Why Not Go For 5% Growth?

Some skeptics have complained about the 5% national economic growth target put forth by former Minnesota Governor Tim Pawlenty in his speech this week about his economic plan. They say it can’t be done. But I think the goal makes a great deal of sense. It would focus policymakers like a laser beam on the great benefits that come from higher growth and on the pro-growth policies needed to achieve it. As with any goal, if you take it seriously, you’ll choose policies that work toward that goal and reject those that don’t.

As stated in the speech, “5% growth is not some pie-in-the-sky number.” One way to see why is by dissecting the number into its two parts using basic economics. As we teach in Economics 1, economic growth equals employment growth plus productivity growth. Productivity is the amount of goods and services that workers produce on average in a given period of time. Thus, higher economic growth can come from higher employment growth or from higher productivity growth. Now consider some examples of average growth rates over the next ten years.

First, look at employment growth. Given the dismal jobs situation, that’s the highest priority. Currently the percentage of the working-age population (age 16 and over) that is actually working is very low at 58.4 percent. In the year 2000 it reached 64.7 percent, so that is at least a feasible number. Raising the employment-to-population ratio to 64.7 means an employment increase of 10.8 percent (64.7-58.4/58.4 = .108) or about 1 percent per year over 10 years, even without any growth of the population. Adding in about 1 percent for population growth (from Census projections), gives employment growth of 2 percent per year.

Now consider productivity growth. Since the productivity resurgence began around 1996, productivity growth in the United States has averaged 2.7 percent according to the Bureau of Labor Statistics. So numbers in that range are not pie in the sky. As Harvard economist Dale Jorgenson and his colleagues have shown, the IT revolution is part of the explanation for the productivity growth, and, if not stifled, is likely to continue, as is pretty clear to me as I sit a few hundred yards from Facebook and other high-tech firms.

Now if we add the 2.7 percent productivity growth to the 2 percent employment growth, we get 4.7 percent economic growth, which is within reaching distance of—or simply rounds up to—the 5 percent target set by Governor Pawlenty. Thus, five percent growth is a good goal to aspire to, whereas 3 or 4 percent would be too little and 6 or 7 percent too much. Of course, one can fine-tune these calculations–for example, by estimating changes in hours per worker or the difference between nonfarm business (which BLS productivity numbers refer to) and total GDP–or raise questions about demographic effects on the employment-to-population ratio. And one could use different examples, perhaps lower employment growth and higher productivity growth, but the basic point about the goal would be the same.

You can see how the types of pro-growth policies in the Pawlenty plan would work toward the goal by reducing spending growth enough to balance the budget without tax increases and thereby remove threats of a debt crisis; by lowering marginal tax rates to spur hiring and job growth; by scaling back unnecessary new regulations which impede private investment and higher productivity, and by restoring sound monetary policy to remove uncertainty about inflation or another financial crisis.

About John B. Taylor 117 Articles

Affiliation: Stanford University

John B. Taylor is the Mary and Robert Raymond Professor of Economics at Stanford University and the Bowen H. and Janice Arthur McCoy Senior Fellow at the Hoover Institution. He formerly served as the director of the Stanford Institute for Economic Policy Research, where he is now a senior fellow, and he was founding director of Stanford's Introductory Economics Center.

Taylor’s academic fields of expertise are macroeconomics, monetary economics, and international economics. He is known for his research on the foundations of modern monetary theory and policy, which has been applied by central banks and financial market analysts around the world. He has an active interest in public policy. Taylor is currently a member of the California Governor's Council of Economic Advisors, where he also previously served from 1996 to 1998. In the past, he served as senior economist on the President's Council of Economic Advisers from 1976 to 1977, as a member of the President's Council of Economic Advisers from 1989 to 1991. He was also a member of the Congressional Budget Office's Panel of Economic Advisers from 1995 to 2001.

For four years from 2001 to 2005, Taylor served as Under Secretary of Treasury for International Affairs where he was responsible for U.S. policies in international finance, which includes currency markets, trade in financial services, foreign investment, international debt and development, and oversight of the International Monetary Fund and the World Bank. He was also responsible for coordinating financial policy with the G-7 countries, was chair of the working party on international macroeconomics at the OECD, and was a member of the Board of the Overseas Private Investment Corporation. His book Global Financial Warriors: The Untold Story of International Finance in the Post-9/11 World chronicles his years as head of the international division at Treasury.

Taylor was awarded the Alexander Hamilton Award for his overall leadership in international finance at the U.S. Treasury. He was also awarded the Treasury Distinguished Service Award for designing and implementing the currency reforms in Iraq, and the Medal of the Republic of Uruguay for his work in resolving the 2002 financial crisis. In 2005, he was awarded the George P. Shultz Distinguished Public Service Award. Taylor has also won many teaching awards; he was awarded the Hoagland Prize for excellence in undergraduate teaching and the Rhodes Prize for his high teaching ratings in Stanford's introductory economics course. He also received a Guggenheim Fellowship for his research, and he is a fellow of the American Academy of Arts and Sciences and the Econometric Society; he formerly served as vice president of the American Economic Association.

Before joining the Stanford faculty in 1984, Taylor held positions as professor of economics at Princeton University and Columbia University. Taylor received a B.A. in economics summa cum laude from Princeton University in 1968 and a Ph.D. in economics from Stanford University in 1973.

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