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Economic Growth: Causes, Benefits, and Current Limits
Testimony of Chad Stone, Chief Economist, Center on Budget and Policy Priorities, Before the Committee on Small Business Subcommittee on Economic Growth, Tax, and Capital Access, U.S. House of Representatives
Chairman Brat, Ranking Member Evans, and other members of the Committee, thank you for this opportunity to testify today about the causes of economic growth, the benefits associated with economic growth, and current limits on economic growth in the United States. These are important topics to understand better if we are to evaluate properly President Trump’s bold claim that his policies will supercharge the economy and return us to the higher rates of growth we enjoyed in an earlier era.
My testimony makes four essential points:
- Growth matters both for fiscal stabilization and for raising living standards.
- Economic growth over the next decade will be much closer to the 2 percent average annual rate the Congressional Budget Office (CBO) projects than to the 3 percent or better the Trump Administration is promising.
- Large tax cuts are far from a surefire way to spur growth, higher taxes don’t preclude growth, and tax cuts can harm growth if they add to the budget deficit or are paired with cuts to productive public investments.
- Small businesses are an important piece of the American economy, but in evaluating sources of growth, it’s new businesses rather than small businesses per se that matter.
Why Growth Matters
Faster growth in gross domestic product (GDP) expands the overall size of the economy and strengthens fiscal conditions. Broadly shared growth in per capita GDP increases the typical American’s material standard of living. But GDP is not meant to be a measure of economic welfare, and other considerations are important in fully assessing the costs and benefits of policy changes.
Estimates from both the Office of Management and Budget and CBO suggest that faster economic growth would improve the fiscal outlook. They find that a 0.1 percentage point increase in annual economic growth would reduce deficits by roughly $300 billion over a decade, mostly through higher revenues.  While actually boosting economic growth does reduce future budget deficits, all other things equal, making unrealistic growth claims for one’s policies as a way to offset their cost will understate the adverse impact of those policies on actual future deficits.
Broadly speaking, there are two main sources of economic growth: growth in the size of the workforce and growth in the productivity (output per hour worked) of that workforce. Either can increase the overall size of the economy but only strong productivity growth can increase per capita GDP and income. Productivity growth allows people to achieve a higher material standard of living without having to work more hours or to enjoy the same material standard of living while spending fewer hours in the paid labor force.
GDP measures the market value of goods and services produced in the country, but it captures only market activity and is not designed to be a measure of economic welfare. A parent in the paid labor force contributes to GDP; one who stays home to take care of children or an aging family member does not, but, if the family hires someone to perform these same duties, that labor would contribute to GDP. Health, safety, and environmental regulations can impose costs on businesses that may slow measured GDP growth, but any such costs must be compared with the benefits of better health, safer workplaces, and a cleaner environment that may not be captured in GDP.
Finally, a full assessment of the benefits of economic growth requires consideration of how widely Americans share in that economic growth. There’s a big difference between growth like that we experienced between 1948 and 1973, which doubled living standards up and down the income distribution, and the growth accompanied by widening income inequality we’ve experienced since. 
Sources of Economic Growth
CBO projects that, under current laws and policies, the economy will grow 2.3 percent this year but that growth will average just 1.9 percent a year between now and 2027.  As a candidate, President Trump boasted that his economic plan “would conservatively boost growth to 3.5 percent per year on average . . . with the potential to reach a 4% growth rate.”  And Treasury Secretary Steven Mnuchin has said that under President Trump’s policies, economic growth will pick up to “3 percent or higher.”  Last week, Mnuchin said the President’s economic plan would pay for itself with growth. 
It is not unusual for an administration’s economic forecast to be somewhat more optimistic than CBO’s, since the administration is presumably proposing policies it expects will improve economic performance over current laws and policies. But the gap between CBO’s forecast and the numbers we are hearing from the Trump Administration is unusually large.
An economy recovering from a recession can temporarily achieve relatively high rates of “catch-up” growth as demand for goods and services rebounds from weak recession levels. Businesses can readily meet the rise in demand for their output by hiring unemployed workers and more fully utilizing productive capacity that had been idled by the recession. Once excess unemployment has been eliminated and capacity utilization is back to normal, however, the economy’s growth rate is constrained by growth in its ability to supply goods and services.
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Economists use the term “potential output” or “potential GDP” to describe the economy’s maximum sustainable level of economic activity. Growth in potential GDP is determined by growth in the potential labor force (the number of people who want to be working when the labor market is strong) and growth in potential labor productivity. The potential labor force, in turn, grows through native population growth and immigration, while potential labor productivity grows through business investment in tangible capital (machines, factories, offices, and stores) as well as investments in R&D and other intangible capital. Improvements in labor quality due to education and training can also boost productivity, as can improvements in managerial efficiency or technology that allow businesses to produce more with the same amount of labor and capital.
