Edward Renshaw
Professor of Economics
State University of New York at Albany
A flap over how fast the US economy can grow (Bleakley 1996) and the shift to a chain weighted measure of real GDP makes this a propitious time to update Arthur Okun's (1962) paper on "Potential GNP: Its Measurement and Significance" which has since achieved the distinction of being considered a law.
While no law has been subject to more breakdowns there is one version of this law that was formulated by Stephen McNees in (1984) which has continued to explain the historical data rather well. See Tables 15.1 and 15.2.
Since 1966 the year-year changes in the civilian unemployment rate have been about equal to 64 percent of the year-to-year growth rate for the civilian population 16 and over, minus 39 percent of the growth rate for real GDP in chained 1992 dollars plus .9 percentage points for those years following a transition from positive to zero or negative growth rates for real GDP.
The dummy variable equal to one after recessionary declines in real GDP helps to account for the large gains in labor productivity that usually occur during the first year of recovery from an economic recession. During this phase of the business cycle it is possible to boost output significantly by making better use of a firm's underemployed labor and capital.
When the change in the unemployment rate is set equal to zero and the equation in Table 15.1 is solved for an adult population growth rate of 1.0 percent and a spreading of the dummy variable coefficient over a five year period, the conclusion is that the potential or full employment growth rate for the US economy may have declined to about 2.1 percent per year.
Estimates of the potential growth rate which are obtained using econometric methods should be checked by a more informal examination of the data. One can use a labor force identity to show that the longer term growth rate for real GDP should be about equal to the growth of the civilian population 16 and over from which out labor force is recruited plus the growth rate for the civilian labor force participation rate, plus the growth rate for the civilian employment rate plus the growth rate for real GDP per worker. See Table 15.3.
The growth of the population aged 16 and over, has slowed from an average rate of over 2.1 percent in the 1970s to a little less than 1.1 percent in the 1990s.
A downward trend in male participation in the labor force was almost sufficient to offset a large part of the upward trend in female participation from 1989-96. With female participation approaching a condition of saturation it doesn't seem likely that changes in labor force participation will have a very large effect on the potential growth rate in the remainder of this century.
The civilian employment rate (which is equal to 100 minus the unemployment rate), after plunging to 92.6 percent in 1992, has recovered to a more normal rate of 94.6 percent in 1996.
The Commerce Department's new method of deflating nominal GDP with chain type weights has reduced the growth of real GDP per worker to a lack lustre increase of only .8 percent from 1989-96, in spite of much publicized efforts on the part of large corporations to downsize their work force. Adding this number to say a 1.3 percent contribution from population growth, labor force participation and a possible improvement in the civilian employment rate helps to support the econometric conclusion that the potential growth rate may have drifted downward from 4.4 percent in the 1960s to about 2.1 percent in the 1990s.
Jerry Jasinowski, president of the National Association of Manufacturers, Lester Thurow of MIT and a number of economists associated with the Clinton administration have gone on record in suggesting that the US economy could grow a lot faster in the rest of this decade without causing an acceleration of the inflation rate. In the Economic Report of the President, which was transmitted to Congress in February 1997, it was assumed that the growth of chain weighted real GDP will accelerate from about 2.0 percent in 1997 and 1998 to an average 2.3 percent from 1999- 2003.
While business enterprises have recently been investing record proportions of their revenue from sales in computers and other types of producer's durable equipment there is no evidence, as yet, to suggest that this is being translated into a very dramatic "productivity revival".
In this decade there has been a lot of contracting out by manufacturing firms of accounting, legal and overhead functions that were once a part of in house operations. There has also been a tendency on the part some firms to purchase labor inputs indirectly from firms that are in the business of providing temporary help. The net effect has been to shift some labor input from the manufacturing sector to the service sector and bias upward estimates of labor productivity in manufacturing.
While we may be on the verge of greater productivity in the service sector, it is questionable whether more computer power will compensate enough, for little or no improvement in finger dexterity, to offset the negative effect on output growth of a slow down and eventual reversal of the upward spiral of female participation in the labor force. It should also be noted that there are large portions of the US economy where not much is happening to improve labor productivity.
In 1963 this analyst examined various factors which had contributed to a dramatic "Substitution of Inanimate Energy for Animal Power" (such as the speed, scale and efficiency of converting energy into useful working effects), noted that none of these factors seemed to be open ended or exempt from the law of diminishing returns, and suggested that real wages, which had doubled, redoubled, and then redoubled for a third time in the space of about one century might "never double again." The average hourly earnings of production workers in 1982 dollars peaked out a decade later in 1973 and were only about 3.6 percent greater, on the average, in 1996 than in 1963.
The slowdown in long-term economic growth in the industrialized countries, however, has sparked a renewed interest in growth theory on the part of younger economists and ignited a new debate about how policy makers can promote faster growth. Stanley Fischer has noted that most of the policy prescriptions of the new growth theory are the same prescriptions that have been offered by the World Bank and the International Monetary Fund for years: keep budget deficits small; keep inflation low and stable; do not overvalue the exchange rate; keep the economy open to international trade; deregulate; privatize; keep the tax system simple; and invest in physical capital, infrastructure, and human capital. (Federal Reserve Bank of Kansas City, 1992, p. 231.)
