Wednesday, March 22, 2017

"Why US Growth of 2 Percent Is Plausible—And Unlikely to Get Much Higher"

We owe someone a hat tip on this but don't know where it came from, we don't have the PIIE in any of the feedreaders.
From the Peterson Institute for International Economics, March 21:

The US economy will likely grow at a rate of around 2 percent a year over the next decade. While this estimate seems low relative to the average annual growth rate of 3.5 percent from 1950 to 2000, it is not reflective of some newly found pessimism. Instead, it is largely based on two demographic facts: aging baby boomers entering retirement and the end of the influx of women into the workforce. In fact, without the cyclical boost in recent years from the falling unemployment rate, achieving even 2 percent annual growth will require substantially faster productivity growth than the United States has seen in recent years, along with a stabilized labor force participation rate on an age-adjusted basis.

A piece I wrote on Vox (link is external) explores plausible variations around this central expectation, either due to luck or to policy. A possible range of this uncertainty—that is, how different assumptions about productivity growth and labor force participation would affect this growth forecast—is shown in the table below. The Vox piece also documents how policy can make a small difference but cannot radically change the picture.

Alternative potential real GDP growth scenarios, 2016–26

  Labor force participation rate scenario
Productivity scenario Pessimistic        
(–0.3 p.p. per year)  
Base case        
(–0.2 p.p. per year)
  (–0.1 p.p. per year)
(1.4 percent per year, 10th percentile)
   1.4    1.5    1.7
Base Case
(1.7 percent per year, CBO projection)
   1.7    1.8    2.0
(2.8 percent per year, 90th percentile)
   2.8    3.0    3.2
CBO = Congressional Budget Office; p.p. = percentage point
Sources: Bureau of Labor Statistics; CBO; author’s calculations.

This blog post provides additional detail on how estimates for growth for the next decade are calculated. It focuses on the base case, which corresponds to the Congressional Budget Office’s (CBO) projection of annual growth from 2016 to 2026, but the same method applies to the other cases shown in the table as well. (The Blue Chip consensus of private forecasters is slightly more optimistic, with a 2.2 percent projection for long-run growth.)

The analysis derives real potential GDP growth from two main variables: the annual percentage-point change in the labor force participation rate and the annual rate of labor productivity growth. While these are the two most consequential and uncertain variables underlying potential economic growth, they are not the only ones. This note explains in more detail the other elements of the equation.
The simple version of the base case with 1.8-percent annual growth is as follows, wherever possible following or approximating the CBO’s assumptions:

Labor Inputs
The population (ages 16 and older) is expected to grow at 0.8 percent per year. The fact that the labor force participation rate is falling by 0.2 percentage point per year subtracts 0.4 percent from the annual growth rate of the labor force (approximately 0.2 divided by the CBO’s estimate of the 63.5 percent potential labor force participation rate for 2016). Together with the assumption of no change in the length of the average workweek, this yields annual growth of labor inputs of 0.5 percent (0.8 - 0.4 + 0.0, with some rounding error)....MORE