An Optimistic View of the U.S. Economy

 

The current economic expansion, beginning in June 2009, is now one of the longest in recent years.  Furthermore, low-wage workers are beginning to see bigger gains in pay.  Since the rate of inflation is still remarkably low, under 2% annually, the expansion may well continue for some time.


The primary negative factor is the relatively slow rate of growth averaging just 2% since June 2009.  But two economists, Michael Mandel and Bret Swanson, have just issued a remarkable report, “The Coming Productivity Boom,” on behalf of the Technology CEO Council, predicting that the diffusion of information technology into physical industries is likely to boost economic growth to 2.7% over the coming 15 years.
Consider:

  • The next waves of the information revolution – interconnecting the physical world and infusing it with intelligence – are beginning to emerge. Increased use of mobile technologies, cloud services, artificial intelligence, big data, inexpensive and ubiquitous sensors, computer vision, virtual reality, robotics, 3D additive manufacturing and 5G wireless technology are on the verge of transforming the traditional physical industries – healthcare, transportation, energy, education, manufacturing, agriculture, retail and urban travel services.
  • At 2.7%, productivity growth in the digital industries over the past 15 years has been strong, compared with only an anemic .7% annual growth in productivity in the physical industries.

  • The digital industries, which account for 25% of U.S. private sector employment and 30% of private sector GDP, make 70% of all private sector investments in information technology.
  • This “information gap” means that the physical economy is operating well below its potential, dragging down growth and capping living standards.
  • The coming transformation could boost annual economic growth by .7% over the next 15 years. This would add $2.7 trillion to annual economic output by 2031.
  • Policy changes will be needed to achieve maximum growth. Better tax policy can encourage more domestic investment. Regulators will have to embrace innovation and technological change.

Conclusion. “The information age is not over. It has barely begun. … But launching this new productivity boom demands a new, pro-innovation focus of public policy.”  In turn it will lead to an increase of wages and salaries to workers of $8.6 trillion over the next 15 years.

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What Is Slowing Down Today’s Economy?

 

We will soon have a new President and, even though his election was somewhat of a fluke, he will obviously want to help the blue-collar workers who elected him.  The best way to do this is to make the economy grow faster.
The Gallup economist, Jonathan Rothwell, has just issued an excellent analysis of some of the major reasons for our current slow economy, “No Recovery: an analysis of long-term U.S. productivity decline.”

capture91
Says Mr. Rothwell:

  • The problem is severe. U.S. GDP growth per capita has declined from 2.6% in 1966 to .5% today. Small differences expand into vast gaps in potential living standards. 1% growth for the next 35 years would expand household income from $56,000 in 2015 to $79,000 in 2050 (inflation adjusted), whereas 1.7% growth would raise household income to $101,000 in 2050.
  • Changes in living standards are fundamentally linked to changes of how the quantity of goods and services relate to their cost. Deterioration in the quality-to-cost ratio for healthcare, housing and education is dragging down economic growth. These three sectors alone have increased from 25% of GDP in 1980 to 36% of GDP in 2015.capture92
  • The cost of healthcare is 4.8 times as high today as in 1980, the cost of education is 8.9 times as high today as in 1980 and the cost of housing is 3.5 times as high today as in 1980. These compare to an overall cost increase of all items of 2.5 times today compared to 1980.
  • These three sectors have all gotten more expensive (without getting more productive), thereby absorbing more of families’ incomes, making it harder to satisfy other wants.

Conclusion.  We all want schools that work, adequate housing, and quality healthcare.  The problem is how to achieve these ends in a much more affordable manner.  Stay tuned!