Well-conceived tax, regulatory, and public investment policies can complement labor force growth and private investment in expanding potential GDP. They can also reap public benefits that GDP does not necessarily capture, such as distributional fairness and health and safety protections. Poorly conceived policies, of course, can impede growth and hurt national economic welfare.
Potential GDP represents the economy’s maximum sustainable level of economic activity. Actual GDP falls short of potential GDP in a recession, when aggregate demand is weak; it can temporarily exceed potential GDP in a boom, when aggregate demand is strong. But, over longer periods, actual GDP and potential GDP tend to grow together.
The Great Recession produced a large output gap between actual and potential GDP, which narrowed only slowly over the next several years as the economy recovered from the recession. CBO projects that the remaining gap will be closed by the end of 2020 and that the major constraint on economic growth going forward will be the growth rate of potential output rather than weak aggregate demand.
CBO estimates that potential GDP will grow at an average annual rate of a little under 1.9 percent over the next decade. About 0.5 percentage points of that growth comes from increases in the potential labor force and about 1.3 percentage points comes from increases in labor productivity. These projections of labor force and productivity growth are each lower than those that produced 3.2 percent average annual growth in potential GDP between 1950 and 2020 (see Figure 1).
Conditions are different now. The population is aging and, without more immigration, the potential labor force will grow much more slowly than when baby boomers were flooding the labor market. Productivity also grew much faster during the “golden age” of economic growth in the generation after World War II and in the late 1990s than CBO projects it will grow in coming years — and the benefits of that productivity growth were shared more equally than they have been recently. Trump policies would have to produce some combination of stronger labor force participation and productivity growth totaling 1.4 percentage points to match the 3.2 percent historical average.
Economist Edward Lazear, Chairman of President George W. Bush’s Council of Economic Advisers, attempted in a recent Wall Street Journal op-ed to explain how this might happen.  Like the Trump team, Lazear touted the purported benefits of “investment-friendly tax policy” and business relief from “burdensome” regulations. However, he concluded that achieving such a high growth rate is “unlikely.”
Tax Cuts and Economic Growth
Exaggerated claims for the economic growth benefits of large tax cuts have been around since the emergence of supply-side economics in the late 1970s and persist to this day. But there’s scant evidence to support, for example, House Speaker Paul Ryan’s claim that cutting tax rates across the board is the “secret sauce” that generates faster economic growth, more upward mobility, and faster job creation or Treasury Secretary Mnuchin’s claim that the Trump economic plan will pay for itself through growth. What the evidence shows is that tax cuts — particularly for high-income people — are an ineffective way to spur economic growth, and they’re likely to harm the economy if they add to the deficit or are paired with cuts to investments that support the economy and working families. 
History shows that tax cuts for the rich are far from a surefire way to boost growth — and that higher taxes don’t preclude robust economic and job growth. Compare, for example, changes in employment and economic growth following the Bush tax cuts of 2001 with those following the Clinton tax increases on high-income taxpayers in 1993, which supply-siders were certain would lead to slower growth and large job losses (see Figure 2). Small business job-creation was also more robust under Clinton. After the Bush tax cuts for the very highest-income households expired at the end of 2020, the economy continued to grow and add jobs steadily.
In a comprehensive review of the literature, economists Bill Gale and Andrew Samwick conclude that “growth rates over long periods of time in the U.S. have not changed in tandem with the massive changes in the structure and revenue yield of the tax system that have occurred.” 
When Kansas enacted large tax cuts overwhelmingly for the wealthy, Gov. Sam Brownback claimed the tax cuts would act “like a shot of adrenaline into the heart of the Kansas economy.” But rather than seeing an economic boom since the tax cuts, Kansas’ growth — including small business job growth, economic growth, and growth in small business formation — has lagged behind the country as a whole. 
These simple relationships are not controlled experiments to isolate the effect of tax cuts on growth, but they are a warning against credulous acceptance of supply-side claims. Careful economic research reinforces that conclusion. It finds that tax cuts on high-income people’s earnings or their income from wealth (such as capital gains and dividends) don’t substantially boost work, saving, and investment.
They are likely to hurt growth if they increase deficits or are paired with cuts to investments that help working families and the economy. CBO, which aims to provide objective, impartial, and non-partisan analysis reflecting expert opinion, finds that even tax cuts that increase incentives to work, save, and invest with potentially positive effects on growth are a net drag on growth if they increase the budget deficit.
Financing tax cuts for the rich by cutting productive public investments that help support growth, such as education, research, and infrastructure, are also harmful. Finally, a growing body of research suggests that investments in children in low-income families not only reduce poverty and hardship in the near term, but can have long-lasting positive effects on their health, education, and earnings as adults.
