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GDP Growth Has Been Well Below Potential Growth

The 2007–2009 crash produced the worst recession since the Great Depression. However, the even bigger problem with the decade of the 2000s was that the U.S. economy performed well below its historical average and potential growth rate.

This concept of "potential growth rate" is particularly critical to both understanding and diagnosing America's economic woes. Any nation's potential growth rate (also called "potential output") measures the highest GDP growth rate a country can sustain over time without generating significant inflation. When the American GDP is growing at an annual rate consistent with its potential growth rate, our economy is creating as many jobs as it can in a sustainable fashion. However, if the American economy grows at a rate significantly below its potential growth rate for any sustained period of time, such as it did during the 2000s, millions of jobs that would otherwise be created are lost—and are very difficult to recover.

Exhibit 1.1 illustrates this problem of slow, below-potential growth by comparing the average annual, inflation-adjusted GDP growth rate during the 2000s to that of a historical benchmark based on the postwar period of 1946 to 1999.

Exhibit 1.1. The 2000s: A Decade of Underperformance

Average Annual GDP Growth Rate

1946–1999

3.2%

2000–2009

2.4%

During the benchmark period, the American economy grew at an average annual rate of 3.2%. What this benchmark number tells us with more than 50 years of data is that the potential growth rate of the American economy is achieved when the GDP grows a little over 3% a year.

What Exhibit 1.1 also tells us, however, is that during the nought decade of the 2000s, the American economy substantially underperformed that potential. It averaged a 2.4% GDP growth rate2—0.8% below the historical average.

You may think that a difference of only 0.8% in the GDP growth rate is a small number. However, this 0.8% gap makes an enormous difference in terms of the ability of the American economy to create new jobs and income growth.

The rough rule of thumb is that every 1 percentage point of GDP growth creates about a million jobs. This means that on a cumulative basis, a 0.8% underperformance in growth over the course of a decade translates to close to ten million jobs our economy failed to create. This is a stunning finding, because if we had created those jobs in the nought decade, the American economy would be much closer to full employment than it is today. If the American economy continues to perform well below its full potential growth rate, this will mean continued persistent high unemployment, downward pressure on wages and income, and a stagnant or perhaps even falling standard of living.

To understand why the American economy grew below its potential in the 2000s—and why it is likely to perform below its potential growth rate in this new decade unless something is done—we need to turn to our diagnosis of the ills afflicting each of the four GDP growth drivers.

To set up this diagnosis, look at Exhibit 1.2. It compares the percentage contributions of each of the four GDP growth drivers in our benchmark period of 1946 to 1999 to those contributions in the decade of the 2000s.

We first see that in the postwar period from 1946 to 1999, consumption expenditures accounted for an average of 64%, or just shy of two-thirds, of America's GDP growth rate. That's a share of the GDP that is consistent with most developed economies.

However, we also see that the share of consumption jumped significantly in the nought decade of the 2000s—specifically, to 70%. As we will discuss further, this is a signpost of America's overconsumption during that decade, which helped lead us first to a housing bubble and then to a housing bust.

The second statistical comparison that really leaps out from Exhibit 1.2 has to do with net exports. In our benchmark period from 1946 to 1999, American trade with the rest of the world had virtually no net negative impact on GDP growth—net exports were near 0%. However, during the 2000s, as our trade deficit more than doubled and grew to record proportions, the net negative impact of net exports on total annual GDP jumped to fully minus 5%. In doing so, this negative net export effect may have reduced our annual GDP growth rate by as much as half a percent—with the collateral loss in millions of jobs that might otherwise have been created.

Exhibit 1.2. Structural Imbalances in the U.S. Economy Emerge in the Nought Decade

1946–1999

2000–2009

Consumption

64%

70%

Business investment

16%

16%

Government spending

20%

19%

Net exports

0%

-5%

As a final statistical comparison, Exhibit 1.2 shows that government expenditures as a percentage of GDP were actually slightly lower than the historical average during the nought decade. This means that at least during the nought decade, a bloated government sector does not appear to have been a significant brake on growth.

In this new decade, however, the problem we have going forward is a huge one.

As we will illustrate and discuss further, government expenditures are projected to zoom to as high as 30% of GDP under the impetus of massive fiscal and monetary stimuli and rapidly ballooning entitlement programs. Note particularly how the future projected deficits dwarf the current ones—which are historically large. Prospectively, the GDP Growth Driver equation therefore faces a significant worsening of its government spending problem—and a new and massive structural imbalance in its economy.

With these observations as background, let's turn to a more detailed analysis of each of the individual drivers of the GDP growth rate, starting with consumption.

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