What is Economic Growth Growth

 

Economic Growth

Growth is central

Sclerotic growth is the overriding economic issue of our time. From 1950 to 2000 the US economy grew at an average rate of 3.5% per year. Since 2000, it has grown at half that rate, 1.7%. From the bottom of the great recession in 2009, usually a time of super-fast catch-up growth, it has only grown at two percent per year.² Two percent, or less, is starting to look like the new normal.

Small percentages hide a large reality. The average American is more than three times better off than his or her counterpart in 1950. Real GDP per person has risen from $16,000 in 1952 to over $50,000 today, both measured in 2009 dollars. Many pundits seem to remember the 1950s fondly, but $16,000 per person is a lot less than $50,000!

If the US economy had grown at 2% rather than 3.5% since 1950, income per person by 2000 would have been $23,000 not $50,000. That’s a huge difference. Nowhere in economic policy are we even talking about events that will double, or halve, the average American’s living standards in the next generation.

Even these large numbers understate reality.

GDP per capita does not capture the increase in lifespan — nearly 10 years — in health, in environmental quality, security and quality of life that we have experienced. The average American today lives far better than a 1950s American would if he or she had three rather than one 1950s cars, TVs, telephones, encyclopedias (in place of internet), or three annual visits to a 1950s doctor.

But even these less quantified benefits flow from economic growth. Only wealthy countries can afford environmental protection and advanced health care. We can afford to worry about global warming. India worries about 600 people per toilet, emphysema from burning cow patties, and easily treatable parasitic infections. Our ability to defend freedom around the world — even if we are wise enough to do it sensibly — depends on robust economic growth. If GDP had grown at 2%, not 3.5%, we would only be able to afford half the military we have today. The immense improvements in the quality of goods and many services we have today are part of the engine of economic growth.

Looking forward, solving almost all our problems hinges on reestablishing robust economic growth. Tax revenue equals tax rate times income, and growth determines how much income there will be. The amount of tax revenue our government has available to pay off debt and to pay the ballooning social security and health care expenses depends almost entirely on economic growth. Larger tax rates can’t come close to raising that much money.

For example, the Congressional Budget Office, making its regular gloomy analysis of the US long-run budget outlook, assumes 2.2% growth from now until 2040.³ But if GDP grew by 3.5% instead, even with no structural reforms at all, GDP in 2040 would be 38% higher, tax revenues would be 38% higher, and a lot of the problem would go away on its own. A 38% increase in Federal Revenue by higher tax rates or a 38% cut in spending are unlikely. Conversely, if GDP only grows 1%, GDP and tax revenues will be 26% lower than the CBO forecasts, which will force a fiscal crisis.

38% more income — or 26% less income — drives just about any agenda one could wish for, from strong defense, to environmental protection, to the affordability of social programs, to the welfare of any segment of the population, to public investments, health, and fundamental research.

And 3.5% is only a return to the post-WWII norm. Pre-2000 economic policies were not ideal. If we achieve 4% or more growth, even greater benefits occur.

The source of growth

Over long periods of time, economic growth comes from one source: productivity, the value of goods and services each worker can produce in a unit of time.

In turn, productivity comes from new ways of doing things. New ideas, at heart; new inventions, new products, new processes, new technology; new ways of organizing companies; new and better skills among workers. Southwest Airlines figuring out how to turn a plane around in 20 minutes, and Walmart mastering supply logistics, are as much productivity growth as installing scanners or ATMs. Workers who know how to use computers rather than shovels produce a lot more per hour.

Higher productivity typically comes from new companies, which displace old companies — and displace the profits of their owners, and the healthy pay and settled lives of their managers and workers. Southwest enters and either displaces the legacy carriers — Pan Am and TWA — or forces wrenching changes for survivors such as American and United. A&P displaced mom and pop stores. Walmart displaced A&P. Amazon may displace Walmart. Nobody likes the process. Everyone needs the results.

