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More Economic Growth is Possible and Will Soon Become a Higher Priority for Our Government

Article by Ike Brannon June 23, 2014 //   11 minute read

Two and a half years ago I began writing for the Four Percent Growth Project at the George W. Bush Institute. My affiliation, when announced at an event where I am speaking, invariably brings forth the same question each time: Is such a goal possible?

There’s no doubt that it is a daunting task if we do the arithmetic: over the last century economic growth has averaged slightly over three percent a year, so a four percent growth rate would be well above the historical norm. What’s more, today’s workforce is growing more slowly than at almost any other time over that span, making it even harder to boost growth. The post-war formula to achieve three percent economic growth was one percent labor force growth and two percent productivity growth: if labor’s growing at only half that rate, then four percent growth requires a productivity growth rate over three percent, or a full fifty percent higher than the long-run average. That’s never occurred in the postwar history over the course of an entire business cycle.

Northwestern economist Robert Gordon argues that another factor tamping growth down today and in the future is that we’ve already picked the low-hanging fruit in terms of innovations. To come up with new ways to improve efficiency and enhance productivity we’re going to have to devote more resources and effort to do so. And it’s not clear we’re willing to make the sacrifices necessary to do that, he avers.

Despite such a daunting headwind I remain a believer that the US economy could accomplish four percent growth for a sustained period of time. Here’s why.

1. We’re getting better at using our capacity.

One way to boost productivity is to give workers more capital to work with--more and bigger bulldozers, faster robots, trucks that don’t break down. But that can only take us so far: one man can’t drive two bulldozers.  Instead, we need to come up with ways to combine physical capital and human capital in better ways--what economists call multifactor productivity. The data show that we did a good job boosting multifactor productivity but that these gains have diminished of late.

However, we still have all kinds of assets in the economy that we don’t use all that efficiently. For instance, former Obama adviser Peter Orszag has noted that we have hundreds of billions of dollars of capital investment in our nation’s hospitals that we use for roughly forty hours a week--no one can get an MRI or Xray outside of normal business hours unless it’s an emergency. If we operated these facilities on nights and weekends we could do twice as many MRIs without buying one more machine--or the same amount of MRIs with more capital free for other medical investments.

Hospitals don’t do this because they’re largely insulated from the vicissitudes of the market, but perhaps the Affordable Care Act can be tweaked in a way to incentivize greater capacity utilization.

Using capital more intensively has been the key to success in the various sectors of the economy for decades. A friend who bought a printing company in the 1980s became rich when he realized that he could double output by running a second shift--or nearly triple capacity if he ran a third--without requiring him to invest a dime more in capital.

More often increasing capacity utilization is driven by necessity. I know more than one fellow economist who has found himself advising a favorite local brewpub hoping to stave off bankruptcy, and the answer they invariably provide--and one which shouldn’t take a PhD to ascertain-- is to find other customers and ramp up production so their equipment is being used 30 days a month rather than seven or eight. The steadily increasing market share of craft beer I attribute in part to this inexorable impetus that hits all brewers, no matter how big or small, to fully use their capital.

The best example of a recent innovation that helps us use our capital more efficiently is Uber, which allows the same amount of people to get around town with many fewer cars, with limo drivers, cabbies, and anyone registered as a driver with Uber using their car more than just an hour or two a day.  If we were to combine wholesale adoption of Uber with a mechanism that allowed us to replace the gasoline tax with a vehicle miles traveled fee that changed with the congestion, our transportation grid would also become more productive, speeding up traffic without an expansion of our roads.

2. A change in the tax code is iminent

I’m under no illusions that Ways and Means Committee Chair Dave Camp’s tax reform proposal will become law anytime soon--Mr. Camp himself has said as much. But I do think that a major change in the tax code is inevitable--for economic, not political reasons.

Over the last quarter century a seismic shift has occurred in the taxation of corporate profits across the globe, as countries have raced to reduce rates. Since 1990 every single country in the OECD has reduced its corporate tax rate save for one--the United States. Since 2000 alone there have been over 100 incidences of OECD countries cutting their corporate tax rate. These efforts have left us with the highest corporate tax rate in the OECD, at a rate just over 39%, including state and local taxes, with the OECD average more than a dozen points lower and falling.

We’ve been able to resist this in part because of historical accident and the sheer size of our consumer market has left us with a sizeable corporate base. However, our relative size compared to the rest of the globe shrinks every day, and corporate inversions, whereby foreign-domiciled companies operating under a low-tax regime take over US-based businesses, have become the norm. Our high corporate rate these days doesn’t bring us any more money than a lower rate, Apurna Mathur and Kevin Hassett have estimated in research they published a few years ago.

While pundits have spared no ink in lamenting the downward trend of lower corporate rates, envisaging it as a lost chance to sock it to faceless corporations, a thoughtful corporate tax reform would be good for economic growth. Taxing capital is the most expensive way the federal government extracts revenue from the economy, in terms of foregone economic activity. A higher corporate tax rate reduces the returns to capital, reducing investment, productivity, wages, and ultimately economic growth. This reform will happen soon not because of any political efforts but because the populace will come to see that it is in our best interest for it to happen.

3. Growth’s become a necessity to fix our broken federal budget.

There has been a lot of debate about income inequality in the last few years, something Thomas Piketty’s book has added to. There’s a significant cohort in this debate that has concluded that most growth goes to the wealthy and that, because of that, pursuing growth isn’t a way to help the poor.

While that’s an assertion that’s unsupported by the data or even basic arithmetic--Steve Rose pointed out in Rebound that GDP’s doubling in the last 25 years means that if only the top decile benefited, their average income would have to quintuple--it nevertheless guides the policy choices of a significant cohort, who remain unpersuaded that pursuing more economic growth is worth even the smallest sacrifice.

However, the sizeable federal budget deficit--which shows no signs of diminishing--can mainly be attributed to income redistribution, with fully ⅔ of the federal budget devoted to entitlement programs. Not only are these programs crowding out defense and everything else we expect government to do, but our current tax system simply isn’t generating enough money to pay for them.

As demographic pressures grow the day will come when we either need to cut back on entitlements and figure out a way to generate more revenue. While the left would prefer to put that burden wholly on the one percent, short of confiscating their paychecks there is simply not enough money there to cover these unfunded government liabilities.

The only way to stave off a choice between reducing entitlements or broad-based tax increases is to generate more tax revenue by other means--and that’s where economic growth comes in. Sustained economic growth generates gobs of tax revenue by boosting incomes and pushing people into higher tax brackets. From 1996-2000, when growth averaged 4%, tax revenue went up by fifty percent and from 2004-2007, when growth averaged slightly more than 3%, tax revenue went up by 42 percent.  

Economist Tyler Cowen has pointed out that the quarter century diminution in productivity growth from 1971-1994 inflicted an enormous toll on future growth. Had the 2.5% growth that was the norm before and after that period continued uninterrupted our GDP would be nearly fifty percent higher than it is today, or roughly $6 trillion. A spare $6 trillion could fix a lot of what ails our economy today.

There are a lot of reasons to think that more growth can happen, I’m arguing--new innovations are occurring that are good for growth, there are policy changes afoot that can enhance growth, and there may soon be a bipartisan consensus to make economic growth a priority. And a government that prioritizes growth has an entire laundry list of choices it could make to get there--in fact, I know of an entire blog devoted to that very topic.