There’s an interesting tension in the current economic debate over the underlying growth rate. Most economists believe that, absent the temporary stimulus from hundreds of billions in deficit-financed tax cuts and spending, often derided as a “sugar high,” the gross domestic product would be closer to 2 percent, rather than the 3.2 percent by which it rose in the first quarter. Sometime later this year, as the fiscal stimulus fades, we would expect growth to decelerate.
But President Trump and his economics team say their “supply-side” tax cut is working as planned. Their view is that by cutting taxes on corporations and the wealthy who make up the investor class, they’ve freed up more capital for business investment, boosting productivity growth. That’s not a sugar high, they argue. It’s a far more nutritious diet leading to lasting economic improvement.
A recent Wall Street Journal article reported that Trump may have more of a case than many economists believe: “Signs are emerging that the supply side of the economy — the workers and the tools and machines they use to produce goods and services — is becoming energized, improving the chances that faster growth can be sustained.”
A close examination of the data, though, shows why most experts remain skeptical. There’s still no reliably faster growth in productivity, nor is there significantly greater capital investment.
It’s true — and good news! — that Thursday morning’s data release from the Bureau of Labor Statistics shows the productivity growth rate over the past year at a robust 2.4 percent, the strongest growth rate since 2010, when GDP was finally growing out of the Great Recession but hours worked were still weak.
But as the figure shows, productivity growth is so jumpy that it takes much more than a few good quarters to establish a new trend. Most economists insist on at least a five-year moving average to tease out the underlying trend, but to give the recent values more weight, I’ve used a three-year average. Even so, there’s not much to see yet.
The lack of a surge in capital investment is an even bigger problem for supply-siders. And it’s a surprise, given the corporate tax cuts (which include immediate, full expensing of new equipment), low interest rates and high corporate profitability. I and others have made the point that business investment is trundling along as usual, with no evidence of any supply-side acceleration. But net investment is historically quite low at this stage of the expansion. That measure nets out depreciation, so it’s a more accurate take on the equipment available to produce new output.
So, if there’s little reason to believe the productivity growth is accelerating, at least for now, that leaves us with a sugar high, meaning slower growth ahead.
That’s probably right; it’s certainly my forecast. But there’s an interesting alternative that’s worth looking out for in future data: There’s a way in which the sugar high itself can lift the economy’s labor force and productivity growth. If the temporary stimulus pulls more people into the workforce who would otherwise have stayed on the sidelines, and they stay there even after the stimulus fades, the faster labor force growth will raise output growth.
Similarly, if persistently low unemployment leads to higher labor costs, employers seeking to maintain their profit margins might try to squeeze out production inefficiencies that didn’t hurt them when slack labor markets depressed labor costs. They may try to find ways to better use existing capital or give their workforce more training. As economist Josh Bivens argues, with evidence, they may increase capital investment. That’s not yet in the investment data, but any of these channels has the potential to boost trend productivity growth.
If this fortuitous scenario does occur, it raises a challenging question: Was it caused by the alleged investment incentives from the tax cuts or the longer-term effects of temporary stimulus? Luckily, that’s not hard to answer. If the dominant force behind improvements in labor supply and productivity is tighter labor markets pulling people in and incenting employers to discover efficiency gains, it’s a demand-side phenomenon, not a supply-side one.
Trump still gets credit for stimulating an economy that most economists wrongly thought was already at full employment, though the structure of his tax cuts was unquestionably wasteful. Rather than tax cuts and loopholes for the wealthy, productive infrastructure and resources for income-constrained households would have been a lot better for both the economy and the people in it.
But no matter what happens to future growth rates, deficit-financed stimulus has taught economists an important lesson: The unemployment rate can fall a lot further than most economists thought without triggering faster inflation. That’s already providing important benefits to those who depend on tighter labor markets for a bit of the bargaining clout they’ve long lacked.
And who knows? It could even induce faster growth that sticks around.