Unless it is dramatically different from candidate Trump’s tax plan or the House “Better Way” plan, the tax plan President Trump is working on will provide massive tax cuts that overwhelmingly benefit high-income taxpayers and lose huge amounts of revenue. That’s certainly true under conventional revenue-estimating methods used by Congress’s official budget scorekeepers, CBO and the Joint Committee on Taxation (JCT).
It’s also true under most “dynamic scoring” that takes into account macroeconomic feedback effects on economic growth and revenues. The Tax Foundation, to whose analysis supply-siders gravitate, is an outlier with respect to dynamic scoring.  It tends to find significantly larger dynamic effects for tax proposals than CBO or JCT have found in their own past analyses, and significantly larger effects than the Tax Policy Center/Penn Wharton model finds in its analyses of the Trump  and Better Way  proposals. But even the Tax Foundation’s Alan Cole rejects the idea that Trump tax policies could produce enough economic growth to pay for themselves. 
A centerpiece of President Trump’s campaign tax proposal and the Better Way tax plan is a special, much lower top rate for “pass-through” business income — which is currently taxed at owners’ individual income tax rates rather than the corporate rate and as dividend income in the hands of shareholders. About half of pass-through income flows to the top 1 percent of households, while only about 27 percent goes to the bottom 90 percent of households. 
These proposals would cut the top rate on pass-through income below the top rate on ordinary income (to 15 percent and 25 percent respectively), giving wealthy individuals a strong incentive to reclassify their wage and salary income as “business income” to get the lower pass-through rate. This would produce a substantial loss in revenue, while providing no benefit to the vast majority of small businesses, whose tax rate would be unaffected (see Figure 3).
The beneficiaries don’t fit anyone’s reasonable definition of a small business. They include hedge fund managers, consultants, and investment managers, who are among the pass-through business owners currently in the 39.6 percent tax bracket; the 400 highest-income taxpayers in the country, who have annual incomes exceeding $300 million each and receive about one-fifth of their income from pass-throughs; and business owners like President Trump, who owns about 500 pass-through businesses, according to his attorneys.
Kansas Gov. Sam Brownback exempted pass-through income from all state income taxes as part of his aggressive supply-side tax cutting in 2020. As I’ve already noted, this did nothing for the Kansas economy, but it wreaked havoc on the state’s budget, with the pass-through exemption alone costing $472 million in 2020, leading Kansas to cut services, drain “rainy day” funds, delay road projects, and turn to budget gimmicks. Two bond rating agencies have downgraded the state due to its budget problems. The Kansas legislature recently passed bipartisan legislation to close the loophole, although Gov. Brownback vetoed the bill.
That’s an object lesson in how not to do tax reform, but what should we do? In broad strokes, well-designed tax reform could spur growth by eliminating or scaling back inefficient tax subsidies and raising additional revenues to invest in national priorities and reduce deficits. At a minimum, it must not lose revenues. 
A Word About Small Business
As I’m sure many on this committee are aware, research over the last several years has modified the longstanding claim that small businesses are the engine of job growth. This research shows that the age of a business matters more than its size as a contributor to job growth, although new companies are typically small to start with. Every year there is huge turnover in the population of small businesses as firms fail or go out of business and new firms start up. To quote one of the pioneers in this research:
Most entrants fail… [M]ost surviving young businesses don’t grow. But a small fraction of surviving young businesses contribute enormously to job growth. A challenge of modern economies is having an environment that allows such dynamic, high-growth businesses to succeed. 
Economic Growth, Its Measurements, Causes, and Effects
How It’s Measured and What Are the Causes
Image by Evan Polenghi © The Balance 2020
Economic growth is an increase in the production of goods and services over a specific period. To be most accurate, the measurement must remove the effects of inflation.
Economic growth creates more profit for businesses. As a result, stock prices rise. That gives companies capital to invest and hire more employees. As more jobs are created, incomes rise. Consumers have more money to buy additional products and services. Purchases drive higher economic growth. For this reason, all countries want positive economic growth. This makes economic growth the most-watched economic indicator.
How to Measure Economic Growth
Gross domestic product is the best way to measure economic growth. It takes into account the country’s entire economic output. It includes all goods and services that businesses in the country produce for sale. It doesn’t matter whether they are sold domestically or overseas.
GDP measures final production. It doesn’t include the parts that are manufactured to make a product. It includes exports because they are produced in the country. Imports are subtracted from economic growth.
Most countries measure economic growth each quarter.
The most accurate measurement of growth is real GDP. It removes the effects of inflation. The GDP growth rate uses real GDP.
