Page 1. Long-term Economic Growth

Page 1 Long-term Economic Growth

Long Term Economic Growth World Per- Capita Income in $1990 Rising standards of living for humans really begins with the industrial revolution! Page 2

US Long Term Economic Growth Real Per-Capita Income (Th $2018) Black line is Real GDP /Population Page 3 If history repeats in the long run Year Factor Real GDP per Capita $000 2017 1 $66,624 2050 2 $133,249 2083 4 $266,498 2116 8 $532,996

Long Term Economic Growth and Distribution If all boats rise with the tide the table below has significant implications for raising the standard of living for households and families If over the next generation the distributional issues continue, the political and social implications will be aggravated Year Factor Real GDP per Capita $000 2017 1 $66,624 2050 2 $133,249 2083 4 $266,498 2116 8 $532,996 Page 4

Key Concept Income Doubling Small Differences in Economic Growth make Big Differences to Improvements in the Standard of Living over time Illustration using Doubling of Real GDP per Capita Growth Rate Years to Double Per 1.0% 69 1.5% 46 2.0% 35 2.5% 28 3.0% 23 5.0% 14 7.0% 10 Page 5

Growth Rates and Doubling Times Number of Years to Double GDP per Person Page 6 Growth Rate Years to Double Per 1.0% 69 1.5% 46 2.0% 35 2.5% 28 3.0% 23 5.0% 14 7.0% 10 This is why EVERY developed and less developed country wants to increase its LONG RUN growth rate: Small increases in growth rates lead to perceived and actual increases in the rate the standard of living improves

Application of Long Term Economic Growth to Policy Key economic policies are tied to projections of the economic potential of the nation (i.e., Potential GDP ) Social Security Health Spending: Medicare, Medicaid, and the Affordable Care Act Federal taxation policies Federal spending policies Projections of future deficits and debt Whether or not economists can accurately forecast Potential GDP, it is required by the inherent nature of longer term consequences of many policy issues. And it is Method for Assessing Trump Economics Page 7

Latest Projections of Potential GDP : 2018-2028 Labor = 0.5%/Yr Labor Productivity = 1.4%/Yr Potential GDP grows 1.9% per Yr Trillions of $2012 Page 8

Since Economic Growth is So Important What explains long term economic growth? Page 9

Since Economic Growth is So Important A little bit of math Suppose we break GDP into workers hours (L) and how much each worker produces on average (GDP/L). GDP/L is also called output per hour or labor productivity The U.S. Dept. of Labor has an entire department that tracks and studies labor productivity GDP = L * GDP/L Page 10

Since Economic Growth is So Important A little bit of math GDP = L * GDP/L %DGDP %DL + %D(GDP/L) Growth of Labor Force Growth of Labor Productivity In Words: Economic Growth over time is explained by the growth rate of employment + the growth rate of labor productivity Page 11

Growth of Labor over Time Three factors explain the growth of labor input Working Age Population Growth The share of working age population that CHOOSES to be in the labor force AND has a job or is looking for one This is called the Labor Force Participation Rate To avoid effects of recessions, when analyzing long-term growth trends economists analyze periods of relatively full employment Worker education/skills. Also known as Human Capital Usually measured in terms of education and employment experience Page 12

Labor Force Participation Rates Selected Cohorts LFPRs (%) Page 13 LFPR = Labor Force(i)/Population(i) i = cohort by age, gender and ethnic group

Growth of Labor Productivity over Time Two factors explain the growth of labor productivity Growth in the capital/labor ratio (a.k.a., capital deepening or more capital and tools per worker) Technological change %D Q/L = w %D K/L + rate of technological change Where w.36 These vary over time, but there are some very important conclusions from the research Page 14

Sources of U.S. Labor Productivity Growth Avg. Annual Growth Rate (%) Page 15 Source: CBO = Congressional Budget Office

Sources of U.S. Labor Productivity Growth 1950-2017 Almost 2/3 of improvements in our standard of living is from technological change. A bit more than 1/3 is from having more capital per worker. Page 16

Math of Capital Stock Growth vs. Investment The growth rate of capital per worker contributes to the growth of labor productivity weighted by w its share of output However The value of the capital stock is the accumulation of past purchases of capital less the accumulation of past retirements and depreciation So, based on estimates, the value of capital stock is about 10 times the value of investment And the rate of deterioration and retirement is about 5% of existing capital The growth rate of capital =%D K = a - d Where a = Investment/Capital ratio ~ 10% d = The rate of depreciation ~ 5% Page 17

Implication to Labor Productivity The growth rate of capital =%D K = a - d Where a = Investment/Capital ratio ~ 10% d = The rate of depreciation ~ 5% Impact on growth rate of capital: Suppose a tax bill that increases investment by 10% over what it would otherwise be would increase the growth rate of capital from 5% to 6% or by 1% Now multiply by 1% by.36 to get impact on growth rate of labor productivity It takes a material increase in the investment to have a meaningful impact on the growth rate of labor productivity Page 18