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How to Get Our Economy Back On Track

 

My last several posts have expressed dissatisfaction with both presidential candidates and the hope that whoever wins in November (very likely Hillary Clinton) will work with the Republican House of Representatives to implement its “A Better Way” plan for national renewal.
In particular, faster economic growth would produce more jobs and better paying jobs and hence is highly desirable.  As many people, including myself,  have pointed out, it is low productivity growth caused by low business investment, which is largely responsible for slow economic growth.
The economist John Taylor has an excellent analysis of this problem.  He points out that the rate of economic growth equals the growth of labor productivity plus the growth of employment.

capture73
He then shows that:

  • Productivity growth slowed from the mid-1960s until the early 1980s, then increased until the mid-2000s, and has slowed way down in the past ten years.
  • The labor force participation rate has dropped dramatically since the Great Recession but only a small part of this drop off was caused by demographic trends (i.e. more retirees).

    capture72Such relatively long cycles of productivity growth and decline (longer than normal business cycles) suggests that government policy is having a major effect on economic performance. According to Mr. Taylor, what is needed is:

  • Tax reform to lower tax rates to improve incentives for work and investment.
  • Regulatory reform to prevent regulations which fail cost-benefit tests.
  • Free trade agreements to open markets.
  • Entitlement reforms to prevent a debt explosion.
  • Monetary reform to restore predictability in financial markets.

Conclusion. Mr. Taylor makes a very strong case that faster economic growth is not only possible but even achievable in the short run if our national leaders would just make some common sense policy changes.

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Why Is U.S. Economic Growth So Slow?

 

In a recent post I discussed the issue of slow economic growth in the U.S. and why it is so harmful and dangerous to our nation’s future.  In short, it not only deprives many citizens of a more prosperous life and makes it more difficult to shrink our annual budget deficits, but it also endangers our national security as our chief competitor, China, grows faster than we do.
In the long run, an economy can expand only at a rate sustained by the growth of its labor force and the productivity of its workers.  I have previously pointed out  that there are far too many prime working age men who are unemployed.
capture67Today let’s talk about the rate of productivity growth (see the above chart).  In particular:

  • From 1994 – 2003, U.S. output per hour worked rose annually by an average of 2.8%.  Since then it has grown at an annual rate of 1.3%, including just 0.4% since 2011.
  • Business capital spending is down as companies are spending their profits to buy back stock rather than making new investments (see second chart).

    capture69As I have previously discussed, the U.S. is now caught in a vicious trap:

  • Slow growth keeps the under-employment level (U6) 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 maintain
  • Low Interest Rates to try 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 really having to worry about paying interest on this “free” money. This leads to
  • Massive Debt. But what is going to happen when inflation does eventually take off and the Fed is forced to raise interest rates? Then 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 inevitably lead to a severe
  • Fiscal Crisis.

    Conclusion.
    It is absolutely imperative to speed up economic growth.
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The Source of Economic Growth

 

In my last post, “What the Republican presidential candidates should be saying,”  I summarized the argument by the economist, John Cochrane, that “sclerotic growth is the economic issue of our time.” Mr Cochrane shows dramatically that even small differences in the growth rate over time can make a huge difference in raising living standards.
Capture0He goes on to say that

  • There is only one source of growth. Nothing other than productivity matters in the long run.
  • The vast expansion in regulation is the most obvious change in public policy accompanying America’s growth slowdown. Most recently under the Dodd-Frank Act and the Affordable Care Act, the financial and healthcare sectors of the economy have seen radical increases in regulatory intervention. But environmental, labor, product and energy regulation have all increased dramatically as well.
  • Regulation during the financial crisis did not fail for being absent. It failed for being ineffective.
  • The best way for the government to subsidize healthcare efficiently is to give straightforward vouchers which people can use to buy insurance or to fund health savings accounts. Such vouchers should replace Obamacare, Medicaid and Medicare.
  • The basic structure of growth-oriented tax reform is lower marginal rates, paid for by broadening the base by removing exemptions and loopholes. Several additional tax principles are:
  • The ideal corporate tax rate is zero. A high corporate tax rate hurts the workers more than anyone else.
  • A growth-oriented tax system taxes consumption, not income and savings.
  • Eliminating or moving away from taxing income, would lessen the value of personal deductions such as for mortgage interest or charitable donations.
  • The estate tax is a particularly distorting tax on saving and investment. The tax code should not give strong incentives to middle-age people to stop building their businesses or investing their money.
  • Solving our immigration problem would turn 11 million illegal immigrants into productive citizens. Guest worker and e-Verify enforcement are fixable problems.