The World Bank uses gross national income instead of GDP to measure growth. It includes income sent back by citizens who are working overseas. It’s a critical source of income for many emerging market countries like Mexico. Comparisons of GDP by country will understate the size of these countries’ economies.
GDP doesn’t include unpaid services. It leaves out child care, unpaid volunteer work, or illegal black-market activities. It doesn’t count the environmental costs. For example, the price of plastic is cheap because it doesn’t include the cost of disposal. As a result, GDP doesn’t measure how these costs impact the well-being of society. A country will improve its standard of living when it factors in environmental costs. A society only measures what it values.
Similarly, societies only value what they measure. For example, Nordic countries rank high in the World Economic Forum’s Global Competitiveness Report. Their budgets focus on the drivers of economic growth. These are world-class education, social programs, and a high standard of living. These factors create a skilled and motivated workforce.
These countries have a high tax rate. But they use the revenues to invest in the long-term building blocks of economic growth. Riane Eisler’s book, “The Real Wealth of Nations,” proposes changes to the U.S. economic system by giving value to activities at the individual, societal, and environmental levels.
This economic policy contrasts with that of the United States. It uses debt to finance short-term growth through boosting consumer and military spending. That’s because these activities do show up in GDP.
The Phases of Economic Growth
Analysts watch economic growth to discover what stage of the business cycle the economy is in. The best phase is expansion. This is when the economy is growing in a sustainable fashion. If growth is too far beyond a healthy growth rate, it overheats. That creates an asset bubble. This is what happened to the housing sector in 2005-2006. As too much money chases too few goods and services, inflation kicks in. This is the “peak” phase in the business cycle.
At some point, confidence in economic growth dissipates. When more people sell than buy, the economy contracts. When that phase of the business cycle continues, it becomes a recession. An economic depression is a recession that lasts for a decade. The only time this happened was during the Great Depression of 1929.
The chart below shows the different phases of the U.S. economy since Q4 of 2005 up til Q4 of 2020.
Causes of U.S. Growth
The United States has an abundance of the four factors of production. These are land/natural resources, labor, capital equipment, and entrepreneurship.
The United States’ large land mass compares to those of Russia, Canada, and Australia. But it has more natural resources than these countries. The best of these are:
- Tillable soil in the Great Plains called the breadbasket of the world.
- A temperate climate.
- Fresh water, lakes, and rivers.
- Large deposits of oil, coal, and natural gas.
Canada and Russia are thwarted by a cold climate. Australia is dry.
These natural resources attracted labor. As a result, the U.S. labor force is large, skilled, and mobile. It responds quickly to changing business needs. The large and diverse population provides a home-grown test market. It gives domestic companies experience in knowing what consumers want. This has given the United States a comparative advantage in producing consumer products. As a result, almost 70% of what the country produces is for personal consumption.
Economic growth has also been driven by productivity gains. That measures how much each hour of worker time produces in output. Its free-market economy encourages technological innovations.
All of these give U.S. companies an advantage in exporting. As a result, the United States is the world’s fourth-largest exporter. It has allowed the country to excel in producing the fourth factor of production, capital equipment. These include computers, semiconductors, and medical equipment. It also includes industrial machinery and equipment.
The U.S. services industry is also innovative. The most successful are financial services, health care, and intellectual property such as computer software.
Ways to Spur Economic Growth
If a country is not blessed with the factors of production, it must find other ways to spur growth. Governments want to increase growth because it increases tax revenue. Growth allows businesses to hire workers, increasing their income. When people feel prosperous, they reward political leaders by re-electing them.
The government stimulates growth with expansive fiscal policy. It either spends more, cuts taxes, or both. Since politicians want to get re-elected, they use expansive fiscal policy to stimulate the economy.
But expansive fiscal policy is addictive. If the government keeps spending more and taxing less, it leads to deficit spending. It works for a while but eventually leads to higher debt levels. In time, as the debt-to-GDP ratio approaches 100%, it slows economic growth. Foreign investors stop investing funds in a country with a high debt ratio. They worry they won’t get repaid or that the money will be worth less.
Governments should then be careful with expansive fiscal policy. They should only use it when the economy is in contraction or recession. When the economy is growing, its leaders should cut back spending and raise taxes. This conservative fiscal policy ensures that the economic growth will remain sustainable.
A nation’s central bank can also spur growth with monetary policy. It can increase the money supply by lower interest rates. Banks make loans for auto, school, and homes less expensive. They also reduce credit card interest rates. All of these boost consumer spending and economic growth.
The Economy Is Strong. So Why Do So Many Americans Still Feel at Risk?
The sunny job numbers and steady growth hide the fact that most people think the economy works only for people in power.
By Jacob S. Hacker
Mr. Hacker is the author of “The Great Risk Shift: The New Economic Insecurity and the Decline of the American Dream.”
