December 21, 2017
An NYT article on the Republican tax cut told readers:
“When President Trump adds his distinctive signature to the tax bill, he will also be making a huge bet that the Republican strategy of deep cuts for businesses and wealthy individuals will fuel extraordinary growth across the board.
“Perhaps more than any other American political leader, Mr. Trump knows that long shots, like his own presidential bid, sometimes pay off. In that vein, he and congressional Republicans are arguing that their bitterly contested and expensive rewrite of the tax code will ultimately create more jobs and raise wages.
“If they are proved correct, they will be repudiating not only historical experience, but most experts. From Congress’s own prognosticators to Wall Street’s virtuosos, scarcely any independent analyses project anything like the rosy forecasts offered by the president’s top economic advisers.”
While this is a correct assessment of the views of economists, there is another possibility left out of this discussion, the economy may already be on a faster growth path for reasons having nothing to do with the tax cut.
The key issue going forward in determining economic growth is the rate of productivity growth. Labor force growth over the next decade will be weak primarily because of the retirement of the baby boomers. (Hostility to immigrants will also slow labor force growth.) While there is little uncertainty on this issue (we can still pull some more prime-age workers back into the labor force), there is a huge amount of uncertainty about the future course of productivity growth, the other factor determining GDP growth.
Productivity had been growing at almost a 3.0 percent annual rate from 1995 to 2005. For reasons that are not well understood and certainly not foreseen, the rate of productivity growth slowed to just over 1.0 percent annually in the years since 2005. (It has been just 0.7 percent in the last five years.) Most growth projections assume that this slow rate of productivity growth will persist into the indefinite future.
However, there was a sharp uptick in productivity in the third quarter. It grew at more than a 3.0 percent annual rate. While the quarterly numbers are notoriously erratic, this jump followed a 1.5 percent growth rate in the second quarter. The economy is on track for productivity growth to again be above 2.0 percent in the fourth quarter.
This raises the possibility that we are back on a faster productivity growth path for reasons having nothing to do with the tax cut. This is actually a very plausible story since companies have more reason to try to use labor more efficiently when it becomes scarce and therefore more expensive.
If it turns out that productivity is back on a faster growth path, then GDP will also be on a faster growth path. This means that the Republicans may hit their deficit targets, but for reasons having nothing to do with their tax cut. This possibility should have been mentioned.
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