There’s an obscure but important bit of new economic news, and while the media is rightfully focused on President Trump’s surely illegal and absolutely un-American religious ban, I don’t want this economic point to get lost. Plus, all these moving parts connect. We don’t just have an economy; we have a political economy wherein, as I stress at the end of this column, political actions such as Trump’s ban can reverberate through to economic growth.
The narrower economic point is that the output gap – the difference between actual and potential GDP – is almost closed. Let me explain.
Real GDP is just the good old value of the goods and services that comprise the U.S. economy, amounting to almost $19 trillion. “Potential” GDP is an estimate of what GDP is when the economy is firing on all cylinders, meaning all available resources, such as labor and capital equipment, are being utilized in producing the national product.
Actual, or real GDP, is what the government statisticians who measure it each quarter tell us it is (there’s another important argument here – one I’ve written about on this page – about protecting the integrity of this system in the age of alternative facts). Potential GDP is estimated by, among others, economists at the Congressional Budget Office, and the important point about these estimates is that they change over time. An aging workforce, for example, means slower growth in “labor inputs” (hours worked) and that means that even at full potential, the level of economic output will be lower than if the growth of the workforce were accelerating. There’s also the skill levels of the workforce, its capital stock, and importantly, how efficiently that workforce is turning inputs into outputs, or productivity.
Let’s look at the data. In the figure below, the top line shows the future path of potential GDP that CBO predicted in 2007. Based on estimates of labor force and productivity growth at the time, if you asked a standard-issue, 2007-vintage macroeconomist where real GDP would be today, this is the line she would have shown you.
The next line shows the results of the same exercise, but 10 years later. By 2017, analysts had significantly marked down potential GDP, based partly on the fact that the labor force had contracted more than they thought back in 2007 and more so because productivity growth since then has been a lot slower.
The bottom line, as it were, is actual GDP, and you see that with the data we got Friday on 2015Q4 GDP, the actual has just about caught up with the new potential, which is another way of saying the output gap is finally almost closed.
This is, of course, good news, but there are many grains of salt with which it should be taken. First, the sharply negative impact of the Great Recession is clear in the figure. In this regard, think of GDP like a runner who severely sprained her ankle. Her actual speed, reduced by the injury, is analogous to GDP in a recession; her potential speed is how fast she can run when her ankle is fine.
But depending on the severity of her sprain and how well it heals, her potential speed could be reduced even when she’s fully recovered. The injury could have done permanent, or at least lasting, damage. If the depth and length of the downturn is such that resources – skills, machines, investment, consumer confidence – deteriorate more than they would have otherwise, that can lower the potential growth rate.
The gap between the 2007-version of today’s potential GDP and the new, lower potential is almost $2 trillion, or about $15,000 per U.S. household and $6,000 per person. That’s how much income is lost from the damage done to potential GDP. A minor part of the damage is caused by our aging demographics, as forecasters in 2007 could see that coming. But a good deal comes from bad policy, gridlocked politics and sloppy economics, including the inflation of credit bubbles, austere fiscal policy, insufficient public and private investment, stagnant earnings for the middle class, and high inequality.
That said, our injured runner has just about caught up to a goal post that was moving toward her. The job market is closing in on full employment, and paychecks are getting in on the action. New data from the Bureau of Labor Statistics shows that real earnings for middle-wage workers rose 3.7 percent from 2014 to 2016, compared to zero percent from 2012 to 2014 (to be fair, a third of that real acceleration was the result of slower inflation from tanking energy prices).
Which brings me back to where we stated: political economy. Amid all the uproar over the weirdest and most disturbing first week of a presidency in my lifetime – and I’m old – we’re losing the fact that Trump inherited an economy that’s both injured and strengthened. The smart, rational play would be to try to heal the injuries and boost the strengths.
But despite the financial market’s Trump bump, which I view as largely misguided and unjustified, that’s not what we see. Instead, we see amplified uncertainty, talk of walls and actual barriers to entry by people based on their religion or country of origin. Such action is nothing less than an assault on rationality and basic American values driven by fear, prejudice, insularity and a hard-right ideology that’s as hateful as it is unflinching.
How does it map onto economics? Well, none of us know where this is headed, but I can assure you that apartheid was terrible for the South African economy as was fascism for Germany and Italy. For now, I will simply point out that Trumpism is not analogous to those systems – at least not yet.