May 21, 2020
President Trump is running for re-election on the strength of the economy, and why not? The unemployment rate is lower than it’s been in five decades. The stock market is booming. Overall economic growth has been steady.
There’s just one problem: Voters are not particularly enthused about it. Recent polls suggest a substantial majority of Americans feel the economy is working only for “those in power.”
A big reason for this disconnect is that many Americans feel insecure. They may be doing well at the moment, but they fear that, however high they are on the economic ladder, a single bad step or bad event could cause them to slip. A booming economy hasn’t quieted these concerns, because insecurity remains a huge and growing problem in ways that voters and candidates instinctively get but the sunny job numbers largely hide.
Insecurity is the broad challenge that all 2020 presidential candidates must address — and it helps explain why Democrat s are tripping over one another to present bold plans for universal health care, public retirement supplements, guaranteed jobs and a much higher minimum wage.
Even with unemployment at a 50-year low, the job market is failing to reach millions of potential workers. That’s because those who aren’t working or looking for work are left out of the unemployment statistics. And the number of such workers has been growing: When unemployment was last down near 3.5 percent, in 1969, virtually all men ages 25 to 54 were in the work force. Today, the proportion is below 90 percent, the result of a long-term decline in work force participation that has hit men most severely, but has recently affected women, too.
Other rich countries haven’t seen this troubling fall, in part because they have p olicies that help workers find jobs, keep their skills up-to-date and balance work and family. Unfortunately, the United States hasn’t done much on any of these fronts. It once nearly led the world in levels of work force participation ; now it’s toward the back of the pack.
This reversal has had many bad effects. It’s reduced the incentive to bid up wages, which used to be seen as the inevitable consequence of tight labor markets. It’s also made unemployment less and less useful as a measure of job security.
The basic problem is that most of the jobs offered today don’t provide the guarantees that workers once expected. This transformation is obvious in “gig economy” jobs like driving for Uber. But the gig economy is still pretty small; for most Americans, the problem is that their work has been gig-ified. Corporations used to pool major economic risks within their labor forces. They did so because they could — the pressures of financial markets and global competition were less constraining. And they did so because they thought they had to if labor unions were to remain satisfied. Now those risks are mostly on workers alone.
These changes aren’t unique to the United States. Yet they’re uniquely consequential because of how we safeguard economic security. The United States spends more on social benefits than any affluent country besides France once you take into account tax breaks and employer-sponsored benefits. But there is a big difference: We have a system that is premised on employers providing many of the benefits that governments elsewhere provide directly.
Privately Funded Public Goods
Of these 20 countries, the United States spends the second most, after France, on social protections — various forms of financial support to households and individuals — as a percentage of G.D.P., after taking into account relative tax levels. But a far greater share of that spending comes from private institutions.
on social protection
on social protection
on social protection
on social protection
Note: Data is from 2020 to 2020.
Source: Organization for Economic Cooperation and Development Social Expenditure Database
By The New York Times
In the mid-20th century, American corporations came to be seen as mini-welfare states, providing workers not only with job security and continuous training but also with generous health benefits and a secure retirement income. That world is gone, and it’s not coming back.
In short, the implicit social contract that once bound employers, families and government has unraveled, and nothing has taken its place.
This unraveling has taken different forms in different areas. In metropolitan America, it’s seen in rising income volatility and the disconnect between wages and the skyrocketing costs of housing, health care and education. In rural and small-town America, the loss of productive employment looms larger. But what I’ve called the “great risk shift” is more or less universal for all Americans.
Which helps explain why ideas for tackling rising insecurity have broad appeal. At a recent town hall with Bernie Sanders on Fox News, the host thought he was setting a trap by asking audience members if they’d be willing to give up their employer-sponsored insurance for Medicare — and the audience cheered.
Universal health care would go a long way toward strengthening economic security (I’ve advocated achieving universality through a big expansion of Medicare). Moreover, Medicare’s ability to contain costs is so superior to the private sector’s that a broadened Medicare program would ultimately free up enormous amounts of state and federal spending to tackle insecurity in other domains.
Equally important are new measures to help people cope with an insecure labor market. Candidates running to unseat Mr. Trump have presented a range of ideas — from the familiar (ensuring unemployment insurance reaches all workers and limiting employers’ ability to classify their workers as independent contractors) to the pathbreaking (a federal system of paid family leave and a retraining and jobs guarantee to draw discouraged workers back into the labor market).
Similarly, young Americans need a system for financing college that does not leave them deeply in debt. In an age in which the returns to college are not only higher but also more variable, it makes no sense to have young adults borrowing heavily to make a risky investment. Fortunately, proposals for debt-free college and income-contingent repayment of student loans are at the top of candidates’ agendas, too.