Nothing other than productivity matters in the long run. A factor of three increase in income in 50 years, and the much larger rise in income and health since the dawn of the industrial age, dwarfs what unions bargaining for better wages, progressive taxes or redistribution, monetary, fiscal or other stimulus programs, minimum wage laws or other Federal regulation of labor markets, price caps and supports, subsidies, or much of anything else the government can do.

More people working, and working longer hours, can improve income a bit, but soon runs in to an upper limit. Our grandparents worked long hours, but were much worse off than we are.

Saving, investment and capital formation can improve income a bit, but its benefit is limited as well. A 1950 worker working with twice as many 1950 machines produces much less than a modern worker using current technology. Only new ideas, new products, new technologies, new organizations, and new skills produce such huge increases in prosperity.

In this context, the decline of US GDP growth coincides with more worrying changes. Productivity growth is declining. New business formation is sharply down. Mobility of people from job to job has declined.

Restoring growth: a general strategy

A debate rages among economists why America’s growth has slowed. Most commentators advocate one side of that debate, and advocate strong policies according to their favorite theory. Lots of new ideas and grand policy programs are being dreamed up. Someone putting together a policy program might feel they have to choose a side in that debate, or they might wish to let that debate settle, to identify the most important policies.

Either approach is, I think, a mistake, given the urgency and magnitude of the problem, and given the likelihood that such a highly politicized economic debate will come to useful resolution anytime soon.

Let us instead work on the simple, common-sense things that everyone knows are broken, everyone understands are retarding growth, and that when fixed can increase growth. As opposed to looking for big magic bullets, new and clever theories, and ignoring the simple problems staring us in the face.

Will this approach restore 3.5% growth? Will it bring us to 4% or more growth? Well, really, it doesn't matter. When we have a big problem, and we know simple steps will help that problem, we should take those steps. We should do so, especially, because most of these simple steps can be taken at no fundamental economic or other cost.

Our economy is like a garden, but the garden is choked with weeds. Rather than look for some great new fertilizer to throw on it, why don’t we get down on our knees and pull up the weeds? At least we know weeding works! For another metaphor, our economy has become like a hoarder’s house. For a while he could get through the passages and keep life going, but now the junk is closing in. Well, rather than read the architectural magazines about just what the perfect house will look like, let’s get to work cleaning up the mess.

Politics

Alas, such a common-sense, weed-the-garden program has little attraction to many ambitious politicians. Many politicians want a big new program, big new laws and initiatives — a New Deal, a Fair Deal, a Great Society. They don’t see cleaning up the mess left behind by their predecessors as the way to getting one’s face carved on Mt. Rushmore, let alone to win an election. Economists like big new ideas and programs too. Nobody got a Nobel prize for saying, let’s take Adam Smith’s 250 year old classics to heart.

But it is a big idea, a big program, and one that needs and will reward the courageous leadership of great politicians. Everybody has to give up their little deal, protection, tax break and subsidy; everyone has to allow their businesses or profession to be open to competition. Each person must understand that the small loss that he or she will experience directly will be more than made up by everyone else giving up theirs. Politically, rather than fall back on “I’ll support your little deal, you support mine,” everyone has to become part of the coalition that supports reform — “no, I’m not getting mine, so I’m not going to support you getting yours.”

Forming such a coalition and keeping it together is hard. It is the essence of what great politicians can achieve.

Cleaning out the weeds also needs a large effort of simple governance. The President has to revisit and rewrite the mass of executive orders and memos. The Congress has to get serious and pass laws that are actually laws, not thousand page instructions for agencies to figure things out. It has to get around to repealing laws everyone understands are bad — the Jones act restricting shipping, the ban on oil exports, and so on — and reforming laws that everyone understands need to be reformed. It needs to actually follow its own budget law. The heads of agencies will have to renew the staff and reorient them to growth-oriented policy, and undertake a sweeping house-cleaning of regulations and procedures. They will have to implement managerial techniques such as pervasive cost-benefit analysis, regular retrospective review, and sunsets.

All of this is hard too. But it is the basic work of competent, growth-oriented government.

It is tempting to cast the question before us as growth vs. redistribution, or growth vs. inequality, as the rhetoric of redistribution and inequality pervades the arguments from those who want to continue the policies that are strangling growth.

