It’s
a sure thing that Donald Trump will spend much of his State of the
Union boasting about the economy. So this seems like a good time for a
refresher on some basic macroeconomics – and the reasons why the
expansion of 2017, which continued the long expansion that began in
2010, is in no sense a justification for wildly optimistic growth
projections looking forward.
As a reminder, the Trump Treasury department claims that tax cuts will pay for themselves because the economy will grow at almost 3 percent
a year for the next decade. This growth projection didn’t come from any
model; it was just pulled out of … well, you fill in the rest. But
every time there’s a good quarter of growth, the usual suspects take
time off from talking about deep state conspiracies to claim that the
forecast is coming true. Why is this nonsense?
First,
you need to know that quarter-to-quarter and even year-to-year growth
rates are very variable. The economy grew at a 5 percent annual rate
during much of the Carter administration (how many people know that?);
it grew around 4 percent during the second Clinton administration:
What’s
behind these growth fluctuations? The business cycle. Potential output –
the economy’s productive capacity – grows fairly smoothly. But
recessions leave some of that capacity idle, and the economy can
temporarily grow fast as that capacity is put back to use. The
unemployment rate is an imperfect measure of idle capacity; still,
there’s a strong relationship – Okun’s Law – between changes in the unemployment rate – capacity going into or out of use – and short-run economic growth.
The
thing is, however, that we’re currently close to full employment. The
unemployment rate is historically low. Other indicators, like the rate
at which workers are quitting jobs (a sign of how confident they are of
finding new jobs) also point to a more or less full employment economy.
Wage growth and inflation are still subdued, but it’s still unlikely
that unemployment can fall a lot from here. This means that growth over
the next decade will have to come from rising capacity, meaning growth
in potential output.
So
is there any sign that potential output growth is anywhere near 3
percent, or in fact that it has accelerated? No. Here’s Okun’s Law for
the past decade:
The
relationship isn’t perfect, because this is economics, but it’s pretty
strong. It suggests a potential growth rate – growth consistent with
constant unemployment – of maybe 1.5 percent. And 2017 isn’t an outlier.
Why
is potential growth so low? Unfavorable demographics are one big
culprit: the baby-boomers are getting old (you kids get off my lawn), so
the working-age population is barely growing. Oh, and cracking down on
immigration is, you know, not likely to help on that front.
Productivity growth is also lackluster, despite all the hype about robots and all that.
So
if you think about it, 2017 offers no evidence to support big talk
about future growth. On the contrary, the fact that unemployment
declined despite not-so-fast growth is a sign that growth will be a lot
slower going forward, now that we don’t have a lot of unemployed
Americans to put back to work.
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