What Would We Need for Persistent 5% Growth?

Last week, I argued that Governor Tim Pawlenty’s aspiration for 5% economic growth over a full decade, is implausible since the United States has achieved such steady growth only once since World War II.

Over at Economics One, Stanford economics professor John Taylor offers a more positive take, defending the goal and offering a recipe for achieving it: 1% from population growth, 1% from employment growing faster than the population, and 2.7% from productivity growth.

Add it all up and you get 4.7% growth, a bit short of Pawlenty’s target but close enough for government work.

That sounds great, and I hope it happens, regardless of who is president. But let’s take a moment to kick the tires on Taylor’s assumptions.

Two seem fine:

• His population growth assumption is perfectly reasonable. Indeed, it matches the estimate used by the President’s Council of Economic Advisers in its most recent Economic Report of the President (Table 2-2).

• His productivity growth assumption is optimistic, but realistically so. Nonfarm productivity has grown at a 2.7% pace, on average, since 1996. Few analysts see that persisting. CEA forecasts assume 2.3%, for example. But the U.S. economy has demonstrated that 2.7% productivity growth is possible for a decade or more.

Three other assumptions are problematic.

• Taylor uses a very optimistic assumption about how much employment growth can exceed population growth. Today, about 58% of the working age population has a job. That woefully low level ought to rise as the Great Recession recedes. Taylor assumes that we can boost that ratio back to its 2000 level of almost 65%. But 2000 was the tail end of a technology boom that lifted America’s employment-to-population ratio to record heights. Since then, the working population has aged, so the employment-to-population ratio will be persistently lower even in good times. CEA thus forecasts that labor force changes will trim about 0.3% annually from potential growth in coming years. Getting the employment-to-population ratio back up to 65% thus won’t happen unless we have an even bigger boom than the late 1990s delivered.

• Taylor assumes that workers will keep working the same number of hours that they do today. That sounds innocuous except for one thing: average hours have been declining. CEA estimates that trimmed 0.3% per year from potential economic growth from 1958 to 2007 and will trim another 0.1% per year from 2010 through 2021.

• Taylor assumes that the rest of the economy will enjoy the same productivity growth as the nonfarm business sector. In reality, the other parts of the economy – most notably government – are lagging behind. CEA estimates that slower productivity growth outside the nonfarm business sector trimmed 0.2% from potential economic growth from 1958 to 2007 and sees an even bigger bite, 0.4% annually, in the coming decade.

Taylor’s scenario thus assumes that everything breaks right for the U.S. economy for a full decade, with remarkable job growth and remarkable productivity growth in the economy as a whole. Not impossible but, unfortunately, not likely either.