Forty years of risk-shifting won’t be reversed easily or quickly. The jury-rigged system that is crumbling still has powerful defenders, and it still works tolerably well for advantaged workers. Most daunting of all, it’s still far too easy to scare Americans into thinking that extending security to those historically denied it will make them worse off, rather than better protected.
In an era in which trust in the public sector has plummeted, restoring economic security will require rebuilding that trust — and increasing the capacity of our governing institutions to earn it. But if Americans’ unease amid affluence tells us anything, it’s that we won’t fix what’s ailing our economy until we rebuild our fraying social contract.
Jacob S. Hacker, a professor of political science at Yale, is the author of “The Great Risk Shift: The New Economic Insecurity and the Decline of the American Dream.”
Why Growth Matters
US Senator Bernie Sanders speaks during a demonstration against Republican led tax reform outside . [+] the US Capitol in Washington, DC, on December 13, 2020. (Photo credit: ALEX EDELMAN/AFP/Getty Images)
Tax reform is now done, but it was a bitter partisan fight over who should pay how much in taxes and how progressive the tax code should be. Liberals like to claim that letting the rich keep more of their own money is somehow redistribution from the poor and middle class to the rich (it’s not). Similarly, Obamacare was, is, and will remain a battle over redistribution, upcoming entitlement reform talks will be all about redistribution, even the debate over avoiding a government shutdown in the next few weeks will be framed in the context of redistribution and to whom the government is and should be giving money.
People on both sides of the political aisle would like to see less poverty and more families moving up the economic ladder to at least middle-class comfort. Similarly, everyone would like to see that middle-class comfort be more comfortable with the middle class having more in savings and fewer people living paycheck to paycheck. That is why raising the rate of economic growth is so important.
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There are two ways to help the poor and middle class economically: we can use the force of government to take from the rich and give to the poor and middle class or we can grow the economy so that people see their incomes rise from more abundant jobs and higher pay. Economic growth makes the second option possible, which means we can avoid the political fighting and class warfare of the first option. That is why raising the rate of economic growth is so important.
If there is little to no economic growth, people and politicians devolve to fighting over who gets the biggest slices of the pie. Rent-seeking and crony capitalism reigns. When economic growth is robust, the pie gets bigger, making it easier for people to be self-reliant and not depend on the ephemeral largesse of the federal government for their well-being. And since what the government gives the government can take away, being self-reliant is far better. That is why raising the rate of economic growth is so important.
Albert Einstein supposedly called compound interest the most powerful force in the universe. The same principal applies to economic growth. If real GDP per capita grows at 1% per year, it takes 70 years for Americans to double their per capita real income. At 1.5% per year, it only takes only 47 years; at 2%, 35 years; at 2.5%, 28 years. These growth rates are in the range of recent data, so you can see that small, plausible increases in economic growth lead to large differences in future wealth. Even tiny changes add up: the difference between 2.0% and 2.2% growth means the economy is 8% larger in 25 years. That is why raising the rate of economic growth is so important.
Under President Bill Clinton inflation-adjusted economic growth averaged 3.8% per year. This rapid economic growth helped lead to a 3.6 percentage point decline in the poverty rate once government transfers are accounted for, a drop of 25%. Between economic growth creating jobs, boosting wages, and providing government with the revenue to afford social safety net programs, one in four people living in poverty escaped in those eight years. That is why raising the rate of economic growth is so important.
Economic growth creates jobs. Economic growth provides families with income and savings that help them pay for education for their children. Economic growth provides financial stability. Economic growth gives workers more power, because employers know that workers can get another job easily. All these things increase financial security and family stability. That is why raising the rate of economic growth is so important.
The only reason we are fighting continually over inequality and how much redistribution the government should carry out in response is that economic growth has been so slow during this recovery. When people are unable to achieve the level of economic success they desire, envy sets in and the political battles begin. With a restoration of normal levels of economic growth, people can achieve their own financial success instead of using the government to steal somebody else’s. And that would make the country a much more pleasant, less antagonistic place to live. And that, as much as everything else, is why raising the rate of economic growth is so important.
Does the Economy Really Need to Keep Growing Quite So Much?
Questioning a basic orthodoxy
Robert Galbraith / Reuters
Most things don’t grow forever. If a person grew at the same rate for his whole life, he’d become gigantic and perhaps perish (or else rule the world). Yet most economists are united around the idea that the economy needs to grow, always. And at a high rate, for the good of the country and its people.
As the thinking goes, growth of gross domestic product (GDP), which measures the goods and services produced in an economy every year is essential to a country’s stability and prosperity. It is growth that is responsible for each generation being better off than its parents’ generation, economists say. “More growth is better, period,” Robert Gordon, a Northwestern economist, told me.
