NOTE: The Growth Economics Blog has moved sites. Click here to find this post at the new site.
Robert Gordon released a paper recently where he presents his estimates of potential GDP for the U.S. going forward. I had planned on writing a longer post discussing about why you should take his projections seriously, and maybe some speculation about what would have to happen to reverse his conclusions. Seriously, I had a few paragraphs written, a couple figures cut out and ready to go, and then Jim Hamilton put up precisely the post I wanted to write. So the first thing you should do is go read Jim’s post.
…and if you are still here, let me provide an uber-quick summary of my own before I talk about how you could convince yourself that Gordon is overly-pessimistic (he’s probably not, but if you want to rock yourself to sleep at night, this might help).
So, what does Gordon find? Basically, GDP growth is equal to growth in GDP per hour worked (productivity) times growth in hours worked. Hours worked are unlikely to grow much, given that unemployment has already fallen back to 6%, that average hours per worker have recovered much of their decline, and that the labor force participation rate is unlikely to recover much of its recent decline. So the only way for GDP to grow fast enough to hit our prior level of potential GDP (which is essentially what the CBO projects it will do) is for productivity (GDP per hour) to grow much faster than it has at any time in the last decade.
You can see his implications in the above figure. The red line is Gordon’s projection for potential GDP based on his assumed lower productivity growth rate, which is closer to recent averages. The CBO potential GDP path is driven by what Gordon says are aggressive assumptions about how fast productivity will grow.
In short, we aren’t going to recover back to the pre-Great Recession trend line for potential GDP any time soon. One might quibble a little about Gordon’s assumptions, and perhaps we won’t diverge from the prior trend line (the yellow one) as much as he suggests. But it’s really hard to come up with reasonable evidence that the CBO is making the right assumption regarding productivity growth.
Now, if I want to go to bed at night believing that we might be able to get back on that prior trend line, what should I tell myself? I’m not going to tell myself that we’ll be magically saved by some kind of technology boom. It could happen, I guess, but that’s not something I could rely on, or having any way of reliably predicting.
What I might tell myself is that productivity – because of the way it is backed out of the data – is not simply a measure of technical productivity, it’s a measure of revenue productivity. I talked about this in a prior post, but the difference is that revenue productivity measures firms ability to generate dollars, not their ability to generate widgets. Revenue productivity can thus experience a temporary burst of growth if firms are able to exert some market power, in the same way that revenue productivity can experience a temporary sag if firms lose pricing power during a recession. So if some of the distinct drop in measured productivity growth over the 2008-2014 period was because firms lost pricing power (and not because of a slowdown in innovation/technology growth), then this could be recovered if firms are able to reassert that pricing power.
A few points on this. Why would firms gain (or why did they lose) pricing power? My guess is that it depends on the willingness of consumers to “shop around”, which in turn is based on economic conditions. When things get bad in 2008, people become more sensitive to price changes, and so firms lose pricing power, and hence revenue productivity falls. If consumers were to recover in the sense of becoming less sensitive to price changes, then firms could gain pricing power and that would raise measured productivity. Will that happen? My guess is yes, it will, I just don’t know when. Will that boost to revenue productivity be sufficient to put potential GDP back on the pre-Great Recession path? I don’t know.
The last thing to point out is that revenue productivity is exactly what we want to measure in Gordon’s case, where he ultimately is worried about Debt/GDP ratios. Because the debt is denominated in dollars, what I care about is the economy’s ability to generate dollars, not widgets. There’s an entirely different post to be written about why the Debt/GDP ratio is a stupid way to measure the debt burden, but I’ll leave that alone for now.
In short, if you want to be optimistic about bouncing back to the pre-Great Recession trend for potential GDP, then part of that optimism is that firms regain lost pricing power, and thus experience a boost to their revenue productivity. This can occur in the absence of any change in the underlying pace of real technological change, and isn’t tied to our expectations about the usefulness or arrival of new technologies.
Interesting, but possible iff demand returns to support pricing power.
