestic spending, which would mostly fall on the poor.”
Capture1But the American Enterprise Institute’s James Pethokoukis points out that social spending in the U.S., both public and private, is very generous and second only to France in the entire OECD. So here is how we could proceed to address our basic problems in a unified manner:

  • Balance the Budget by a combination of Republican spending cuts and cutting back on two major tax deductions: Employer-sponsored Health Insurance (cost: $250 billion per year) and Mortgage Interest (cost: $70 billion per year).
  • Boost Economic Growth by expanding the Earned Income Tax Credit to encourage more people to accept low paying, entry level jobs. Increase the Social Security eligibility age from 67 to 70, thereby keeping near retirees in the workforce for three additional years (this will also extend the solvency of the Social Security Trust Fund).
  • Decrease Income Inequality. Cutting back on tax deductions, in part to pay for expansion of the EITC, lessens income inequality as well as shrinking the deficit. A faster growing economy also lessens inequality by providing more opportunities for upward mobility.

In other words, addressing each of these fundamental problems in an intelligent manner contributes to solving the remaining problems as well.  This creates a virtuous circle for economic progress!

The Slow Growth Fiscal Trap We’re Now In.

 

Our economy has been growing very slowly, about 2.2% per year on average, since the end of the Great Recession in June 2009.  The Congressional Budget Office predicts that this slow growth will continue indefinitely, although with a brief respite of 2.9%  growth in 2015 and 2016.  The American Enterprise Institute predicts an even lower, less than 2% growth rate, going forward.
CaptureHere’s the essence of the overall problem:

  • Slow growth keeps the unemployment level high and also means minimal raises for employed workers  The resulting economic slack leads to
  • Low Inflation. But low inflation in turn means that the Federal Reserve can try to increase growth with quantitative easing and at the same time maintain
  • Low Interest Rates to encourage borrowing. But an unfortunate side effect of low interest rates is that Congress can borrow at will and run up huge deficits without having to worry about paying interest on this “free” money. This leads to:
  • Massive Debt. But what is going to happen when inflation does take off which is bound to happen eventually? Then the Fed will be forced to raise interest rates quickly and we will be stuck with huge interest payments on our accumulated debt. When this happens, interest payments plus ever growing entitlement spending will eat up most, if not all, of the federal budget. This will almost inevitably lead to a severe
  • Fiscal Crisis.

                                                    FLOW CHART

  Slow Growth->Low Inflation->Low Interest Rates->Massive Debt->Fiscal Crisis

Of course, there are alternative scenarios.  Congress might become more responsible and cut spending and/or raise taxes.  We might luck out, so to speak, with such prolonged slow growth that inflation stays low indefinitely and interest rates never increase.  But slow growth is not pain free.  There are 20 million unemployed or under-employed Americans who want to work and whose lives are much less satisfying as a result of being idle.
Isn’t it obvious that the best response to this slow growth fiscal trap is to adopt policies to make the economy grow faster?  There are lots of things that could be done, many of which I addressed in my last post (https://itdoesnotaddup.com/2015/03/01/will-middle-class-economics-lift-us-out-of-secular-stagnation/) so I won’t repeat them here.  But I’ll be coming back to them again and again in the future!

Inequality Does Not Reduce Prosperity

 

In the national elections this year four states: Alaska, Arkansas, Nebraska and South Dakota raised their state minimum wage rates above the national rate of $7.25 per hour and, at the same time, elected Republicans to the U.S. Senate, in three cases replacing Democratic incumbents.  Does this represent contradictory behavior by the voters?
CaptureThe American Enterprise Institute’s James Pethokoukis recently reported (see above) that the U.S. has the third highest rate of billionaire entrepreneurs behind only Hong Kong and Israel, as well as by far the most billionaires over all.  These are the high-impact innovators like Bill Gates, Steve Jobs and Mark Zuckerberg and the Google Guys.
These observations are put in context by the Manhattan Institute’s Scott Winship who recently reported that “Inequality Does Not Reduce Prosperity.” Here is a summary of his findings:

  • Across the developed world, countries with more inequality tend to have higher living standards.
  • Larger increases in inequality correspond with sharper rises in living standards for the middle class and poor alike.
  • In developed nations, greater inequality tends to accompany stronger economic growth.
  • American income inequality below the top 1 percent is of the same magnitude as that of our rich-country peers in continental Europe and the Anglosphere.
  • In the English-speaking world, income concentration at the top is higher than in most of continental Europe; in the U.S., income concentration is higher than in the rest of the Anglosphere.
  • With the exception of a few small countries with special situations, America’s middle class enjoys living standards as high as, or higher than, any other nation.
  • America’s poor have higher living standards than their counterparts across much of Europe and the Anglosphere.

Conclusion: Americans are fair-minded and would like to help the working poor do better.   But Americans also appreciate the value of innovation and entrepreneurship.  When there is a tradeoff between increasing prosperity and reducing inequality, greater prosperity comes first.