Virtually all of the research over 50 years points to technological change as the key source of improving the standard of living and having a skilled workforce to produce goods and services Increasing investment per worker is helpful, but its contribution is relatively small compared with technological change. Want to Increase the Standard of Living? It takes a large increase in investment as a share of GDP to have a meaningful effect on the growth rate of labor productivity So, it s all about generating more innovation If countries knew how to create Steve Jobs, they would. Social returns to higher education continue to be significant. Page 19

Major Policy Concerns Education Challenges Keeping the least affluent IN SCHOOL Providing equal educational opportunities to all income classes Keeping cost of secondary education low Public financing constraints: Recessions reduce budgets at state and local level that finance K-12, Community Colleges, and Public Universities General Economic Rule: The more the US privatizes the cost of education the lower the growth in human capital and the potential growth rate of the entire economy, played out over decades. Page 20

Cross Country Comparisons Movie Page 21

The Supply Side When the economy is at or near full employment, how the capacity of the economy grows starts to become more important in terms of evaluating the potential impact of a tax cut The potential growth of an economy s capacity at full employment depends on three factors Growth of labor hours Growth of capital services Technological change %D Real Potential GDP = w % D L + (1-w)% D K + Tech D Page 22 w = weight in total production 64% or about.64 of inputs are labor inputs

Potential GDP Estimates Labor Force (Millions of Workers) Output per Worker in $Th Page 23

Potential GDP Estimates Labor Force Output per Worker Page 24

CBO Says Current Potential Growth # Annual Growth Rates Period 2008-2017 2018-2022 2023-2028 (a) Growth Rate of Labor 0.5 0.6 0.4 (b) Growth Rate of Productivity 0.9 1.4 1.4 (c) Growth Rate of Potential GDP 1.5 2.0 1.8 Page 25

Page 26 Income Distribution

Income Distribution Income distribution has become a hot topic In the past, it was not usually the issue incorporated in macroeconomic discussions I m covering it briefly because I d be remiss in not discussing There are some first principles to recognize There are now some longer term trends internationally that has many policy makers concerned. Page 27

Income Distribution Preliminary Comments Do Economists Know What an Optimal Income Distribution Is? No We know what is fairer but we don t know what s fair. So, all of the analyses are about how over time the economy has become less fair. Can Economists Claim that When Income is Distributed More Equally, Economies will Grow Faster? No There are many factors influencing why economy A grows faster than economy B in different periods of time Data on distribution of income is one factor and simply doesn t explain much of the growth differentials either over time or across countries. Page 28

Income Distribution Preliminary Comments Some propositions that underlie all of the discussions Given the general level of prosperity in the US and other developed nations, social welfare is improved by providing some kind of social safety net All developed countries have social safety nets The size and amount of resources devoted to providing a safety net are highly controversial Any social safety net involves taxing A to pay B There are legitimate concerns about incentive effects Biggest transfers in the economy: cross-generational, a.k.a., entitlement programs: Social Security and Medicare Equality of opportunity, independent of inherited wealth and income is a generally shared social goal Page 29

Income Distribution Preliminary Comments There are significant differences in measurement and implications of income vs. wealth distributions We have far more and far better measures of income distribution Those measures that we do have of wealth distribution indicate wealth distributions are far more unequal than income. Capital income raises far more measurement issues than wage and salary income Page 30

Two Major Caveats None of the data that have recently used to talk about the top 1% take into account transfers. They are all pretax Recent research is using tax data to analyze the top 1% The Piketty study does not account for transfers Mobility between groups is not captured in the data shown and is much harder to analyze Some preliminary research indicates upward mobility is limited and has not improved over time and varies significantly by region. Page 31

A Little Math When distributions of income become less fair over time, while the economy is growing The relative growth rates of income of those who are getting vs. those who are giving can be even larger Example with 2 groups: Item Group A Group B Income Share Period 1 20% 80% Growth in Agg. Income 20% Income Share Period 2 16.7% 83.3% Growth of Income for Group 0% 25% Relatively small changes in shares of total income lead to significant differences in the relative growth rates of income Page 32

A Method for Describing Income Distribution The Gini Coefficient and How it is Calculated Page 33

The Gini Coefficient Some of the data is going to make use of the single measure of income distribution called the Gini Coefficient (after Italian statistician and socialist Corrado Gini). If all families have exactly the same income and we compare the share of families to the share of total income, we get a 45 degree line % of Total Income Page 34

The Gini Coefficient (cont.) If family incomes are not equally distributed we get a curved line. % of Total Income Page 35

The Gini Coefficient (cont.) % of Total Income Gini = A/(A+B) = 2*A 0 Gini 1 Larger Gini More Inequality Page 36

