There’s a lot of things in life that aren’t what they used to be. That includes the economy, which has endured subpar growth in recent years. And many economists don’t expect the situation to get better any time soon.
That’s because they foresee little growth in the labor force, as massive numbers of baby boomers retire and a smaller number of young workers take their place, and sluggish productivity growth. Overall economic growth results from the combination of labor force expansion and productivity growth.
“The explanation is so simple and boring that economists have to make up something more exciting to say,” says James Stock, professor of political economy at Harvard University. “But this one fits the numbers without any backflips.” He cites the theory of secular stagnation, advanced most prominently by fellow Harvard economist Larry Summers, as a sexier explanation. Secular stagnation posits a sustained period of low demand and near-zero interest rates. By merely focusing on labor force and productivity numbers, “you don’t have to add low demand and zero interest rates into the story,” Stock says.
Gross domestic product (GDP) growth has averaged 3 percent a year since 1960, but only 2.1 percent since the global financial crisis ended in 2009. Economists like Stock expect growth of about 2 percent to prevail for the next decade.
The expansion will likely top 3 percent in some quarters, as the 3.7 percent growth rate of the second-quarter illustrates, he says. “But that’s not the expectation on average.”
David Stockton, a senior fellow at the Peterson Institute for International Economics, and Edward Leamer, an economics professor at the University of California, Los Angeles, agree. “It would be wonderful to return to 3 percent growth, but that’s unlikely in the next decade,” says Stockton, former head of U.S. economic research and forecasting at the Federal Reserve. “About 2 percent is more likely.” Leamer says the long-term trend rate is probably 2.5 percent.
As for the labor force, it increased 1.25 to 1.5 percent annually through the 1990s. But now it’s growing at just 0.5 percent a year, the slowest pace since the end of World War II. In fact, the labor force participation rate stood at 62.6 percent in July, tied with June for the lowest month since 1977.
And that trend is likely to persist, as baby boomers continue to exit the workforce, economists say. “I think it’s undeniable that the growth of the working-age population will shrink to almost zero in the next decade,” Leamer says. He believes that will take 1 percentage point off the historical 3 percent growth rate.
Part of the problem is inadequate training of workers, he says. “We don’t have a workforce suited to the 21st century. This has been a problem since 1990.” The Internet bubble of the 1990s and the housing bubble of the 2000s masked the problem, Leamer says. “But this time, there’s no bubble to save us.”
That brings us to productivity, which has averaged growth of about 1 percent per year during the recovery. That’s a far cry from the 2.6 percent growth of 1995–’06.
Productivity has been in a cyclical slump on the back of weak business investment, Stockton says. “You’d expect some pickup, but certainly not the 2.5 percent rate you’d need to get 3 percent GDP growth,” he says, assuming the labor force continues to expand by a 0.5 percent rate. Productivity growth did average 2.5 percent from 1950 to 1973, but that was thanks to the investment surge following World War II, Stockton notes. This time around, productivity growth of 1.5 percent is more likely, he says.
To be sure, Leamer is more optimistic on productivity. “I think there’s a lot that’s not being measured,” he says. “In an age of incredible technological advances, something like Uber doesn’t show up in GDP.”
Still, even the 2.5 percent growth he forecasts won’t be enough to finance workers’ retirement needs, Leamer says. “That requires at least 3 percent. Taking care of the elderly is hugely expensive.”
Stockton cautions against overconfidence in forecasting subpar economic growth, however. “Neither demographics nor productivity are immutable forces of nature,” he says. Looser immigration might spark growth in the labor force. Other changes such as tax reform and increased infrastructure spending might inspire more investment, boosting productivity. “But we don’t have a magic bullet,” he notes.
In any event, don’t hold your breath waiting for 3 percent growth to return.
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