Right on. That’s basically the point. There is kind of a positive feedback loop that is possible (if not probable). Better economic conditions make people feel better off. This leads them to both spend more, and to be less sensitive to price changes. Being less sensitive to price changes, firms get some market power, and this raises revenue productivity. Higher revenue productivity leads to improved economic conditions, etc. etc..
So the optimistic case is one of hoping that you can jump-start that positive feedback loop.
Isn’t part of Gordon’s problem is that he is trying to explain outputs without attention to inputs? Filling the output gap with fiscal spending would gap up all his numbers. Second, if we quit liquidating capital assets, both private and public but especially public and perhaps even more especially intangibles such as education, we could relieve the downward pressure on productivity. Boosting investment well above trend should have similar effect.
It just does not seem to be such a hard problem from a business perspective.
Actually, I think Gordon is doing the opposite. He is precisely explaining that output cannot possibly reach the CBO’s projection because there is no way inputs (number of workers, basically) can grow sufficiently. This is because (1) the unemployment rate is now almost back to trend and (2) there is a long-term decline in labor force participation due to Baby Boomers retiring.
From Gordon’s perspective, even if there was some kind of big fiscal spending push, this would have a hard time raising GDP all the way back to pre-recession trends because of those labor force trends.
On the other hand, one could certainly argue that part of the decline in productivity may reflect the impact of declining investment in either tangible (equip. and machinery) or intangible (human capital) capital.
Two questions: one minor clarification, one substantive:
1) Are the following clarifications concerning the figure correct?
(Especially the first one, in comparisson to the second paragraph after the figure.)
-The *blue* (not “red”) line is “Gordon’s [alternative] projection for Potential GDP based on his assumed lower productivity growth rate”
-The red line is Gordon’s projection for Actual GDP (constrained by the blue potential GDP line, which is hidden behind the red line after about 2016)
-The Green line is CBO’s projection for Potential GDP
-The Yellow line is CBO’s projection for Actual GDP (constrained by their Green Potential GDP projection, and hiding it after about 2020)
2) The claim that the labor force participation rate is “unlikely to recover much of its recent decline” is not immediately clear to me. Could you comment on this?
1) Yes, I wasn’t clear on this. Blue is Gordon’s projected potential line. Red is actual GDP, and around 2015 it and the blue line are identical. Green is CBO potential GDP, yellow is CBO projected actual GDP. Sorry for the confusion.
2) The labor force participation rate has something of a built-in decline because of Baby Boomers. As they retire, the participation rate will fall. Some argue that the recession just accelerated this process. There’s a paper from the Chicago Fed that is a nice explanation of this. Basically, Gordon uses this to argue that it’s unlikely we can get back to the CBO potential GDP because the participation rate just isn’t going to come back to pre-recession levels.
Thanks… a follow up question (without yet having yet read Gordon’s paper, or tthe Chicago Fed paper that you link to):
Any chance Baby Boomers won’t retire ‘as much’ (e.g. as young, or by shifting to part-time work instead) if they are more healthy than the previous generations of ‘seniors’ and their retirement savings have been wiped out during the crisis? (And/or their public pensions get reduced?)
Economists will slowly come around to understanding the new lower trend line of real GDP. I have been writing about this for well over a year.
I saw the new low trend line back in early 2013.
And as for productivity, it is blocked against the effective demand limit. It will not increase until space opens up for effective demand, which could signal an economic contraction.
So this story about low potential GDP growth is old news, but it will be new news for those who can’t see it yet.
I guess this brings us back to square one. According to Mokyr, we are observing unprecedented technological change leading to welfare increases. You mentioned in an earlier post that one way to capture this is to look at TFP growth (ideally TFPQ growth). Gordon is pessimistic about future growth and more recently John Fernald also has a piece in the NBER Macro Annual, on how TFP growth slowed down well before the recession (late 2003). So we really dont know where we are headed. I think we are just doing a really bad job of measuring TFPQ growth.
Pingback: Productivity Pessimism from Productivity Optimists | The Growth Economics Blog
Pingback: The Slowdown in Reallocation in the U.S. | The Growth Economics Blog