How fast can our economy grow? We often answer this question by talking about spending. Will people buy more consumer goods? Will businesses buy more equipment? What about spending by government and the rest of the world?
Those questions imply that more spending means more production. If consumers want to buy more cars, companies will hire more workers and rev up their factories to build more cars. If consumers want to eat out more often, restaurants will expand their hours or establish new locations, hire more staff, and serve more meals.
But what if there are no more people to hire? Suppose the unemployment rate is as low as it can go, so there’s no one in the human resources office waiting to be interviewed. Suppose everyone who wants to work is working or about to be hired. Suppose the population that is capable of working is growing slowly. Then growth is limited by the capacity to produce. We can grow only as fast as employment and productivity allow.
How fast is that?
Let’s start with population. This is the “non-institutional population 16 years old and over,” measured by the U.S. Department of Labor, meaning the population old enough to work and capable of working. Since 2009 it’s been growing by about 1 percent per year. That’s the slowest rate since World War II. Back when the baby boomers were turning 16, between 1962 and 1980, population grew by about 1.7 percent per year. Since then we’ve had a baby bust. The fertility rate continues to fall, as it has in most decades since 1800. The baby boom was the big exception.
What share of the population is actually employed or looking for work? That’s the labor force participation rate. It’s almost unchanged over the past couple of years. It rose from about 59 percent to 67 percent between 1962 and 2000, as women entered the labor force in ever-greater numbers. That increased growth by a quarter-point to a half-point each year. Since 2006 labor force participation has been falling, as the boomers have started retiring. That’s been subtracting from growth.
The unemployment rate is the share of the labor force that is not employed but is looking for work. It was 3.8 percent in February. Usually the unemployment rate decreases when spending increases. Spending gives businesses a reason to produce more goods and services, so they hire more people. Between 2009 and 2015 the unemployment rate dropped from 10 percent to 5 percent, which added about a point to growth each year. It’s dropped another half-point per year since then. But it can’t go much lower than 3.8 percent, where it is now.
That leaves productivity, which is output per worker. We can measure it by dividing gross domestic product, adjusted for inflation, by employment. Productivity has been growing by about 1 percent per year since 2009. It grew 1.3 percent in 2018.
Productivity growth has been disappointing. Back in the heyday of industrial America, 1949-72, productivity grew more than 2 percent per year. It dropped during the 1970s and 1980s, to about 1 percent. It increased again with the information technology surge in the mid-1990s, to 2 percent per year. I thought that would continue — technology keeps advancing — but no, after 2009 it dropped back to 1 percent per year.
There are lots of explanations for the productivity slowdown: too little investment, lack of competition among tech firms, physical limits to technological advance, and maybe some measurement error. Of course, if there are lots of explanations, it means that no one is really sure why.
Adding it up for 2018, population grew 1.1 percent, labor force participation was unchanged, the unemployment rate fell by about half-a-point, and productivity increased by 1.3 percent. That adds up to 2.9 percent, and that’s how much real GDP grew, based on annual averages.
You can see, though, that if unemployment can’t fall further, and labor force participation is unchanged, employment can only grow as fast as population. That’s about 1 percent per year. If productivity grows only 1.3 percent per year, output will grow 2.3 percent. We can increase our spending all we want, but that’s how much more we can produce.
Larry DeBoer is a professor and extension specialist in agricultural economics at Purdue University. He worked with the Indiana Legislative Services Agency on tax and finance issues from 1988 to 2014 and studies state and local government public policy. Send comments to [email protected].