May 18, 2017 | By Phil Levy

How Fast Can the American Economy Grow?


US Secretary of the Treasury Steven Mnuchin discusses the Trump administration's tax reform proposal in the White House briefing room in Washington. REUTERS/Carlos Barria

At times in last year’s election, the discussion of US GDP growth began to sound like an auction. “I hear 3%, 3%, who will give me 4? Can I get a 4? 4! Can I get a 5…?” The idea, apparently, was that a higher bid would show voters that the candidate was more committed to unleashing the true potential of the American economy.

At a Chicago Council on Global Affairs' panel discussion yesterday, there was a striking amount of bipartisan agreement on how fast the economy could really go. Both Douglas Holtz-Eakin, former top economic adviser to Sen. John McCain’s presidential campaign, and Austan Goolsbee, former top economic adviser to President Barack Obama, settled on the same target: 2.5% growth would be excellent.


Source: Federal Reserve Economic Data

Holtz-Eakin explained that such growth rates are, mathematically, the product of two factors:

     1) How fast is the work force growing?

     2) How fast is output per worker (productivity) increasing?

The work force (number of workers) in the US economy is not growing as fast as it did when the economy would exhibit 4% growth. That could, in theory, be offset by higher productivity growth. But that’s hard to summon up. Not impossible, but difficult.

When Holtz-Eakin was asked why leading officials like Treasury Secretary Steve Mnuchin would push for a number like 4% growth, he pointed to one of the side-effects of bringing in business people to run the government. In the business world, one can resolve to buckle down and double growth. A business, he noted, can grow faster than its market. It does so by driving competitors out of business and taking their market share. That analogy does not carry over to running the American economy.

Note, there may be a temptation here to think of international competition. Couldn’t the American economy grow faster if it increased sales in China or Europe? But the potential growth calculation has to do with capacity, not market demand or sales. When a business expands, it can hire new workers and lease new buildings in a way a country can’t. A country can turn to more liberal immigration policies, but that does not seem to be the Trump administration’s inclination.

Goolsbee argued that there was a downside to the unrealistic claims we’re hearing about American growth potential. If you’re expecting 6% GDP growth, and someone offers a policy reform that will bump growth up by 0.3%, you’ll likely be unimpressed. If you’re expecting a more realistic 2% or 2.5%, you’ll welcome the gains. No holding out for the crazy high bid.

(For a more detailed treatment of the question, with colorful graphs, see this recent report from the Center for a Responsible Federal Budget)

About

Phil Levy is senior fellow on the global economy at The Chicago Council on Global Affairs. Previously he was associate professor of business administration at the University of Virginia’s Darden School of Business. He was formerly a resident scholar at the American Enterprise Institute and taught at Columbia University’s School of International and Public Affairs. From 2003 to 2006, he served first as senior economist for trade for President Bush’s Council of Economic Advisers and then as a member of Secretary of State Rice’s Policy Planning Staff, covering international economic matters. Before working in government, he was a faculty member of Yale University’s Department of Economics for nine years and spent one of those as academic director of Yale’s Center for the Study of Globalization.

His academic writings have appeared in such outlets as The American Economic ReviewEconomic Journal, and theJournal of International Economics. He is a regular contributor to Foreign Policy magazine’s online Shadow Government section and writes on topics including trade policy, economic relations with China, and the European economic crisis. Dr. Levy has testified before the House Committee on Foreign Affairs, the Joint Economic Committee, the House Committee on Ways and Mean, and the US-China Economic and Security Review Commission. He received his PhD in Economics from Stanford University in 1994 and his AB in Economics from the University of Michigan in Ann Arbor in 1988.

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