During the 1990s many developing countries have heeded this type of advice and achieved growth rates that have been substantially in excess of the anemic growth rates achieved by most of the more industrialized countries of the world. One of the more interesting questions to be answered in the remainder of this decade is whether the US and other industrialized nations can be persuaded to accept more of their own advice and whether that will be sufficient to halt a downward drift in the growth of chain weighted GDP that has now persisted for almost three decades.
Bleakley, Fred (1996). "Some Argue for Faster Pace of Growth," The Wall Street Journal, A2 & A4.
Federal Reserve Bank of Kansas City (1992). Policies for Long-Run Economic Growth.
McNees, Stephen (1984). "How Much Growth Is Too Much?" New England Economic Review, January, 84.
Okun, A. (1962). "Potential GNP: Its Measurement and Significance," Proceedings of the Business and Economic Statistics Section of the American Statistical Association.
Renshaw, Edward (1963). "The Substitution of Inanimate Energy for Animal Power," Journal of Political Economy, June, 284-92.
Independent Variables Regression Coefficients
The year-year growth rate for chain weighted real GDP -.389
expressed in 1992 dollars. (-14.277)
The year-year growth rate for the civilian population .643
aged 16 and over. (10.148)
A dummy variable equal to one for those years following .923
a transition from positive to zero or negative growth (5.743)
rates for chain weighted real GDP and zero otherwise.
Summary Statistics
Adjusted R-squared .895
S. E. of Regression .328
Durbin-Watson Statistic 2.580
The figures in parentheses are t-statistics for the hypothesis that the coefficient's true value is zero.
Source of basis data: Economic Report of the President and the Survey of Current Business, January/February 1996.
---Growth Rates for-- Actual
GDP Civilian Civilian Change in the Minus the
Chained Population Unemployment Unemployment Rate Predicted
Year 1992 $ 16 and Over Rate Actual Predicted Change
(1) (2) (3) (4) (5)n (6)n
1967 2.6 1.4 3.8 .0 - .1 .1
1968 4.7 1.7 3.6 - .2 - .7 .5
1969 3.0 1.7 3.5 - .1 - .1 .0
1970 .0 2.0 4.9 1.4 1.3 .1
1971 3.3 2.3 5.9 1.0 1.1 - .1
1972 5.4 2.8 5.6 - .3 - .3 .0
1973 5.7 2.1 4.9 - .7 - .9 .2
1974 - .4 2.1 5.6 .7 1.5 - .8
1975 - .6 2.0 8.5 2.9 2.4 .5
1976 5.6 2.0 7.7 - .8 -. 9 .1
1977 4.9 1.8 7.1 - .6 - .7 .1
1978 5.0 1.8 6.1 -1.0 - .8 - .2
1979 2.9 1.8 5.8 - .3 .0 - .3
1980 - .3 1.7 7.1 1.3 1.2 .1
1981 2.5 1.4 7.6 .5 .9 - .4
1982 -2.1 1.3 9.7 2.1 1.7 .4
1983 4.0 1.1 9.6 - .1 .1 - .2
1984 6.8 1.2 7.5 -2.1 -1.9 - .2
1985 3.7 1.0 7.2 - .3 - .8 .5
1986 3.0 1.3 7.0 - .2 - .3 .1
1987 2.9 1.2 6.2 - .8 - .4 - .4
1988 3.8 1.0 5.5 - .7 - .8 .1
1989 3.4 1.0 5.3 - .2 - .7 .5
1990 1.3 1.5 5.6 .3 .5 - .2
1991 -1.0 .9 6.8 1.2 1.0 .2
1992 2.7 1.0 7.5 .7 .5 .2
1993 2.3 1.1 6.9 - .6 - .2 - .4
1994 3.5 1.0 6.1 - .8 - .7 - .1
1995 2.0 .9 5.6 - .5 - .2 - .3
1996 2.4 1.0 5.4 - .2 - .3 .1
(5)n. The predicted change in the unemployment rate is equal to minus 39 percent of the growth rate for real GDP in column (1) plus 64 percent of the population growth rate in column (2) plus .9 percentage points for those years following a transition from a positive to a zero or negative growth rate for real GDP in column (1).
(6)n. Column (4) minus column (5).
Civilian Labor Force
Year Real GDP Real GDP Civilian Participation Rates Civilian
Billions per Worker Population --------------------- Employment
of 1992 1992 16 and Over Total Males Females Rate
Dollars Dollars (millions) (in Percent) (percent)
(1) (2) (3) (4) (5) (6) (7)
1959 2,212.3 34,230 115.3 59.3 83.7 37.1 94.5
1969 3,388.0 43,491 134.3 60.1 79.8 42.7 96.5
1979 4,624.0 46,790 164.9 63.7 77.8 50.9 94.2
1989 6,060.4 51,647 186.4 66.5 76.4 57.4 94.7
1996 6,907.4 54,514 200.6 66.8 74.9 59.3 94.6
Growth Rates
1959-69 4.4 2.4 1.6 .1 --- --- .2
1969-79 3.2 .7 2.1 .6 --- --- -.3
1979-89 2.7 1.0 1.2 .4 --- --- .1
1989-96 1.9 .8 1.1 .1 --- --- -.0
The GDP growth rate in column (1) is approximately equal to the sum of the growth rates in columns (2), (3), (4), and (7).
Source of basic data: Economic Report of the President.
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