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Is There A "New Normal" for Growth?
By: Dr. Charles Lieberman
Date: 10/12/2009
This time, it is different is recognized as one of the most dangerous ideas in the investment business. So it is somewhat surprising that so many people believe that economic growth will be disappointingly weak, no more than 2% in real terms, for an extended period into the future, as poor credit market conditions, troubled housing markets, and assorted other problems are resolved gradually. So we're supposed to prepare ourselves for this weak growth that is the new normal. But does it make any sense? While it sounds plausible that some adverse conditions might hold back growth until underlying conditions improve, it is neither grounded in economic theory, nor does it make any sense that growth would be limited so severely. And with policy so expansion oriented, anything less than a solid expansion ought to be a disappointment.
Real economic growth has averaged about 3% over the past few decades, an average that encompasses expansions, when growth was quite strong, and recessions, when economic activity contracted. Economists have decomposed this growth into its two critical components, labor force growth (or job losses during recessions) and productivity gains. Our population has been growing about 1% annually, so just by putting 1% more citizens to work each year, output also grows at a 1% pace. In countries like Japan, where the workforce is stagnant or will start shrinking in the near future, there is no population growth to contribute to economic expansion.
More importantly, businesses also become more productive each year, producing more with fewer workers, which is what enables living standards to improve. The rate of productivity gains in the U.S. has been quite variable over the decades, ranging from as little as 1% annually during the late 1970s and 1980s to as much as 3% in some earlier periods. More recently, productivity has improved by 1% to 1.5% annually.
The new normal growth rate of 2% implies that economic growth will be so sluggish that hiring will fail to absorb ANY unemployed workers. To hit the 2% target of the new normal, average annual productivity gains must come in at no more than 1%, the absolute low end of its recent range, while labor force growth also averages just 1%. This combination is extremely unlikely, particularly since productivity tends to be quite high in the early stages of a recovery. Moreover, in such an environment with the unemployment rate stuck at around 10%, anything like the new normal would be totally unacceptable to policymakers, the public, and politicians. In response, it is an absolute certainty that both Fed and Treasury policy would continue with their highly expansionary oriented policies to promote faster growth. Thus, the new normal would neither be considered normal nor acceptable.
There is some truth to the underlying concept that restoration of healthier credit market conditions, restoring normal housing markets, reducing household debt, and other problems might retard growth. But, by how much and from what pace? Severe recessions tend to be followed by vigorous recoveries. Such episodes in the past have recorded growth rates of 6% to 8%. So it is entirely possible that the pace of recovery following this severe recession could be somewhat constrained this time, yet still manage to clock growth of 4% to 5%, hardly fitting the notion of a new normal. The ideas behind the new normal seem to belong in the same category as the never-before-seen W-shaped recovery, a nice concept or story, but one lacking precedent, theoretical foundation, and unlikely to be seen. Instead, expect policy to remain focused on promoting a solid recovery and remaining unsatisfied until that outcome is evident to all.
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