With a new political administration conjuring thoughts of the days of old and promising to restore their commensurate growth rates, it begs the question, given how different the world is now, is it fair to compare today’s growth with that of the past?
Low growth has plagued both the U.S. and other developed nations of late and as a result has been a major cause for concern among both investors and the general populace. In many ways these frustrations have manifested themselves in a call-to-action amongst politicians and economic leaders, with the idea that something must be done to restore the higher growth of old. In order to evaluate the validity of these concerns as well as if they can be assuaged, it is worth looking at the fundamental drivers of economic growth over recent history.
Growth can be broken down as the function of Total Labor Hours Worked x Labor Productivity. Of the two, only Total Labor Hours Worked is directly observable. Labor hours can be broken down further to population growth x hours/worker x workforce participation. When exploring how each contributed to growth over the past 50+ years, it would be wise to start with the elephant in the room – population growth.
As you can see, compared with the 1980s (a period in which Real GDP growth averaged 3.15% vs. today’s 1.6% and the last 10 years at 1.33%) population growth alone is nearly a 2% direct headwind to growth. In fact, excluding immigration, the U.S. work force population is likely to decline over the coming decade.
An increase in Labor Hours Worked could help to offset the declining population, but that is not what the trend is showing. As the graph below shows, the U.S. economy has transformed from a manufacturing economy to a predominantly service-based economy. The affect? Hours worked have stabilized at a significantly lower level.
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In addition to the booming population, prior periods also benefitted from a major secular shift: Women in the workforce.
Post Civil Rights America saw an astronomical rise in female labor force participation. Even with the small offset of lowered male participation rates, this is a benefit the US will not be able to expect going forward.
This leaves us with productivity. Labor productivity is the most controversial of all factors affecting growth as it is not directly observable and thus open to interpretation. As a result, productivity is far and away the most debated growth factor amongst economists and politicians alike. As the chart below shows, productivity is at >30 year lows, the reasoning of which is probably the most mysterious and hotly debated topic in modern economics.
Productivity improvements may yet hold the key to higher growth in the future and many economists do expect productivity to rebound. However, even a very bullish outlook on labor productivity would likely not bridge the growth gap caused by the aforementioned demographic headwinds.
As for policy changes? Policy can very much have an impact on growth, but evidence is skewed as to what the net impact of various policies might be. Many policy changes come with offsetting negatives which aren’t always directly evident. For example, expensive public healthcare is a direct cost to growth, but how does it impact labor production and hours worked to have healthier workers? In addition, many policy changes spur small, short-term changes, which subside over time.
Despite the aforementioned headwinds, it is certainly within the realm of possibilities (perhaps even likely) that GDP growth rates can and will significantly increase. However, the U.S. is a much different place demographically than it was in the past, and it would appear that when it comes to growth rates, as is often the case, results of the past are not necessarily a fair proxy for the future.
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