America is banking on economic growth. Its ability to pay debts, lower unemployment, and provide better living standards all depend on growth returning to its pre-recession levels and staying there. But what if it doesn’t?
Several economists are worried it won’t. Growth can come from three sources: more labor, more capital, or more innovation. The 20th century was remarkable because each of these factors grew. America’s final push to manufacturing, and away from agriculture, increased the use of capital. The volume and quality of labor also increased. More people than ever finished high school and went on to college, and many women joined the labor force. But we can’t repeat these events. Not only that, future demographic trends are not favorable. American education isn’t giving many young people the skills they need to be competitive in the global economy. An aging citizenry means a smaller share of the population will be working to support everyone else. Lower rates of economic growth will make it harder to repay America’s debt — both entitlements and outstanding treasury bonds. Servicing debt will take more resources from the economy, creating a vicious cycle of high rates and low growth.
But not all hope is lost; there’s still innovation. Innovations make existing resources more productive. Productivity is measured by calculating how much output (GDP) increased or decreased given the inputs (capital and labor) used. If you get more output for the same amount of inputs, productivity has increased. That means if western economies innovate more, and thereby constantly increase productivity, they will still grow. If productivity outpaces the economic headwinds, America can still grow at the pace it used to. But that’s easier said than done.
In his new book, Nobel Prize winner Edmund Phelps frets that the culture of dynamism that leads to innovation has dwindled. He recently hosted a conference on the future of innovation where Robert Gordon of Northwestern argued, using results from a paper he wrote last year, that the pace of innovation has slowed because all the big and important things (electricity, indoor plumbing, cars) have already been discovered. Tyler Cowen argued a similar idea, with his book The Great Stagnation. He also believes all the low-hanging fruit has been picked; there isn’t much left to innovate that will have a notable increase in living standards. That suggests we’ve not only run out of new labor and capital but ideas, too.
This view seems to be confirmed by recent productivity estimates. Productivity increased by 2.3 percent, on average, each year between 1891 and 1972, but only by 1.33 percent from 1972 to 1996 and 1.33 percent between 2004 and 2012. Gordon believes the heady days of full integer growth are behind us. Between 1871 and 2007 GDP per capita grew 2 percent a year, on average; this meant living standards doubled every 35 years. But between the slower pace of innovation, changing demographics, debt and the environment he anticipates the American economy will only grow at 0.2 percent a year in the future.