Harvard Professor Martin Feldstein : The Future of American Growth

The near-term outlook for the US economy has improved, owing to the sharp increase in household wealth in 2013, together with the end of the fiscal drag caused by the increase in tax rates in 2012. The United States now has a chance to raise real (inflation-adjusted)per capita GDP faster than the feeble 1.7% average rate recorded during the four years since growth resumed in the summer of 2009.

Of course, significantly faster GDP growth in 2014 is not guaranteed. For starters, achieving it requires overcoming the negative impact of the jump in long-term interest rates that followed the Federal Reserve’s announcement last June that it would likely end its asset-purchase program this year. Moreover, the cloud of rising budget deficits at the end of the decade – and exploding national debt after that – is also discouraging investment and consumer spending.

But let’s look beyond 2014 and ask what will happen to US economic growth over the longer term. The Congressional Budget Office (CBO) projects that real per capita GDP growth will slow from an annual rate of 2.1% in the 40 years before the start of the recent recession to just 1.6% between 2023 and 2088. The primary reason for the projected slowdown is the decrease in employment relative to the population, which reflects the aging of American society, a lower birth rate, and a decelerating rise in women’s participation in the labor force. While the number of persons working increased by 1.6% per year, on average, from 1970 to 2010, the CBO forecasts that the rate of annual employment growth will fall to just 0.4% in the coming decades.

A drop in annual growth of real per capita GDP from 2.1% to 1.6% looks like a substantial decline. But even if these figures are taken at face value as an indication of future living standards, they do not support the common worry that the children of today’s generation will not be as well off as their parents. An annual per capita growth rate of 1.6% means that a child born today will have a real income that, on average, is 60% higher at age 30 than his or her parents had at the same age.

Of course, not everyone will experience the average rate of growth. Some will outperform the average 60% rise over the next three decades, and some will not reach that level. But a 30-year-old in 2044 who experiences only half the average growth rate will still have a real income that is nearly 30% higher than the average in 2014.

But things are even better than those numbers imply. Although government statisticians do their best to gauge the rise in real GDP through time, there are two problems that are very difficult to overcome in measuring real incomes: increases in the quality of goods and services, and the introduction of new ones. I believe that both of these problems cause the official measure of real GDP growth to understate the true growth of the standard of living that real GDP is supposed to indicate.

Consider the problem of accounting for quality improvements. If I pay the same price for some product or service this year as I did last year, but the quality of the product or service is better, my standard of living has increased. The same is true if the price rises but the quality increases even more. Unfortunately, a government statistician cannot judge the increase in quality of everything from restaurant meals to medical care. So looking only at the cost of a meal or of a day in the hospital causes an overestimate in the price index and an underestimate of the rise in the real standard of living.

The problem of taking new products into account is even more difficult. Virtually everyone around us uses a smart phone, a laptop computer, or a tablet. We know what these cost and how much they add to the total nominal value of GDP. But how much more than the standard retail price would individuals pay to keep these “must-have” products? Likewise, what is the value to patients of laparoscopic surgery or drugs that relieve anxiety or prevent heart attacks?

In short, I am convinced that the real standard of living produced by the goods and services that we buy is increasing faster than our official data reveal. That is true now, and it is likely to continue to be true in the future.

That is not a reason for complacency. The US can and should adopt policies that will cause real incomes to rise even faster. But that is a subject for a future column.