But giving in to that rhetoric is a mistake. The US, in fact, has one of the most progressive tax systems in the world. And the relatively minor costs of government assistance to truly poor, needy, mentally ill or disabled people are not major impediments to growth. The weeds choking the economy represent cronyist redistribution to wealthy people, well-connected industries, and other powerful groups such as public employee unions, and large transfers among middle income people (social security and medicare). They are not, by and large, the result of genuine and effective redistribution from rich to needy poor.

When the average person (voter) expresses concern over inequality, what they really mean is that they are concerned that average people are not getting ahead economically. If the average person were getting ahead, whether some big shot CEOs fly on private jets or not would make little difference. Conversely, the average voter, if not the average left-wing pundit, does not support equality of misery. If the average person continues to do poorly, it would bring them little solace for the government to tax away the lifestyles of the rich and famous.

Long-term robust economic growth is the only way to deliver sustained improvements in the lot of average Americans, and the less fortunate in particular. Redistributing Marie-Antoinette’s jewelry did little for the average French farmer.

The golden rule of economic policy is: Do not transfer incomes by distorting prices or slowing competition and innovation. The golden rule of political economics seems to be: Transfer incomes by distorting prices and regulating away competition. Doing so attracts a lot less attention than on-budget transfers or subsidies. It takes great political leadership to force the political process to obey the economic rule.

Regulation

The vast expansion in regulation is the most obvious change in public policy accompanying America’s growth slowdown. Most recently, under the Dodd-Frank act and the ACA or Obamacare, these two large segments of the economy have seen radical increases in regulatory intervention. But environmental, labor, product, and energy regulation have all increased dramatically as well.⁴

Sometimes, regulation slows growth in return for public benefits, such as environmental protection or transportation safety. One can argue whether it does so efficiently, but there is a purpose.

Most economic regulation, however, is specifically designed to slow growth. The purpose of most economic regulation is to transfer money to a specific group of people, companies, or industry. It does so by slowing down new entrants, impeding competition, mandating uneconomic actions or cross-subsidies, slowing innovation, turning off price signals, distorting incentives, and encouraging waste. These are the tools of economic regulation, and they all impede economic growth.

People often complain that there are too many rules and regulations, or that the cost of filling out forms is too high, that there is too much red tape, that there are too many lobbyists, or that the direct measurable costs on industry are too large. The economic impact of regulation goes far beyond these standard complaints. The overwhelming cost of regulation is the economic dislocation: companies not started, products not produced, innovations not innovated, people not hired, costs not slashed, prices too high. And growth too slow. Just because it’s harder to measure these costs does not mean that these are not the overwhelmingly more important costs, and the costs that we need to address.

Economic regulation has left behind the rule-of-law framework that many Americans suppose governs their affairs. In the popular imagination, regulation is about rules, and there are just too many of them. In many areas, however, the regulations are so vast, so complex, self-contradictory and so vague, that they basically give the regulators free rein to do what they want. In many cases, there is not a set of rules that you can read and comply with. You need to ask for preemptive permission from a regulator, who determines if your project can go ahead. Delay in getting needed approval is as good as denial in many cases. Projects that cost millions cannot bear years or often decades of delay in getting approvals.

In other cases, vague and expansive laws and regulations give regulators ammunition to pursue a few selected victims, to extort big settlements or send a few examples to jail. And by doing so to frighten the others into following the regulators’ commandments. In many areas just about everyone is in technical violation of some law or regulation.

We are used to the right to see evidence against us, challenge witness testimony, and appeal decisions to an independent and higher court. These rights often do not apply to regulations, where the agency is prosecutor, police, judge, jury, and executioner all wrapped in one. The methods for determining an “abusive” practice or “discriminatory” outcome are not revealed ahead of time so that people could structure their actions in accordance with the rules.

Much of this state of affairs is Congress’ fault, for writing long vague bills which devolve legal power to the agencies. But in an increasing trend, regulatory agencies are going far beyond even the clear limits of their statutory authority and writing rules or commanding outcomes clearly far beyond the plain language of the law. The EPAs expansion of carbon regulation and the definition of wetland are good cases in point.

