2% Constant Growth Might Not Last

Source: Growth Economics blog, Sep 2015

Jones and Fernald break down the roughly 2% growth in output per capita in the U.S. from 1950 to 2007 as follows:

  • 0 percentage points due to capital deepening. In short, the capital/output ratio in the US has remained roughly constant.
  • 0.4 percentage points due to increasing human capital. This is calculated from the fact that average years or schooling were rising in this period.
  • 0.4 percentage points due to scale effects. This captures the fact that increasing population generates more people doing R&D as well as larger markets that increase incentives to do R&D.
  • 1.2 percentage points due to increasing R&D intensity, meaning that the share of the labor force engaged in R&D was growing.

Of these, the increase in human capital and the increase in R&D intensity both reflect growth in control variables. In short, neither can grow forever, as they are bounded. Years of schooling is bounded by life-span (and actively removes labor from production) and the share of workers engaged in R&D cannot go above 1. So by necessity, both of those terms cannot continue to grow forever, and hence growth would have to fall below 2% as some point.

We can already see in the data that average years of education is starting to level off at about 14. And so that 0.4 p.p. we got from growing human capital may begin to disappear in the near future.

Of all the terms above, only the scale effect is not a control variable, and hence is capable of continuing to provide growth forever. This means that the underlying balanced growth rate of the economy may be as low as 0.4% per year. But even that may be an overestimate, as population growth is slowing down over time.

The question of what happens to growth over the next few decades boils down to two sub-questions. (A) Will the intensity of R&D effort level off, or will rich countries as well as India and China continue to push greater proportions of their resources and people into R&D? If so, then growth can be kept close to 2% for a long time. (B) Will there be a fundamental shift in the nature of technological progress?


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