All Commentary
Friday, June 23, 2017

Does Economic Growth Have a Numeric Limit?

Innovation matters more than pure numbers.

Several recent newspaper articles – eg, this one from the Wall Street Journal – have discussed limits to the ability of American real GDP to grow. President Trump asserts that his economic policies, if adopted, could increase American economic growth from its anemic 1-2 percent a year (which has been routine over the last 8 -10 years) to well over 3 percent per year.

Other, more optimistic, commentators, like Art Laffer, claim that Reagan-era growth rates over 4 percent are possible.  Pessimists such as Fed Chair Janet Yellen have expressed doubt that sustained growth rates over 2 percent are possible.

Productivity Times Labor

Most pessimists base their arguments on a simple equation:

Where Q is real GDP, and L is the size of the labor force.  The ratio Q/L is labor productivity – output per unit of labor input. Equation 1 is trivially true, and it implies that the growth rate of Q is (approximately) the sum of the growth rate of labor productivity and the growth rate of the labor force.

The pessimists note that labor productivity growth and labor force growth have both been unusually low for several (at least ten) years. It follows, they argue, that real GDP growth is, no matter which economic policies are adopted, severely limited. It is as if possible rates of economic growth depend on the bedroom and uncontrollable, mysterious historical forces behind labor productivity. The economy, it seems, is limited by trivial mathematics.

Equation 1 can be rewritten as:

Where Z is anything you want it to be. If Z is live oak trees, the equation would say that real GDP is output per oak tree times the number of oak trees. So, are there oak-tree limits to growth? Probably not.

If Z were the number of units of productive capital, which could be called K, equation 2 would suggest capital-based limits to growth. That seems at least as plausible as labor-based limits. Perhaps the reason economists abjure discussions of  Q/K is that K is extremely heterogeneous, and, therefore, it is impossible to define a unit of measure for K.

Frank Knight famously “solved” the problem of heterogeneity of K by inventing the mythical Crusonia plant (better than oak trees?), but this was a pretense too far for most economists.

Measuring the Labor Force

Too many economists are comfortable discussing Q/L because it appears superficially that total L can be measured, and those measurements can be plugged into equation 1 enabling economists, who ought to know better, to pretend to be scientific.

Private-sector entrepreneurship is the most important force behind economic growth.

But labor is no less heterogeneous than capital. The Bureau of Labor Statistics (BLS) can count human bodies, but the “total labor force” is meaningless among the enormous variety of private-sector economic decision makers.

Are 2 accountants plus 3 computer engineers a bigger or smaller quantity of L than 4 filing clerks and 1 economics professor? Is one union-free worker the same quantity of L as one union-impaired worker?

The idea that there is some economically significant thing called the “labor force” is an excuse to employ the ciphers at the BLS and its parent, the US Department of Labor. Thank God the Crusonia plant fantasy didn’t lead to a US Department of Capital. The US Department of Commerce is bad enough.

Coordinating the Different Parts

Private-sector entrepreneurship manifested as creative innovation, is the most important force behind economic growth (but don’t even think of rewriting equation 2 to include units of E). Regulation of economic activities by the Departments of This-and-That is the principal restraint on economic growth because it hampers entrepreneurship. Thus the Trump Administration’s new Office of Innovation will inevitably become another impediment to economic growth as are the administration’s anti-free-trade regulations.

Why does entrepreneurship matter? In brief: At any time there is an enormous variety of labor and an equally enormous variety of capital and other non-human resources. Over time, the varieties of labor, capital and other non-human resources are, because of creative innovation, constantly changing.

Economic growth depends on how well all the disparate parts are coordinated with each other to satisfy consumer wants, which also are constantly changing. We have to count on profit-motivated entrepreneurs to make it all fit together and keep it fitting together.

Profit-motivated entrepreneurship is impaired by government regulation, but it cannot be captured in trivial, or even complex, mathematics.

  • Charles Baird is a professor of economics emeritus at California State University at East Bay.

    He specializes in the law and economics of labor relations, a subject on which he has published several articles in refereed journals and numerous shorter pieces with FEE.