Opinion + Voices

UCLA faculty voice: Four percent economic growth? Yes, we can achieve that

With business-friendly policies the U.S. economy can exceed the dismal projections of the most recent Congressional Budget Office forecast

Economics graph

Andrew Atkeson is the Stanley Zimmerman Professor of Economics at UCLA. Lee Ohanian is professor of economics. William E. Simon Jr. is a visiting professor in the UCLA School of Law and co-chairman of William E. Simon and Sons. This op-ed appeared earlier this month in Investor’s Business Daily.

It is no secret that the recovery from the recession that ended in June of 2009 has been virtually non-existent. More striking, however, is the impact that this recession and its aftermath have had on the conventional wisdom in Washington regarding America’s long-term economic future.

This is clearly seen in current forecasts of America’s future economic potential from the Congressional Budget Office (CBO) which predict that a large portion of America’s economic potential has been permanently lost.

We believe that this remarkably pessimistic forecast is wrong. An economic policy agenda aimed at restoring the American economy back to the growth path that we were on before the recession can lead to much higher economic growth than is expected in Washington.

Consider first how pessimistic the view in Washington of America’s economic potential is now, compared to long-term forecasts made as recently as 2007.

Every year, the CBO produces a 10-year and a longer-term forecast of the future path of America’s potential output. This is the size of our future real GDP that we should expect, absent the temporary and unpredictable factors that influence the economy, such as the business cycle.

The CBO’s June 2015 estimate of America’s potential real GDP for this year is nearly 9 percent lower than the CBO forecast 2015 made in 2007. Our actual economic performance now is even worse — over 12 percent below the 2007 estimate of where we should be after a full recovery from this recession.

This gap exceeds $1.2 trillion, or over $6,600 for every American. And the CBO forecasts that this gap between America’s current real GDP and its potential as of 2007 will never be closed.

Economic growth is the result of higher employment and higher worker productivity, and the CBO expects both to be much lower in future years than they did in their earlier forecast.

Relative to their 2007 report, the CBO now expects the labor force to be about 3 percent lower on a permanent basis, which currently represents a deficit of about 4 million workers.

The CBO also expects that those who do work in the future will be about 6 percent less productive than they expected in their earlier report.

This revision to estimates of the potential labor force should not be interpreted simply as the consequence of an aging population. The age structure of the population can be accurately predicted far into the future, and the CBO already accounts for it in their forecasts.

Moreover, the labor force participation of those aged 16–34 has dropped four percentage points from 2007 to 2014, which is a larger drop than occurred for the population as a whole.

We should not accept such a dismal forecast as the new normal. The failure of our economy to achieve any economic recovery to the pre-recession trend is unprecedented in our history.

Our long-run historical trend, in which real GDP has grown about 3.5 percent per year on average, has accurately characterized trend growth of the U.S. economy as far back as economic historians Simon Kuznets and John Kendrick were able to construct detailed estimates of national economic activity that date back before 1900.

Following every historical economic shock, including the tremendous dislocations of the Great Depression and World War II, every postwar recession, various oil shocks and international crises, and the vast demographic changes associated with women entering the labor force in greater numbers, the U.S. economy has always returned to this trend path of output.

This means that the economy always grew more rapidly than average following periods of below normal economic growth, and that economic disruptions — no matter how severe — did not permanently affect U.S. prosperity.

For comparison, previous severe recessions, such as the 1974–75 and 1981–82 recessions, were followed by three years of real GDP growth that averaged around 5 percent per year, and that grew the economy back to trend.

But today’s economy is much further below pre-recession estimates of trend than either the 1974–75 economy or the 1981–82 economy. This means far more room for the economy to rebound today than after previous recessions.

If our economy were to achieve 4 percent growth per year, it would return to the 2007 CBO trend line by late 2023 or early 2024.

This calculation highlights just how far our economy is below its potential — and that growing at 4 percent per year for a sustained period of time is a reasonable expectation.

Expecting more from our economy, however, means expecting more from our policymakers, and policies will need to change considerably to job opportunities and raise productivity.

Safety-net policies should not discourage work through high implicit tax rates resulting from means-tested programs. Regulatory policies should not erect barriers to competition and raise costs. Education policies should expand competition and reward the most successful teachers. Immigration policies should expand the number of skilled workers and immigrant entrepreneurs. And tax policies should simplify the tax code, reduce business and personal marginal income tax rates and broaden the tax base.

Getting people back to work and boosting productivity should lie at the heart of the next president’s economic agenda.

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