How to speed up economic growth ought to be one of the basic issues in the presidential election campaign. Here are some good ways to do this.

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Economic Growth is Slowing Down: What Shall We Do about It?

 

My last post, “Why Economic Growth is Slowing Down,” reports on the work of the economist Robert Gordon in his book “The Rise and Fall of American Growth.”  Mr. Gordon makes a persuasive argument that the U.S. experienced an unusually strong economic growth spurt from 1870 – 1970 and that we simply cannot expect future GDP growth to replicate such a sustained streak in the future.
Capture0Furthermore, in addition to much slower productivity growth at the present time, we are also facing strong headwinds to growth such as rising inequality, poor educational outcomes, demographic challenges, a huge debt burden and social deterioration at the bottom of the income distribution.
All of this together represents a severe double whammy holding back future economic progress in the U.S.  So what type of public policy response is called for?  Here are what I consider to be Mr. Gordon’s best ideas for simultaneously boosting productivity and combating the headwinds:

  • Toward greater equality of outcomes. Increase the minimum wage (state by state in my opinion), expand the Earned Income Tax Credit to able bodied adults without dependents, reform sentencing to keep more non-violent law breakers out of prison (which makes them unemployable, and therefore poor marriage prospects, upon release).
  • Towards greater equality of opportunity. Provide greater access to preschool education for all children growing up in low-income families. Allow college debt to be repaid as a percentage of taxable income after graduation. Reduce regressive regulatory measures such as occupational licensing.
  • Reducing Demographic Headwinds. Focus immigration reform on raising the average skill level of the working age population. This would include both blue-collar skills and college degrees.

I consider these types of reform to be relatively uncontroversial and therefore more easily doable through the political process. Other policy changes capable of speeding up growth such as broad-based tax reform (lowering tax rates paid for by shrinking deductions), major regulatory reform such as making the Affordable Care Act more flexible and the Dodd/Frank Act less restrictive, and approving the Trans Pacific Partnership to expand trade are all political hot potatoes and therefore will much harder to accomplish.

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Why Is U.S. Productivity Growth Declining?

 

The economist Alan Blinder has just reported, “The Mystery of Declining Productivity Growth” that U.S. productivity growth has fallen dramatically in the last few years.  “The healthy 2.6% a year from 1995-2010 has since been an anemic 0.4%.  What’s scary is that we don’t know why.”
CaptureThe economists Edward Prescott and Lee Ohanian believe the productivity slowdown is caused by a corresponding slowdown in new startups (as illustrated by the above chart).  They point out, for example, that:

  • The creation rate of new businesses in 2011 was 30% lower than the average rate of the 1980s.
  • New startups are critical for growth since many of today’s heavyweights will decline as new businesses take their place. For example, only half of the Fortune 500 firms in 1995 remained on that list in 2010.
  • Startups in high technology have also declined since 2000 even though there is no slowdown in the development of new technology.

Consistent with the recommendations of James Bessen in a recent post of mine, “Learning by Doing,” Messrs. Prescott and Ohanian recommend policy changes such as:

  • Better training, plus immigration reform, to produce more skilled workers.
  • Streamlining regulations that raise cost, especially for small businesses.
  • Tax reform to reduce marginal tax rates.
  • Reforming Dodd-Frank to make it easier for small businesses to obtain loans from main street banks.

In today’s New York Times, the economist Tyler Cowen wonders whether our economy is in the midst of a “Great Reset.”  “Perhaps the most crucial issue is whether economies will return to normal conditions of steady growth, or whether we are witnessing a fundamental transformation” to a less productive economy.
Here’s another way to put it: shall we attempt to adopt better pro-growth policies or shall we just give in to the status quo and accept that we can’t do any better?  Are we optimists or are we pessimists?