Developing economies regularly grow at 5, 7 or even 10 percent a year. So why can’t our country do the same?
That is the good question former Minnesota Gov. Tim Pawlenty raised in the recent Republican presidential candidates’ debate in New Hampshire. Unfortunately for his economic plan, it is indeed difficult for a wealthy nation to grow at even 5 percent for a decade – the assumption on which his plan was based. Pawlenty is correct, however, that economic growth is a key variable in the nation’s long-term fiscal health. So the issue of upper limits on growth is a key one.
Start with the historical record. When Pawlenty first presented his economic plan several days before the debate, the chorus of criticism from economists focused on his unrealistic assumptions, as there has been no period of 10 consecutive years since 1945 when the economy has grown by 5 percent a year, adjusted for inflation. The highest was the decade ending in 1968, during which inflation-adjusted Gross Domestic Product grew by 4.8 percent per year. There is not a single 10-year period ending after 1973 for which average annual growth even topped 4 percent.
A decade of 5 percent growth that would solve all budget problems thus is not likely, given historical precedent. But why should there be a limit? As Pawlenty himself asked when defending his plan during the debate, if Brazil and China can grow more than 5 percent, year after year, why can’t our country?
The quick answer is that it is easier to get high percentage growth from a starting level that is low in absolute numbers. When China embraced a quasi-market economy in 1978, its output was only a few hundred dollars per capita. Even a small increase in absolute output from such a low base would appear dramatic in percentage terms.
Even after three decades of strong growth, China remains a poor nation with per capita output about one-twelfth of the United States. The best data for comparing national economies comes from the World Bank. For 2009, the last year for which comparative numbers are available, per capita GDP in China was $3,750, that of Brazil was about $8,200 and the U.S. some $46,000.
For U.S. output to grow 5 percent, each person would have to produce an additional $2,300 in goods and services in the next year. But for Brazil to meet the same target, each person would have to produce only an additional $412 in goods and services in a year, and for China the per capita increase would be a mere $188.
It doesn’t take much additional output to total $188. At current steel prices, if China produced just 38 additional pieces of 20-foot-long 1/2-inch reinforcing rods per person, the value of its total per capita output would grow by 5 percent. Brazil would have to turn out an additional 79 rebars, and our country 443.
If China grew enough additional rice per inhabitant to fill the bed of my pickup to a depth of six inches, that alone would increase Chinese GDP by more than 5 percent. Brazil would have to fill it by nearly a foot. For the United States, I’d have to add sideboards to accommodate a total rice depth of more than five feet.
It is easier for a poor country that has a poorly educated workforce with few tools and machines to increase output by such amounts. Just increasing education so that the average worker completes grade school and adopting manufacturing technology long used in other countries is enough to give compound growth of 7 percent or more. China has done that for a third of a century now, and each U.S. worker still produces more than 14 times as much per year as the average worker in China.
Indeed, for a formerly communist country like China, merely abandoning the shackles of central planning is enough to give years of strong growth, even without much extra in the way of plants and equipment.
As a developing country’s per capita output and income rise, growth becomes more difficult and average annual growth rates drop. That was true for Japan and the Asian “tiger” economies of Taiwan, Hong Kong, Singapore and South Korea. It was true for Brazil and it will be true for China. At some point their maximum possible sustained growth level will be on par with the United States. And it won’t be 5 percent.
Pawlenty cited 1983-1987 and 1996-1999 as two periods in our history when growth approached 5 percent. But both are special cases. The first was the recovery from the recession of the early 1980s, a result of the Fed’s extremely tight monetary policy under Paul Volcker to lower inflation. In the second, the external shock of high-tech innovation combined with increasingly loose monetary policy under Alan Greenspan, to produce the tech stock price bubble -that collapsed a year later. Neither period is a valid model for a decade of growth.
Economic growth is good. Delusions about the growth that is possible are not.
© 2011 Edward Lotterman
Chanarambie Consulting, Inc.