But some economists are now challenging that view, arguing that it makes more sense to focus on measures of well-being other than growth. After all, despite a growth rate that has averaged three percent over the last 60 years (which is quite robust), there are still 43 million Americans living in poverty, and most people’s wages are essentially unchanged from the end of the Reagan administration. In fact, the median income of households in 2020 was 4 percent lower than it was in 2000, despite positive economic growth in all but two of the years during that time period. For half a century, developed nations have focused on how to make their economies grow faster, hoping that strong growth would improve life for all their populations. But what if growth isn’t the key to raising the standard of living across a society?
“Many of us think we would benefit from a multi-dimensional approach that captures things people care about,” Michael Spence, a Nobel Prize laureate who is also an emeritus professor at Stanford, told me. “Missing from growth are many things: health, distributional aspects of growth patterns, sense of security, freedoms of various kinds, leisure broadly defined, and more.”
Spence and others who agree with him aren’t saying that the economy should stop growing or even shrink (though there is a group of people who do believe that). What they are arguing is instead that it may be more healthy economically to accept a slower growth rate, but still a positive one, while prioritizing policies that address things like inequality and access to services. This idea is, admittedly, somewhat utopian, but giving it serious consideration can illuminate the shortcomings of the current growth-first approach.
It’s not just that maximizing growth doesn’t necessarily help people, but also that rapid growth can itself come at a cost, such as when the pursuit of growth is used to push through policies that are expected increase the GDP but may have negative consequences for millions. For example, companies often say they could grow more quickly and produce more with fewer regulations, but loosening those regulations might also lead to more pollution and accidents in factories. Other times, policies that might be necessary for the country’s long-term survival are avoided because of fears they might harm GDP. For example, conservatives criticize climate accords because they say that cutting greenhouse gases will reduce GDP by trillions of dollars. “The pursuit of growth can be quite dangerous,” Peter Victor, an economist and environmental scientist at York University in Toronto, told me.
Victor, Spence, and other economists have begun to think about what a society that doesn’t prioritize growth would look like. It’s possible, they say, for a nation to thrive even when growth is slow. A country could instead work on making its residents safe and content, and pursue policies that would achieve those goals. That may mean helping people to work fewer hours, or consume fewer resources, or spend more time with their families. Such a nation, they say, would be a better place for everyone.
It was in the sluggish days of the Great Depression that the idea of measuring total output came about. After a group of experts were called into a congressional hearing and couldn’t answer basic questions about the state of the economy, the Commerce Department commissioned the economist Simon Kuznets to create a system that accounted for what was happening in the nation’s economy. The system he designed, which measured what people were producing in the economy, is now what we call the gross domestic product (GDP). It helped determine economic policy during World War II and in its aftermath, when policymakers were convinced that a country that kept making things and then buying more goods was one where all residents prospered. Yet Kuznets was skeptical about using his system to gauge the success of a country. “The welfare of a nation can scarcely be inferred from a measurement of national income,” he wrote in 1934.
Indeed, GDP measures activity in the economy, but there’s no way to know whether that activity is actually good for society. Merely sitting in traffic can cause GDP to go up, since people need to buy all that gas, but it has no societal benefit whatsoever, and additionally has negative consequences, such as pollution and frustration, that don’t show up in GDP at all. The BP oil-rig explosion, which killed 11, and the subsequent spill, which leaked 3 million barrels of oil into the Gulf, actually lifted GDP, analysts said, because of the amount of money spent cleaning it up.
Over the past half-century, policymakers may have focused on economic growth above all else, but the next century could be a time when people obsess less about their jobs and the profits of companies, Victor hopes. Instead, a country could focus on measuring the health or happiness of its residents, rather than what they are producing. This is a tack Britain’s David Cameron took in 2020 when he said that it was time to focus on more than just GDP; he wanted the U.K. to consider the country’s general well-being as well. The U.K. now releases a national well-being survey that measures factors such as people’s self-reported happiness and anxiety levels, their life satisfaction on a scale from 1 to 10, and the rate at which they feel that what they do with their lives is worthwhile.
An economy not focused on growth may be a place where people don’t need to work as many hours, according to Victor. Workers have gotten more productive over the past few decades, after all, so if GDP growth were to be less of a priority, a society could use the benefits of technological production to reduce working hours, all while producing the same amount. This would allow people to spend more time with their families, or to partake in more leisure activities, which Americans say they increasingly don’t have time for.
