RealMoney

A simple way to explain how fast an economy can grow without sparking higher inflation is to deconstruct it based on the growth of the labor force plus productivity gains. Currently, the U.S. labor force is growing at about 1% annually, and productivity, which fluctuates from quarter to quarter, has often been seen around 1.5% to 2%. This yields annual, economy-wide trend growth of 2.5% to 3%. Let's take a midpoint of 2.8% and then express it on a per-capita basis, or 1.8% (given population growth of 1%).

What can change this equation is the amount of productivity gains and the difference between labor-force growth and population growth, focusing on GDP per capita. Lower productivity gains, or faster population growth vs. the labor force, argue for lower GDP per capita growth. In essence, that is how much living standards might be expected to improve.

Robert J. Gordon, an economist at Northwestern University, has an interesting take on how six headwinds can adversely affect living standards. In a paper published by the National Bureau of Economic Research (the same group that dates the beginning and end of U.S. recessions), Gordon suggests that per capita GDP in the U.S. for coming decades could be as low as 0.2%. He asserts that economic growth has been this low as far back as the year 1300, using data for the U.K., and it wasn't until three major industrial or technological revolutions that we saw stronger growth. (He used U.K. data through 1906 and the U.S. thereafter.) These revolutions are railroads and steam engines from 1750 to 1830; internal combustion engines, electricity, petroleum, and communications from 1870 to 1900; and computers, the Web and mobile phones from 1960 to the present.

Gordon views the second group of technological advances as the most important to increasing productivity, including the eventual contributions of air travel, interstate highways and air conditioning. These coincided with demographic trends, such as increased urbanization and the role of women in the workplace, to create increased growth and prosperity.

He believes we are in a phase where these trends will no longer have an incremental benefit to the economy, as their benefits are already included in GDP, hence no additional growth from these factors. In other words, new technologies have already been widely adopted. Instead, we now have six headwinds:

1. Demographics of retiring baby boomers and an end to growth of the number of women in the workforce. This leads to a decline in the hours worked per capita, thus leading to lower incomes taken together.
2. A plateau in educational attainment, as college enrollment is challenged by high costs, while the U.S. lags other nations in math, science and reading (as measured by the Organization for Economic Cooperation and Development).
3. Rising income inequality. Gordon says that the average growth in real household incomes was 1.3% annually between 1993 and 2008, but only 0.75% for the bottom 99%, while the top 1% saw income grow than the average. The top 1% captured 52% of income gains, according to Gordon's calculations.
4. Globalization and information and communication technology (ICT) promote outsourcing of American jobs, and the elimination of some occupations.
5. Energy and environmental legislation, even if necessary for ecological reasons, reduce economic output.
6. High household and government debt divert funds that would have been devoted to consumption to debt reduction.

Together, he reckons that all of these headwinds could reduce U.S. GDP growth per capita to just 0.2% from 1.8% between now and 2100, though he emphasizes the direction, not the particular number. He acknowledges that some as-yet-unknown technological breakthrough could increase growth per capita, but not all of this might accrue to the U.S. because developing economies favor greater growth overseas as they catch up to ours and our wages adjust to factor in that competition.

While future outcomes are always unknown, that should not stop us from considering multiple viewpoints of the possibilities. While none of these headwinds seem unrealistic to me conceptually, Gordon admits his numbers are difficult to quantify exactly. Perhaps his pessimism is unfounded, perhaps not. Only time will tell.