Research Affiliates: 1% ... The New Normal Growth Rate?

November 16, 2012


The unavoidable fiscal contraction required to address our unsustainable budget deficit also dampens the outlook for productivity growth. The U.S. government deficit, as officially measured, has grown to nearly 10% of GDP; if the government were to rely on generally accepted accounting principles (GAAP), our deficit has averaged 10% of GDP for a generation. Debt as officially reported has grown to over 100% of GDP. But, again, this figure soars when we add in state and local government debt and government sponsored enterprises (FNMA and FHLMC). The debt level is truly horrific if we count the present value of entitlement commitments (see Figure 4).

Borrowing to invest can raise our future productivity growth, but only if the return on capital exceeds the cost of debt. Unfortunately, we did not borrow to invest; we borrowed to consume. Debt-financed consumption did not just raise employment. It inflated our measure of output per person. As the global financial crisis so convincingly demonstrated, much of our recent GDP growth was unsustainable, debt-financed consumption. For this reason, reported GDP over recent decades overstates both our true prosperity and our true growth.2 If GDP more properly measured production instead of consumption, then measured productivity growth would have been significantly lower. Reducing consumption to a level that may be sustained by domestic production requires sharply lower growth in real GDP per capita, until we are no longer spending beyond our means (see Arnott, 2011a).

Considering both the aging of our population and the required fiscal contraction, we estimate productivity growth of 0.5% per year for the next several decades. This forecast may strike many as overly pessimistic. But before dismissing our estimate, consider the 2012 writing of Robert J. Gordon of Northwestern University, perhaps the world’s foremost expert on productivity growth. Professor Gordon says: “Even if innovation were to continue into the future at the rate of the two decades before 2007, the U.S. faces six headwinds that are in the process of dragging long-term growth to half or less of the 1.9% annual rate experienced between 1860 and 2007. These include demography, education, inequality, globalization, energy/environment, and the overhang of consumer and government debt. A provocative ‘exercise in subtraction’ suggests that future growth in consumption per capita for the bottom 99 percent of the income distribution could fall below 0.5% per year for an extended period of decades.” We would include the top 1% in Dr. Gordon’s assessment; slow growth will not spare the affluent.

1% Growth Rate
For the 50 years from 1951 through 2000, U.S. GDP growth averaged 3.3% per year.3 We can attribute this historical growth to three primary components: 1.4% from population growth, 0.3% from a rising employment rate, and 1.6% from growth of output per person employed (productivity). In the coming 20 years, all three components of growth will be much lower.

Births and fertility rates are declining. Immigration has slowed to a trickle in response to harsh immigration policies and a dimmed growth outlook. For the next two decades, the U.S. population will grow by only 0.7% per year, half the rate of growth witnessed in the late 20th century.

The total employment rate will continue to decline as boomers move from their 50s into their 60s and 70s. Whereas a rising employment rate added 0.3% per year to GDP growth from 1950 through 2000, the demographic effect on the employment ratio will subtract 0.2% for the next two decades. The population will be growing by 0.7% per year, but the employable work force will be growing by only about 0.5% per year



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