In my last post, I brought up the idea that Tax Policy should not be measured in terms of GDP, and that GDP is, broadly speaking, in a prolonged period of slowing growth. Today, I want to take a closer look at the US GDP, how we calculate it, trends over time, and why it may not be where some influential people want it to be.
GDP stands for Gross Domestic Product, and it measures the value of all final goods and services produced within the borders of a country. That means all goods that are a part of other goods are only counted once, such as car steering wheels only being counted upon assembly into a car, or glass phone screens only counted when they are fixed onto a phone. It also counts all economic activity in a country, including from businesses that have headquarters in other countries, which explains why American politicians are so happy when foreign companies announce plans to open plants in the US.
You can view the Federal Reserve data for US GDP here: https://fred.stlouisfed.org/series/GDPC1
And here is the Fed data for the percentage change in GDP: https://fred.stlouisfed.org/series/A191RL1Q225SBEA
You can almost instantly see a flattening in the both charts. The percentage moves are far less volatile in recent decades than in prior ones, and the total GDP chart is not quite the parabolic shape that would suggest constant percentage gains. Recent data comparisons show the same thing, that GDP growth in the post-financial crisis period has averaged 2% while growth was around 5% in the 1950’s and 60’s.
Why has this been the case? Is there purposeful slack in the economy due to policy errors? Are people just less productive now than they were before? Or is there something bigger going on that we are just not tracking? I will endeavor to explain some possible theories.
First, the popular reasons. Janet Yellen and the Fed would be remiss if they did not mention, in every policy announcement, the slowdown of GDP growth due to several structural factors. First, they say the population is aging, pushing down the workforce participation rate. Then they say that workforce productivity has been weak in recent years, pushing down supply. There is ample data to support both of these factors, available on the Fed’s database. But does this explain the whole picture? If you are a demand-sider, like I am, then you believe that consumer spending influences economic activity more than producer supply, and by extension, that the economy would continue to grow at a constant rate if consumer spending remains the same over time. Wages have remained flat for a few decades even as credit availability has boomed, suggesting that consumers are spending the same amount or more per year, even as GDP growth has slowed. So to summarize, I do not believe productivity is the culprit here. To answer the workforce participation rate question, it is true that baby boomers have begun to retire in larger numbers, but millennials are the largest population group currently in the workforce, having largely replaced the boomers. I believe GDP should increase as the population increases, and a few factors are pushing the population growth rate down. Immigration crackdowns (including deportations of illegal immigrants, who do you think tends to American farms) are growing higher while the US birth rate is at its lowest point since 1913. With not as many new people entering the labor force, we can expect to see GDP slow down, and this has been the case.
Second, we may be seeing lower than normal GDP growth because we may simply be monitoring it the wrong way. I will use the example of employment here, and explain its relation to the greater economy. In prior decades, typical employment was simple; work was done in factories, with taxes withheld on your W-2, and a pension paid after years of work. Back then, the economy was primarily goods-producing. Today, the economy is primarily services-producing, with the good-producing jobs either outsourced or automated. In recent years, and especially with the advent of the internet, employment can be defined many different ways, from being a doctor or accountant, a construction worker, or even a direct marketer or video streamer on the internet. Thanks to advertising revenue and the rise of big data, many more avenues of ’employment’ are possible, each with their own avenues of risk and reward.
We may not be accurately gauging the impact of this on the traditional employment numbers. Would you say a YouTube streamer playing the newest Call of Duty video game for donations is one more worker in the labor force, or one less? Would your answer change if you found out that he makes $100,000 a year doing what he does? Would you call the entertainment he generates for his viewers a service, or just a waste of time? If you want to gain a bigger picture of what employment has turned into in the US, this is something to consider.
Third, and last, comes from a theory that has been around for over 200 years, but a theory that few economists have explored. Adam Smith (yes, the father of laissez-faire capitalism) wrote in The Wealth of Nations an interesting theory about how GDP tends to slow down as nations become more developed. The 1700’s version of this theory took the form of European nations colonizing America. As land was being explored, fresh soil and more abundant resources resulted in more supply for colonizing nations, and growth rates reflected the new territory. But as colonies became more developed, and less new land was gained, growth rates would slow.
I like to extrapolate this example to the various phases of the economy. Going back even to the Industrial Era, the economy has had big boom phases as new industry and secular changes affect the country. Various factors play into these ‘secular changes’, from invention and efficiency in the Industrial Era, to the tremendous labor supply increases in the 1940’s and 50’s as soldiers returned to work and baby boomers were born. The 1970’s had wild growth rates, no doubt affected by stagflation and the subsequent Fed actions, but you can see in the charts above that growth had begun to level out as early as the 1980’s. I believe the ‘secular change’ that brought the growth of the 1990’s was the rise of the internet, and the inception of tech giants Amazon, Apple, and others. But that initial tech boom was some time ago, and the internet is increasingly going from growth to maturity. As there is less ‘room to grow’ in a particular economic ‘era’, then Adam Smith’s theory shows, and GDP growth does tend to stall. For further support on this theory, check out Larry Summers and his work on ‘Secular Stagnation’.
In summary, these are just a few of the many theories as to why GDP growth in the US is consistently below historical norms. There are many factors that play into GDP, and unlike what politicians would want you to believe, it is not easily influenced by any one of those factors. Perhaps GDP is not actually lower than it should be, and it simply reflects where the economy currently is. But at the end of the day, it is important to consider all the factors for the best assessment, as this is how the best policy gets done.