A new economy could also focus more on the health of the environment. While the government has put in place polices that express other values, such as environmental protection—those policies are often said to be directly at odds with economic growth, instead of seen as being in concert with a suite of goals that involve trade-offs. After all, growth depends on countries producing more and more goods, often using natural resources to do so. An economy more focused on environmental health than GDP growth could measure the resources it is consuming—like timber, for instance—and make sure it doesn’t extract them at a faster rate than they can be regenerated. “We’ve had this system that has relied on consumption growth to keep people employed over the last 50 years,” said O’Neill, who is also the chief economist at the Center for the Advancement of the Steady State Economy, which advocates for an economy that consumes materials at the same level that they can be replaced.
Economists often say that without growth it will be impossible to address income inequality. The more economic activity being created, they say, the more room people have to move up the economic ladder and perform to their full potential. “Growth is conducive to meritocracy,” Marshall Steinbaum, a senior economist at the Roosevelt Institute, told me. “In a world of high growth, the future is wealthier than the past.”
But even with growth, there’s no guarantee that inequality will decrease—in fact, the economy’s current trajectory is of increasing inequality. And proposals for addressing inequality, such as raising taxes on the rich, are often nixed because some economists say such prescriptions might reduce economic growth. If growth were less of an imperative, policymakers could prioritize distributional policies more than the current economy does, O’Neill said. That might mean raising taxes on the rich, or increasing tax credits for the working poor or middle class. Redistribution could be achieved by providing better educational or job opportunities for the disadvantaged, without worrying about the downsides of such government spending. It could also mean providing a basic income for the poor, something the Dutch city of Utrecht is about to test. “Current growth patterns do not produce acceptable distributions of incomes, wealth, quality of work,” Spence, the Stanford professor, wrote in an email. “If these issues were addressed effectively (it is hard to do) we would probably be reasonably happy with relatively lower growth.”
Mainstream economists also say that a nation’s economy needs to grow in order to provide more public services to its population, such as universal pre-K. Without growth, said Gordon, the Northwestern economist, if the country wanted to add those programs within its existing budget, it would have to cut something else or raise taxes. “There’s always a demand for more services, whether there’s growth or not. Growth gives you the funding to pay for it,” Gordon said. This goes for paying Social Security and Medicare, too, which are funded through taxes. As the population ages and more people receive Social Security, the economy needs to grow so their benefits can be paid for, he said. Of course, this assumes that the country has a political system that can adequately tax people.
Yet as long as the economy grows at the same rate the population does, it could continue to pay for programs like pre-K. (In 2020, the U.S. population grew 0.8 percent.) Doing so just might mean shifting dollars around from other areas, or raising taxes. Countries could also redesign the way they fund pension programs so they’re not as dependent on a constantly expanding economy. The future of programs such as Social Security, in which benefits for the older generation are funded by the payments of a larger younger generation, is already tenuous. Redesigning such programs for an economy that doesn’t grow quickly is possible, Victor said. After economic growth slowed from four percent to two percent, Sweden redesigned its state-based pension provision in 1998, for example, requiring workers to make certain contributions, rather than just promising them benefits. With Social Security, “it’s not a lack of growth that’s led to a lack of funding; it’s a lack of priority,” Victor said.
For most economists, the idea of focusing on something other than GDP growth is heresy. But developed nations may have to start thinking more seriously about the idea. That’s because of the simple fact that economic growth has been anemic since the recession, and no one is quite sure what to do about it. Though the Bureau of Economic Analysis said in October that the GDP increased 2.9 percent in the third quarter, it had grown at a rate of roughly 1 percent for the previous three quarters. Economists aren’t exactly sure why growth has slowed so much. Steinbaum, of the Roosevelt Institute, told me that economists aren’t even really sure what exactly causes growth, or a slowdown. “Economists decided a long time ago that they can’t explain growth,” he told me. “Lots of people thought they knew what causes growth, but nobody actually does.”
That may mean the country may have to reckon with an economy that doesn’t grow quickly, or at all, whether economists want to or not.
To be sure, this isn’t a realistic proposal for the developing world, where more growth is needed to get people out of poverty and improve living standards. But in the developed world, where the economies are already quite large, there are values besides growth to consider.
This isn’t the first time this idea has been advocated in The Atlantic. In a 1995 article, “If the GDP is Up, Why Is America Down?” Clifford Cobb, Ted Halstead, and Jonathan Rowe argued that it was time for new indicators of progress. GDP takes the breakdown of the natural habitat and portrays it as economic gain, the authors wrote. It hides important work—like that of mothers raising children at home—and marks it as unimportant, because no money changes hands. “We may be witnessing the opening battles in a new kind of politics that will raise basic questions about growth,” they wrote. Such battles did not emerge following the article, in the heady days of the late 1990s, when the economy was booming and few people wanted to question a GDP that was growing at a rate of more than four percent a year. Now that such growth has waned, those battles may be on the horizon once again.
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