Economic Growth: It’s a simple formula, not magic

It’s a simple formula: labor force growth rate plus productivity growth rate equals potential economic growth rate. Now let’s do some math.

This formula gives you the maximum potential sustainable growth rate potential for the U.S. economy or any economy. Like a teenager the economy will experience the occasional growth spurt. These are not sustainable though. If they were then that teenager has the potential to be ten feet tall.

Also like the teenager an economy is subject to stimuli that produce one-time jolts of growth. The teenager has hormones. Economies can be stimulated by government spending, usually debt driven, a printing press run amok, or tax cuts. All have the same temporary effect, a buzz if you will. The next morning all you have is a headache. At best the economy slows to its potential rate, at worse it falls into recession.

If we look at the two components of economic growth what do they look like? Labor force growth depends on population growth and we know U.S. population growth is virtually flat. This is typical of developed economies throughout history. How does a developed country offset this trend? I can’t think of a single example of a developed economy reversing the trend of a declining domestic fertility rate. The simplest way is (pregnant pause) immigration.

Immigration has become a four-letter word. You watch the news so I don’t need to recap here. I will say that when your economy is stagnating it might be a good idea to increase the resources needed to raise the levels of legal immigration. There are a lot of hardworking talented people in the world trying to escape dire circumstances.

The second component is a little more complicated. Productivity, or more specifically labor productivity is the amount of output for each hour worked. Productivity growth has been hovering around 1.3% and in steady decline since 1973. When a worker produces more per hour wages rise. This in turn drives more demand, but since more is being produced price increases do not exceed wage increases: good inflation.

Are you a good witch or a bad witch? Two kinds of inflation.

Inflation comes in two flavors. The good kind discussed above and the bad kind we see in the headlines, in Venezuela for example, that surfaces when authoritarian ideologues think they can control supply and demand through sheer force of will. They apply price controls, restrict imports and exports, nationalize business, print money and raise wages simply to keep citizens from realizing how deep a whole he or she has put them in.

Productivity is driven by innovation plus scores of talented people who can take innovative ideas and make them work broadly across the economy. We have brilliant innovators in the U.S. who have produced wonderful things that delight us. You can argue that many of these innovations are just shiny objects that have done little to improve productivity. That may be true to some extent, but I think it goes deeper than that.

Sustainable productivity requires critical thinking managers and engineers to execute on brilliant ideas. We certainly have critical thinkers, but not enough. Our schools are turning out test takers whose goal is to earn. There is nothing wrong with that unless it is your sole motivation. Well-meaning parents have insisted schools turn their children into people who will achieve wealth and become secure.

Students have learned how to please, not think. They please their parents and their employers. Large employers driven by short term thinking want these pleasers to execute on short term strategies. A drill sergeant will often say to a boot camp enlistee: you are not supposed to think, you are supposed to function.

Many people have an innate ability to think critically, but it has been muted or poorly developed and, in some cases, ignored entirely. With avenues of expression cut off people look to social media to express themselves about oppression, inequality and injustice.

I believe strongly in expressing opinions and standing up for the things in which you believe. What if this passion were directed toward taking innovative ideas and creating jobs and higher incomes for more people? If this were occurring, we would not need to expend so much energy talking about it.

Turning innovation into productivity is certainly occurring in the U.S., but scale is lacking due to resistance. Resistance from people who see change as theft. Theft of a job, theft of choice, theft of a birthright. This perception, or fear, is at its root’s ignorance.

Ignorance is not a crime and it is not a weakness. It is a state of simply not knowing. Not knowing can be cured, if you are willing to learn. This goes back to the problem with schools. If students were being taught how to think and taught the value of being a lifelong student, to embrace their curiosity then change would not be so frightening. Ignorance would die of neglect and productivity growth would increase.

A lack of competition is also contributing to a lack of innovation, but we will discuss that in the next post.

Given the two growth rates above the U. S. economy’s potential growth rate is a shade over 1.3%, give or take. So, when a politician says they can magically make GDP grow at 3-4%, they literally do mean magic.

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