Four Percent Growth: Great for Deficit Control, Hard to Achieve

Senator Marco Rubio argues that getting the economy to grow at a sustained rate of 4 percent a year would create millions of jobs and reduce the 10-year deficit by $4 trillion.

Bloomberg Government senior economic analyst Christopher Payne crunched the numbers in a BGOV Analysis and validated the Florida senator’s budget math, assuming it counts the savings from paying less interest on less debt.

The problem is achieving 4 percent average annual growth over a sustained period. It’s conceivable that the U.S. economy can grow for a while at 4 percent or more, as long as the economy has what economists call an “output gap,” or a shortfall of actual gross domestic product below potential GDP. When the economy is operating below its potential, the labor force is not fully employed.

 That’s been true since the financial crisis began in late 2008, even though joblessness has come down from its peak. The current unemployment rate of 7.7 percent is at least 2 percentage points above the rate consistent with stable inflation, which is what economists use to calculate potential GDP.

The real challenge will be keeping the economy growing at 4 percent after the recovery ends, which means sustaining potential GDP growth at 4 percent, more or less indefinitely. Or, to be fair, at least averaging 4 percent growth after 2017, when the economy should be nearing full employment, taking into account the economy’s inevitable ups and downs.

That’s really difficult to do, some might say impossible. One reason is that the Congressional Budget Office projects the labor force will grow only at a half-percent rate annually during the next decade, down from about 1 percent in the previous 20 years.

If the number of people potentially available to work grows this slowly, then everyone in the work force will have to become more productive each year by 3.5 percent to hit an economy-wide growth goal of 4 percent.

If history is any guide, Payne concludes, that’s highly improbable. The fastest era of productivity growth in the past 60 years was 2.3 percent from 1950 to 1973, according to CBO. During the last 10 years, labor productivity grew only at 1.4 percent annually.

Although CBO projects a modest uptick in labor productivity growth of 1.7 percent annually during the next decade, potential GDP growth over the next decade is projected at 2.2 percent when the labor force projection is factored in.

This is the slowest growth rate of any period since 1950, and it’s only a little more than half the 4 percent growth target Rubio singled out in his State of the Union reply.

So is there any way to juice the potential rate, perhaps not all the way to 4 percent but at least higher than an anemic 2.2 percent?  Advocates of corporate tax overhaul — promoting lower tax rates in return for closing preferences — will claim big boosts in potential GDP, but that’s a stretch.

The new budget austerity means federal support of research and development won’t increase much, if at all; even if it did, the connection between R&D spending and potential growth is hardly automatic.

So here’s another idea to spur faster growth: increased immigration that will unlock entrepreneurial growth. Before joining Bloomberg Government, I directed analysis at the Kauffman Foundation, the nation’s leading supporter of research about entrepreneurship. There I spent a lot of time studying how to increase potential GDP growth, and I also served as a fellow with the 4% Growth Project at the George W. Bush Institute, which published its findings in “The 4% Solution.”

The key to higher potential GDP growth, I’m convinced, lies in the birth and growth of successful new companies. And the most cost-effective way to get more of these enterprises, without spending taxpayer funds, is to greatly increase the number of immigrant entrepreneurs allowed to work in the U.S.

Kauffman released a study last month that said bringing in 75,000 new immigrant entrepreneurs during the next four years would raise GDP in 10 years by 1.6 percent and create between 500,000 and 1.6 million new jobs. That’s a conservative estimate; a more expansive entrepreneur visa program would lead to even greater growth and jobs.

While the country probably won’t let in enough immigrant entrepreneurs to hit Rubio’s 4 percent target — there are political limits and diminishing returns — the U.S. could come closer by changing its immigration policies. This outcome alone is one of the strongest arguments for quickly enacting immigration overhaul. 

For more information about Bloomberg Government, visit http://www.bgov.com.

To learn more about ideas to boost potential growth, see “Better Capitalism: Renewing the Entrepreneurial Strength of the U.S. Economy.” Follow Litan on Twitter: @BobLitan 

 

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