The Congressional Budget Office recently released a report exploring why this economic recovery from the recession trough has been unusually slow. As the report shows, as of the second quarter of 2012, 3 years after the Great Recession’s trough in the second quarter of 2009, the U.S. economy has shown real GDP growth of a little under 7% from the trough level. But the average U.S. recovery since World War II would have shown real GDP growth of about 9% more, or around 16%.
CBO attributes two-thirds of the slow economic recovery growth to slower-than-usual growth in the U.S. economy’s productive potential. The other one-third of the slow economic recovery is due to the economy not moving as fast as in previous recoveries back to its true potential.
The slow growth of productive potential could be seen as slow growth in the potential supply of national economic output. The slow growth of the economy relative to its potential can be seen as slow growth in the demand for economic output relative to supply.
CBO argues that the slow growth of potential output is due to three factors. The first factor is slower than usual growth in working age population due to both the aging of the U.S. population, and an end to the longstanding trend of increased labor force participation by women. In addition, the prolonged recession has reduced the skills of some of the long-term unemployed, which has probably raised the economy’s unemployment rate when it is performing at its potential. (Other research suggests about a one point rise in the economy’s “natural” unemployment rate, from 5% to perhaps 6%.)
A second factor is a slower than average growth in “total factor productivity”, that is in the economy’s technological and institutional ability to produce higher output with a given quantity of capital and labor.
A third factor is smaller growth than usual in net capital investment during the recovery, although CBO explains this slow growth as really being due to other factors. The slower growth of the work force means less net capital is needed to keep up with workforce growth, and slower growth of total factor productivity means new investment is less profitable. In addition, the weak demand during the recession and the housing crash has reduced incentives for investment.
The one-third of the sluggish recovery that is due to insufficient demand for the economy’s potential production is primarily attributed by CBO to four factors. First, consumer spending has been sluggish due to consumers losing housing wealth and having low wages, as well as poor consumer confidence.
Second, housing demand has been sluggish due to the housing bubble and slower household formation growth.
Third, federal government purchases, particular in defense, have grown more slowly than in many previous recoveries.
Finally, the most important factor has been slow growth in state and local government spending. CBO finds that the U.S. economy would have been producing 1% more in total output as of the second quarter of 2012 if state and local government spending had growth as it historically has done during economic recoveries.
Two policy directions that I have advocated in the past would help speed up the recovery and build long-term growth. First, well-designed wage subsidies that would encourage small businesses and small non-profits to hire the long-term unemployed for newly created jobs could help boost current output and employment, while also increasing the long-run productive potential of the U.S. economy by helping maintain the skills of the long-term unemployed. As I have outlined before, such a program could be designed similarly to a past program run in the state of Minnesota called MEED. Such a program might create about 1 million new jobs per year, at gross annual budgetary costs of $30-35 billion, and net annual budgetary costs, after considering increased tax revenues and reduced transfer payments, of $15-$20 billion.
Second, a sustained commitment by all levels of government towards expanding early childhood education programs would help boost short-run demand and supply of economic output while significantly boosting long-run growth in productivity. Expanding early childhood education spending, whether through state initiatives, or federal aid, would boost state and local spending, which has been a big reason for the slow recovery. If early childhood education programs are full-day or include wraparound child care, these programs would also increase women’s labor force participation. For example, if we created universal full day pre-K for all four-year olds, such an initiative might cost $30 billion annually. If such an initiative were tax-financed, it would immediately create 170,000 jobs. If such an initiative were deficit-financed, it would immediately create 300,000 jobs.
But the more important effects of early childhood investment are long-term. After 15 years of sustained investment, universal high-quality early childhood education would begin to significantly boost the growth of the economy’s productivity. This wouldn’t help in the current recovery, but it would help boost the economic prospects of the U.S. economy long-term. With a labor force with better reading and math skills, the “hard” skills, as well as better social skills, the “soft” skills, employers will find it easier to introduce new technologies and new methods of workplace organization. As I have outlined on this blog, and in my book, for each $1 invested in high-quality early childhood education, the long-run boost to the present value of earnings is close to $4, and the boost to overall economic output would be even greater.
We often talk about the budget deficit or other political issues of the moment. But the budget deficit is only important insofar as it affects what we really care about, which should be building broad economic prosperity for all economic groups in the U.S. economy. Early childhood investments would help build that prosperity for all in the long-term. While doing so, such early childhood investments would also contribute to achieving short-run economic goals of greater job growth.