The popular debate is about “more” vs. “less” regulation. Regulation is not more or less, regulation is effective or ineffective, smarter or dumber, full of unintended consequences or well-designed, captured by industry or effective, based on rules or based on regulator whim, accountable or arbitrary, evaluated by rigorous cost benefit standards or by political winds, distorting economic activity or supporting it, and so forth.

So “de-regulation” is also an inappropriate slogan. “Smart regulation,” or “growth-oriented regulation” are much better descriptors of what needs to be done.

Finance

Financial regulation, even more transparently than other regulation, is just about who gives money and who gets money.

Under the Dodd-Frank act, a highly regulated industry has become suffocatingly regulated. The Federal Reserve embeds hundreds of employees at each major bank, who pass judgment on every decision. The justice department and SEC routinely pursue banks and other financial institutions for multibillion dollar settlements, and now will pursue individuals with criminal charges. The fixed costs of running a compliance department are so high that it is nearly impossible to start a new financial company in the US. Just one new bank has been chartered since the passage of Dodd-Frank.

The parts of the financial system that failed and were bailed out in 2008 — Fannie and Freddie, commercial banks — were already among the most highly regulated businesses in America. Regulation did not fail for being absent. Regulation failed for being ineffective.

Alas, the basic structure of the Dodd-Frank act simply doubles down on the same basic design that has failed again and again: The government guarantees a wide swath of debt, by promise (deposit insurance) and by ex-post bailout. An army of regulators tries to keep banks and other financial institutions from exploiting the guarantee and taking too much risk, and clairvoyantly to forecast panics and take action to stop them. That’s like sending your brother in law to Las Vegas with your credit card, but asking his kids to keep an eye on him.

Like much else in America, our government works to cross purposes. It subsidizes debt with tax deductibility, deposit insurance, too big to fail guarantees, regulatory preference for holding short-term assets, liquidity rules, credit guarantees, Fannie and Freddie, the home mortgage interest deduction, community reinvestment act, student loan programs and so forth. And then it tries to regulate against using debt with bank asset regulation, stress tests, consumer financial protection, macro-prudential policy, and so on.

The alternative is clearly laid out in many sources: Risky investments must be largely financed by issuing equity, not by borrowing very short term money. When that happens, the mass of regulation is simply not needed in order to stop financial crises. Then we will “only” face the task of removing needless regulations whose main purpose is to create subsidies and protections for various clienteles.

Health

The ACA, thousands of pages of law, tens of thousands of pages of regulations, and even more decision-making power by newly empowered regulators, such as the thousands of waivers given to individual companies, represents an enormous increase in Federal intervention in the market for health care and health insurance. Like finance, health was already highly regulated. And like finance, most of the ACA simply doubled down on the same basic regulatory structure that had caused so many pathologies before.

The central problem of preexisting conditions was an artifact of regulation. In the ideal form of health insurance, you buy cheap catastrophic insurance when young, but the insurance policy can follow you as you age, change jobs, and move from state to state, and does not radically increase premiums if you get sick.

Why don’t we have that ideal insurance? Because previous rounds of regulation outlawed it. In the 1940s the US government allowed tax deductions for employer-provided group insurance, but not employer contributions to individual insurance or individuals’ contributions to such insurance. By laws, insurance is not portable across state lines. Thus, there is no reason for anyone who might get a job or move to buy long-term individual insurance that protects against the emergence of pre-existing conditions. In response to the preexisting conditions problem, the ACA forces community rating — everyone pays the same price—tries to mandate healthy people to buy insurance, and steps up pressure on employer provided group plans, which are the source of the problem.

Similarly, once insurance was tax deductible, there was an incentive to salt it up. You would not buy car insurance that “paid for” oil changes — especially if you had to deal with insurance paperwork each time. But with a tax deduction it’s worth buying health insurance that “pays for” routine small expenses. Then the government (state and local too) instituted mandates that insurance must “pay for” — and, of course, charge premiums to cover — all sorts of additional procedures, which makes insurance too expensive.

