This article first appeared in the St. Louis Beacon: As deep as the recession that ended in 2009 was, history suggests the recovery should not be limping along as it is. This weakness is not without explanation. You’ve heard that recessions coupled with financial crisis engender prolonged, shallow recoveries. And many of those unemployed during the downturn have not or cannot find work.
Or is this slower pace of economic activity, this unemployment rate staying above 7 percent, the new normal?
Over time, the economy grows at what economists call its potential. Potential output growth is, for all intents, the average or trend rate of growth at which the economy expands when its productive resources — labor, capital and technology — are employed most efficiently. Potential output growth helps define, in an economic sense, a country’s standard of living.
Economics tells us that changing one of those inputs to production could, for better or for worse, alter the future path of potential output. The tsunami that destroyed a significant portion of Japan’s industrial capacity — its capital — lowered its long-term potential output and the future economic well being of the Japanese people.
In the United States, the aging of the population could have such a detrimental effect. And perhaps we are seeing the first signs of this change in the slow recovery.
How so? In the near future there will be more people moving into retirement with fewer people moving into their working age. This will strain social services as demands for Medicare and Social Security rise relative to inflows of funds to finance these programs. It also may negatively impact future standards of living.
One sign of this demographic change is the observation that labor force participation during this recovery is well-below historical levels. If the long-term unemployed remain out of work and a larger share of the labor force simultaneously is entering into retirement, this could reduce growth in the labor force. And that could lower the growth in potential output.
One counter argument is that reductions in the labor force will not impact our future well-being if worker productivity is unchanged. A smaller workforce does not necessarily mean less output if those fewer workers are more productive than their predecessors. If they are smarter or have more and better capital to work with, potential output is not reduced by having fewer workers.
Recent evidence is not too rosy, however. Analyses by the Congressional Budget Office and the president’s Council of Economic Advisers suggest that the weak recovery may stem from a reduction in potential. That is, the economy currently may be operating at full tilt; but what is full tilt today is less than what it was a few years back.
Will this problem dissipate with time? The longer we wait to act, the more output is lost. Since it is difficult to alter the age distribution of the population, what can be done? Consider two policy areas: education and immigration.
Policy makers and parents must undertake actions to halt the slide in U.S. educational achievement. Future policies should assess success using measures of educational quality, eschewing the low-hanging fruit of years-in-school or graduation rates.
Immigration policy must be re-considered. Current policies restrict the immigration of well-trained, educated workers. If continued, this will exacerbate future productivity problems. It is time to reconsider the role of special interest groups, such as unions, medical practitioners and others play in shaping immigration policies that protect their self-interest at the expense of future economic growth.
An aging population, declining educational achievement and immigration policies that restrain workforce productivity are not ingredients for long-term economic success. Delaying action heightens the risk of guaranteeing future generations a lower standard of living.
R.W. Hafer is a research professor of economics and finance at Southern Illinois University Edwardsville and a research scholar at the Show-Me Institute.