Clarification: An earlier version of this column described an estimate of potential GDP as being a 7 percent reduction “from the previous one.” That earlier estimate was created in 2007, a point now made explicit in the updated version that follows.
You might compare the U.S. economy to someone who’s recovering from a serious illness. At first, everyone hopes the patient will return to normal. Then it’s gradually realized that the patient suffered permanent damage and will never be the same. So, perhaps, with the economy. Since the Great Recession, the bland (often unstated) premise has been that the economy would ultimately recover in full. Now, some economists question this and argue that the economic crisis created — or exposed — enduring weaknesses. We’re at a turning point. Even when producing at “full capacity,” the economy will grow more slowly than in the past or than had been expected.
If true, this cannot be good. Economic growth serves as a political and social lubricant. It makes public and private goals more affordable and achievable. Slower growth would dampen gains in living standards. It would make it harder to reduce budget deficits without tax increases. It could threaten inflationary bottlenecks, as the economy hits maximum output before attaining “full employment” at, say, 5 percent unemployment. This would complicate the Federal Reserve’s policymaking.
To be fair, there’s no consensus. One prominent dissenter is Mark Zandi of Moody’s Analytics. In congressional testimony, Zandi said he expects the economy’s growth to accelerate in 2014 to 3 percent and to 4 percent in 2015, up sharply from the 2 percent pace since the recovery’s start. More spending on housing and business plants and equipment will boost growth, he said. Financial conditions are favorable. Households have repaid debt; banks are well-capitalized. Once the economy improves, fears of a growth slowdown will recede like “a passing cloud.”
Economists’ pessimism emerges from their projections of “potential GDP.” GDP (gross domestic product) is the economy’s total output. Potential GDP is an estimate of what could be produced when everyone who wants a job has one and when businesses are operating at maximum capacity. Two factors govern the growth of potential GDP: changes in the number of workers (and time spent on the job) and changes in labor productivity. Productivity means “efficiency” and reflects many influences (technology, worker skills, management quality).
Potential GDP’s growth represents the economy’s speed limit when it’s near peak capacity. Trying to grow faster, it’s argued, will create shortages of workers, goods and services — and raise inflation. Even before the Great Recession, economists had lowered estimates of potential GDP, reflecting the anticipated exit of baby boomers from the labor force. But the recent revisions go beyond this widely predicted shift.
To take one example: Economists at Morgan Stanley cut their estimate of potential GDP growth from 2.5 percent annually to 2 percent. This compares with potential GDP’s actual annual growth of 3.2 percent from 1991 to 2001. These changes may seem small, but they’re huge when repeated year after year. Consider the Congressional Budget Office’s recent re-estimate of potential GDP for 2017. The new estimate reduces GDP by 7 percent from one made in 2007. That’s equivalent to $1.5 trillion in lost wages, salaries, dividends and taxes. Although these forecasts are only educated guesses, they are increasingly downbeat.
Possible explanations abound. The economic crisis may have degraded — for the foreseeable future — the economy’s psychology and mechanics. Labor force growth has dropped, as some of the discouraged unemployed take early retirement or simply stop looking for a job. Cautious companies have curbed their investment spending; this threatens productivity growth. Another possibility is that the economy’s slowdown started before the crisis but was obscured by the artificial stimulus caused by the credit bubble.
Other theories are unrelated to the crisis. Economist Robert Gordon of Northwestern University has argued that, since the early 1970s, technological advances have lagged and that the Internet boom of the 1990s was only a brief interruption. Naturally, productivity growth has suffered. Nobel Prize-winning economist Edmund Phelps of Columbia University, in his book “Mass Flourishing,” identifies a clash of values between what’s required for faster economic growth and what’s desired for personal security.
“Increasingly, the processes of a nation’s innovation — the topsy-turvy of creation, the frenzy of development, and painful closings,” he writes, are seen as something “that we are unwilling to endure any longer.”
The issue is whether the financial crisis and Great Recession mark a significant break with America’s dynamic economic past. Our ability to influence technology, business practices and worker skills is, at best, limited. Or are today’s low expectations a fad: a pessimism bubble that will pop on the first contact with faster growth? The slowdowns in employment and productivity may be consequences, not causes, of weak economic growth. In this view, the resumption of faster growth would automatically improve both. Is the patient still healing — or will injuries persist? On the answer hangs a great deal.
Read more from Robert Samuelson’s archive.