Tuesday, January 3, 2012

How Do We Grow From Here?

Paul Krugman's latest article Nobody Understands Debt outlines why government debt is different than private debt:
First, families have to pay back their debt. Governments don’t — all they need to do is ensure that debt grows more slowly than their tax base. The debt from World War II was never repaid; it just became increasingly irrelevant as the U.S. economy grew, and with it the income subject to taxation.
How do you grow the tax base? Two ways, increase the tax rate and/or (with fixed rate debt) grow nominal national income. My view is that an increase in taxes is inevitable, so let's move on to some components of national income to determine areas of "opportunity".

The chart below breaks out nominal GDP by real GDP per hour worked and hours worked (which combined make up real GDP per capita), population growth (which added to real GDP per capita equals real GDP growth), and inflation (which added to real GDP growth equals nominal GDP growth) over rolling ten year periods. As can be seen, the "lost decade" has resulted in GDP growth levels at generational lows.

So.. what are the opportunities?

Inflation: it seems easiest to simply inflate our way out of our debt issues, raising nominal GDP without concern over the impact on real GDP. Our monetary policy (i.e. zero rates through at least 2013, quantitative easing, etc....) is aiming at just that. The problem is it really isn't all that easy to add "good" inflation (all price move higher), rather than just commodity inflation which actually adds deflationary pressure to non-commodity goods (less disposable income remains). In addition, as long as debt deflation concerns remains in the U.S., European issues continue to work their way through the financial system, and a lack of global aggregate demand continues, downward pressure remains on price levels.

Population: to me this is the easiest way to grow nominal GDP in theory (i.e. just open immigration for the wealthy and educated), but probably the most difficult to enact new policy to deal with considering we have an entire party against this. In a perfect world, this brings in wealth (i.e. aggregate demand), population (a component in the above chart), and technical skills (i.e. increases the GDP per hour). Oh well...

Hours worked: we face a continued lack of aggregate demand, so corporations aren't hiring / the public sector continues to shed jobs in the face of required austerity. In a perfect world we put people able to work... to work. This could include any project that has positive return on capital and with our dilapidated national infrastructure, there are in my view plenty of projects that can do just that. In addition, as I've mentioned before on the blog, any policy dealing with outsourcing of jobs abroad would have (in my opinion) a positive impact.

Productivity (GDP per hour): we need investment, which requires an increase in savings. Looking at the chart, it looks like GDP per hour jumped in the early part of last decade. The issue is that a lot of this was simply due to outsourcing labor abroad (hence the decline in hours worked). This is coming to roost as outsourcing and lower savings has caused productivity growth to slip to generational lows despite the number of people working on the decline.

Source: BEA