Donald S. Allen

English

Research Papers in Economics

NationalEconomicTrends
September 1997
What Determines 
Long-Run Growth?
In the first quarter of 1997, real gross domestic
product (GDP) grew at a surprising 4.9 percent annual
rate.  The general consensus among economists is that
this is not a sustainable rate.  So how fast can the
economy grow?
The level of output of an economy is determined
by the level of inputs (land, labor and capital) used
and the production methods used to convert the inputs
into goods and services.  Output can only be increased
through additional inputs or more efficient use of
available inputs.  How fast we can increase inputs is
limited, however:  Land is essentially fixed.  Population
growth and participation rates determine the size of
the labor force.  
In less-developed economies, a large fraction of
inputs are underutilized and the level of capital is usually
low.  These economies can grow rapidly by increasing
inputs and/or by increasing production efficiency—for
example, by moving toward state-of-the-art technology
and raising the level of education.  Adeveloped economy
like the United States, starting from a higher level of
input use and efficiency, has less margin for high rates
of growth.  Innovation and improvements in existing
technology are the keys to increased growth rates.
The conventional wisdom is that the potential
growth rate of the U.S. economy is between 2.0 and
2.5 percent annually.  This range reflects a projected
growth in the labor force of about 1 percent and a
trend growth of 1.0 to 1.5 percent in labor productivity
(output per hour), which captures capital accumulation
and technological improvement.
The chart shows the historical index of business
labor productivity and the labor force in logarithms,
so that the slopes of these graphs are the growth
rates. Both variables show a distinct reduction in
slope at different points.  Average growth in business
productivity slowed from 3.3 percent annually before
1973 to 1.2 percent annually after 1980.  The growth
in the labor force slowed from 1.6 percent annually
up to 1973 to about 1.4 percent annually since 1980,
after the baby boomers had entered the workforce.
Correspondingly, GDP slowed from an average annual
growth rate of 3.9 percent between 1948 and 1973 to
an average annual rate of 2.6 percent between 1980
and 1996,  primarily reflected in the slowdown in
labor productivity growth. (Hours worked grew more
slowly than the labor force during the pre-1973 period,
reflecting shorter work weeks.)
If recent increases in investment in new technolo-
gy can foster trend productivity gains comparable to
the pre-1973 period, then the United States can look
forward to a rise in the potential growth rate of the
economy, but sustained growth at the 4.9 percent rate
seen in the first quarter of 1997 is unrealistic.  In the
final analysis, the keys to long-run economic growth
are the microeconomic incentives that induce individuals
to work and firms to invest in production technology,
within the limits imposed by demographics and the
rate of technological advances. 
—Donald S. Allen  
Views expressed do not necessarily reflect official positions of the Federal Reserve System
Labor Force and Business Productivity
3.4
3.8
4.2
4.6
5.0
5.4
5.8
1945 50 55 60 65 70 75 80 85 90 95
9.8
10.2
10.6
11.0
11.4 .
11.8 .
12.2 .
(1.6%)
(1.4%)
(3.3%)
(1.2%)
Labor Force
(right scale)
Productivity
(left scale)
Note: Average annual rates of growth over each period are shown in parentheses.
          Trend breaks occur in 1973 and 1980 for productivity and the labor force, respectively.
Log Log

What determines long-run growth?

http://research.stlouisfed.org/publications/net/19970901/cover.pdf

What determines long-run growth?

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics