Here’s Why 3 Percent Economic Growth Is an Ambitious Objective for the US Economy

There are good reasons why so many economists who don’t work in the Trump administration — such as those on Wall Street or in Washington at places like the CBO and Fed — are skeptical the US economy has been transformed from a Two Percent Economy into a Three Percent Economy. Here is the common economic framework for thinking about potential economic growth, as the economics team at Barclays bank explains it:

This framework computes potential GDP growth as the sum of structural productivity growth and the rate of increase in potential labor hours. Structural productivity, in turn, is driven by increases in the amount of capital per unit of work (capital deepening) and by total factor productivity (TFP) — a residual that captures effects from technology and innovation.

And once you think about things in those terms, the problems become obvious. Working hours? An aging population means the growth in the working-age population is declining to half of what it was for the past 30 years. How about more capital? Well, there hasn’t been a big upswing yet despite the 2017 tax cuts. Barclays:

Our calculations using the growth accounting framework show that boosting potential GDP growth by 1pp would require the rate of increase in nonfarm business capital to jump from about 1.7% y/y in 2017 (Figure 3) to of about 4.4-5.3% y/y. This would amount to jump in the level of business fixed investment (BFI) on the order of $1.0-1.3trn chained 2012 dollars. There is little indication that increases anywhere near this magnitude are in train: BFI decelerated noticeably in Q2 and Q3 this year (Figure 4), and the latest estimates place the Q3 18 level at $2.8trn chained dollars — up just 5% from Q4 17. Even if an increase along these lines was spread over a few years, the imprint on macroeconomic aggregates — such as GDP, national saving, and the trade balance — would be unmistakable, in our view.

Then there is TFP, which is often used as a proxy for innovation. Barclays:

Meanwhile, sustained acceleration through TFP would require exceptional circumstances, such as the transformational technologies introduced by the 1960s aerospace boom and the 1990s tech boom. The idea that such circumstances can be engineered through tax policy strikes us as wishful thinking.

Now I hope that we have been introducing transformational technologies that will greatly boost innovation and productivity. And I think government policy can be a plus over the long run, but that is about more than just taxes.