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Politicians Make Unproductive Gamble on Productivity Growth

The federal budget is fairly described as teetering on a precipice: The public debt is growing faster than the economy, by a margin that is widening, while the economy is growing reasonably well. If anything should go wrong with the economy, the downside will be horrific.

Prudent public stewards would address this danger quickly, but you can scratch that possibility off your list. Politicians would search for excuses, such as the proposition that advancing technology will lead to faster productivity growth, and the resulting faster economic growth will boost revenues and smother the deficit. No one knows the future. It could happen. But there are some fundamentals that we must understand before we bet our children and grandchildren on that proposition.

Start with perhaps the most optimistic and aggressive argument. Some say that productivity and, therefore, the economy are already growing faster than we think. We simply are mismeasuring productivity growth. Products, such as home appliances, are improving in quality beyond our awareness. Free or virtually free services online are providing entertainment enjoyed by millions. Why are we not counting that value in the GDP? If we measured that benefit and added it to our formal economic output, we would have much more economic growth.

The problem with this vision is that we do not tax the GDP. You will not see references to the GDP anywhere on your IRS income tax forms. We tax parts of the GDP, not including, as one example, the estimated value of free services from banks, plus some elements of incomes that are not included in the GDP, such as realized capital gains. We do not tax the quality of the products we buy. We tax the dollar receipts from their sale minus the dollar expenses of their production. We do not tax our perceived value of free entertainment on the internet. We tax what we pay for it, which, if it is free, is zero.

Perhaps we are mismeasuring, or more precisely, understating, ongoing productivity growth and, therefore, our current GDP. If so, then our economic output should be larger, and we all must be “happier” than we think we are today. (Wrap your head around that one for a moment.) But if we take the economy we have today, and accept that we have in past years mismeasured productivity or GDP, then correcting that does not change the deficit, or revenues or spending separately, by one dime.

The deficit is a datum. It is precisely equal to the cash (not) in the drawer. If we mismeasured the GDP, then we also mismeasured the relationship between GDP and the deficit by precisely the same magnitude. If we correct our mismeasurement of productivity growth and the GDP, then we must also recalibrate our deficit and GDP model in precisely the same amount. Unfortunately, there is no miracle cure for this.

What would it take to get some good news out of the alleged understatement of technological improvement and the corresponding mismeasurement of productivity and GDP growth? We would need to conclude an increase in productivity or GDP growth because of advancing technology had not yet occured, but that such an acceleration was about to begin, and that it would affect taxable incomes, not improvements in quality of life that are not bought and sold in the marketplace.

What would that require? There would have to be an accumulation of new technology that has not yet bore full fruit, but is just about to do so, or perhaps the technological boom that we are talking about would be all in our future, and not in our past. Some fans of the tax cut bill might agree.

These scenarios are plausible but arguably not likely. Betting the prosperity of future generations, and the debt now building on their shoulders, on such exquisite timing is quite risky. We do know for sure is that faster, but unrecognized, productivity growth two years ago cannot reduce the deficit last year, or this year or next, either.

Joseph J. Minarik (@JoeMinarik) is senior vice president and director of research at the Committee for Economic Development. He served as chief economist at the White House Office of Management and Budget for eight years under President Clinton. He previously worked with Sen. Bill Bradley (D-N.J.) on his efforts to reform the federal income tax, which culminated in the Tax Reform Act of 1986. He is coauthor of “Sustaining Capitalism: Bipartisan Solutions to Restore Trust & Prosperity.”