We need to allow simple, portable, largely catastrophic, lifelong, guaranteed-renewable health insurance to emerge. Right now it’s illegal. To the extent that the government wishes to subsidize health insurance — and it should — then it should give straightforward vouchers, which people can use to buy insurance, or to fund health savings accounts. Such vouchers should take the place of Obamacare, Medicaid, and Medicare.

Health care and insurance is not just distorted from the demand side — too many people paying with someone else’s money. The supply side is ossifyingly restricted as well. New hospitals, new clinics that specialize in cheaply providing one service well, new doctors, new nurses, new insurance companies, all find a wall of laws, regulations, and officials blocking their path. For a reason: To maintain the profits of and cross-subsidies provided by the existing incumbents. Non-profit status itself blocks efficiency: you can’t take over an inefficient non-profit, and non-profits can’t issue equity to make important investments. In reducing the cost and improving the quality of health care, efficiency is far more important than trying to avoid a competitive rate of return to owners.

Energy and Environment

There are few places in the American government where one can witness inefficiency and growth-sapping regulatory bungling on the scale seen in our energy and much (not all) environmental regulation.

Like much else in America, our government pursues conflicting aims. It tries to subsidize and drive down the price of energy. And then it tries simultaneously to regulate against our using energy in a hundred different ham-handed ways, from mileage standards for cars, energy efficiency standards for windows and appliances, special parking places for electric vehicles,

$7,500 tax credits to subsidize $100,000 Tesla cars bought by silicon valley zillionaires, hundreds of annually extended tax credits for various energy boondoggles, and so forth.

The poster child for inefficiency may well be the mandate for gasoline producers to use ethanol. Corn ethanol, it turns out, does nothing to help the environment: It takes nearly as much petroleum energy to produce it as it contains, in the form of fertilizer, transport fuel and so on; it uses up valuable land, which directly emits greenhouse gases, and contributes to erosion and runoff; it drives up the price of food. The only thing sillier was the mandate to include cellulosic ethanol, because the government mandated a technology that simply did not work.

If you were wondering why we do this, it should come as no surprise that corn is produced by big companies in Iowa. If you need more evidence, note that the US also has heavy restrictions on the importation of sugar cane ethanol — as we restrict all sugar cane imports — which actually might be of some environmental benefit. The planet, of course, does not care whether corn is grown in Iowa or sugar cane in Brazil. Corn growers and sugar producers do care.

A litmus test for a presidential candidate ought to be the willingness to stand up in Iowa and say, “Ladies and Gentlemen, a huge government subsidy for corn ethanol is a rotten idea.”

Similarly, if you thought that subsidized production of photovoltaics and the various subsidies to putting solar cells on your roof, including the requirement that your fellow citizens buy electricity back from you at retail prices, are about the environment, you will be puzzled by our government’s heavy import restrictions on cheap Chinese made solar cells. Obviously, mother nature cares not where the cells are produced. Mother politics does.

Energy and transportation policy seem to indulge flights of magical thinking. California, facing a drought, and not having built water projects in decades, is going to spend well over $60 billion dollars on a high-speed rail line. This is advanced in the cause of carbon emission reduction. And quite literally, the case has been made that by building the rail line, we will lower global temperatures, and increase rainfall. If on a dollars per ton of carbon saved the rail line fails elementary cost-benefit analysis, on dollars per drop of water created, it fails the magic vs. reality test.

As this example makes clear, the Federal government is not alone. State and even local regulation is partly to blame as well.

Strong zoning laws forbid people from building houses near where they work, and forbid them from building workplaces near where people live, and from building shops near either. An electric car driving 60 miles is much less energy efficient than living in a high-rise apartment, in a mixed residential/commercial neighborhood, and walking!

A growth-oriented, and anti-cronyist energy policy is pretty simple. To the extent that the government wishes to reduce carbon emissions, impose a simple and straightforward carbon tax. In return, eliminate all the detailed mandates, subsidies, quantity regulations, and boondoggle unprofitable projects. If energy costs more, people will quickly figure out on their own what makes sense.