Distribution of Income of Families % of Total Income Gini (1973) =.356 Gini (2017) =.449 Page 37

Measures of Inequality Income Gini Coefficient Households are defined when unrelated people live together. Page 38

Do All Boats Rise with the Tide? Th of $2018 The standard of living has only been increasing for the upper half of the population for 20 years Page 39

Measures of Inequality Mean Income by Group Top 5 % Thousands of $2018 Top 20% 60%-80% 40%-60% 20%-40% Lowest 20% The standard of living has been increasing for the top 5% and not much more since 1997 Page 40

Measures of Inequality Mean Income by Group Income Group Share of Family Income Share of Increase 1967 1982 2017 1967-82 1982-2017 Lowest Quintile 5% 5% 4% 4% 3% Second Quintile 12% 11% 9% 9% 7% Third Quintile 18% 17% 15% 17% 13% Fourth Quintile 24% 24% 23% 26% 22% 80-95th 25% 27% 28% 31% 29% Top 5% 16% 15% 21% 13% 26% Bottom 80% 59% 58% 51% 56% 45% Top 20% 41% 42% 49% 44% 55% Page 41 The top fifth and top 5% are capturing a much larger proportion of the increase in income than their share implies

Measures of Inequality - Wages Page 42 Econ Report of the President

Real Wages vs. Productivity Index 47Q1 = 1 BLS measures indicate a break occurring in early 1970s with prior trends aligning growth in real labor compensation and productivity Page 43

Real Wages vs. Productivity Gini for Families Page 44 This is what structural breaks in patterns of income distribution look like

Measures of Inequality - International Page 45 Econ Report of the President

Income vs. Wealth Distributions 2016 Estimates Share of Total Income or Wealth (%) Gini(inc) =.48 Gini(NW) =.86 40% of HH of no or little equity Caveats apply: data on wealth are not as reliable as data on income. Page 46 The real distribution of wealth may be even less equal than shown.

Long Term View of Net Worth Trillions of 2018$ Estimates of HH & Non Profit Institutions Net Worth Page 47

Long Term View of Net Worth : View II Trillions of 2018$ Same Data: Estimates of HH & Non Profit Institutions Net Worth Page 48

Great Recession s Impact $20 Trillion Decline in HH Net Worth Trillions of 2018$ 59% Decline in HH Real Estate Equity Page 49 Real Estate Equity is only recently getting close to prior high values

Longer Term Impacts Trillions of 2018$ Net worth in total did not return for all households for 8 years. But for those households with wealth concentrated in real estate equity, net worth is only returning now, 12 years after the peak, 10 years after the crash Page 50

Causes Ongoing Research to Understand Why Has Pretax Distributions of Income become Less Equal in the last 40 Years. Hypotheses: Weakening of unions? Illegal immigration? International trade? Returns to job skills? Research has not found a smoking gun from these sources It is the one hypothesis that has generated results Wages and returns to education have been bifurcating on an international scale Page 51

Causes (cont.) % Change in Hourly Earnings 1965-2010 Pct. Change in Real Hourly Earnings 1965-2010 Males Females Page 52

Mitigating Public Policies Social Safety Net Social Security Medicare/Medicaid/Affordable Care Act Food Stamps & other welfare programs Earned Income Tax Credit Progressive Income Tax Schedules (potentially) Estate Tax Property Taxes Proposition 13 has created long list of winners and losers Public Education (K-12) and Community Colleges Federal Grants for College Page 53

Page 54 Taxes and Distribution of Income

Cross Country Comparisons Tax & Public Expenditures as Mitigating Factors Page 55

International Data on Mitigating Public Policies Pre vs. Post Tax Gini Indices US UK SP JAP IT CAN FR SWE DEN POST TAX PRETAX Page 56 Lower Gini means more equal

US Taxes and Distributional Effects This is a picture of progressivity in the tax schedule This isn t Page 57

Page 58 US Taxes

US Taxes This is a picture of a regressive tax structure Page 59

Data on Mitigating Public Policies Pre vs. Post Tax Gini Indices Among Advanced Economies Gini Index of HH Income Spread between lines indicates the impact of taxes on income equality hasn t changed but mitigates some of the distributional consequences of market economies Page 60 The US tax system mitigates some of the inequality in pre-tax income. Both pre and post tax income have become less equal since the mid 70s.

Data on Mitigating Public Policies: US vs. CAN Pre vs. Post Tax Gini Indices Canada pretax distribution has been becoming less equal but measure of inequality is more offset by its nation s tax policies, which are more progressive than U.S. Page 61

Data on Mitigating Public Policies: US vs. UK Pre vs. Post Tax Gini Indices UK pretax distribution has been becoming less equal but measure of inequality is more offset by its nation s tax policies, and spending policies. Page 62

Page 64 World Gini Indexes 2014