What does and does not boost economic growth?

Hands of the magician with magic wand and top hat, Veer.com

At a time of stagnant U.S. economic growth, magic seems to be not only an attractive option to boost growth, but perhaps the only feasible one. In a series of essays recently published by the Cato Institute, economists and analysts offered a number of ideas to boost growth that they’d implement if they had a magic wand. Commenting on the wide number of proposals in the collection, Washington Post columnist Robert Samuelson says the essays as a whole offer no singular consensus among economists about what policies to implement to boost economic growth. And that’s true—mainly because there’s no consensus about what actually increases growth in the long run. But what economists have done is knock down ideas that won’t boost economic growth, and point out broad areas that might boost it.

First, we have to be clear about what we mean when we talk about economic growth. If we just want to pump up economic growth in the short run, there are a number of ways to do that. But what we should be concerned about is the pace of long-run economic growth. And while economists still really aren’t sure about its source, they have a good idea about what won’t produce a higher growth rate.

Going back to the origins of the Solow growth model, many economists once believed that increasing savings could permanently boost the pace of economic growth, measured as the increase in gross domestic product per person. But under Solow’s framework, adding more capital and labor will only temporarily boost growth, and the pace of growth in the long run will eventually go back to where it was before. What needs to be increased, then, is productivity.

In contrast to the full employment assumptions in the Solow model, making sure labor and capital are utilized to their full potential is still critically important, —especially in the current United States with the aging of the Baby Boomers and the slowdown in female employment since 2000. So policies like the one proposed by Equitable Growth’s Heather Boushey that help workers balance work and family responsibilities are important to boost overall economic growth. But it’s definitely not the end of the story.

Taking a look at another famous growth model can help shape our thinking about what might boost productivity and long-run growth. Twenty-five years ago, economist Paul Romer, now of New York University, published a paper that developed an “endogenous” growth model. In Solow’s model, productivity increases are assumed. In Romer’s model, increases and growth come from individuals in the economy adding to the stock of human knowledge.

Romer’s innovation was to emphasize the knoweldge and ideas that help the economy and incorporate them into his growth model as “nonrival goods.” A good is nonrival if my use of it doesn’t restrict your ability to use it. Ideas are a great example of nonrival goods, as you and I can both use the idea of, say, nonrival good at the same time. As University of Toronto economist Joshua Gans put it in a blog post about the Romer model, “to understand growth surely we need to understand what incentives there are to create and also detract from the pool of knowledge that can help future idea creators.”

In other words, focusing on how ideas are created and then how those ideas are propagated through the economy are key for long-run growth. Spurring innovation can’t and won’t be the only solution to faltering growth. But it’ll certainly play a part.

So yes, economists and policymakers don’t know the exact policies to implement right away to boost economic growth. But there is an understanding of the general areas to focus on or not focus on. There’s a ways to go, but we know the general path to walk on.

October 7, 2015


Nick Bunker
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