Introduction

Case Study

Deirdre McCloskey explains in her book, Bourgeois Dignity (2010), the average person anywhere in the world in 1800 lived on the equivalent of $3 per day. Local economies could barely support the basic needs of their citizens. Those who wanted to improve their lives had few options as wealth was concentrated in the hands of the elite few with political power and was secured by force.

But then, something revolutionary happened. Starting in England and the Netherlands, and eventually in America, average people began to get richer and their situations improved dramatically. Over the past 250 years, economic growth has skyrocketed, especially where free enterprise has been allowed to flourish. The chart below shows how the rise takes off shortly after the Industrial Revolution and the birth of the U.S.

McCloskey points out that in 2010, the average Frenchman consumed about $100 per day, and the average American consumed about $120 per day, representing a sixteen-fold increase in wealth. Even though the Chinese only consumed about $13 per day in 2010, it was still a four-fold increase in the 32 years since the Communist China’s Cultural Revolution in 1978.

What contributed to the largest and most successful anti-poverty program in human history? A number of economic factors, but according to McCloskey, what fundamentally changed was the attitude people had about business and entrepreneurship:

“What changed was the sociology…the attitude of the rest of the society toward businesspeople, and with that new attitude came a change in government policy. It was suddenly alright — most clearly in the most bourgeois country on earth, the U.S.A. — to get rich and to innovate.” 

For more on this, see The Policy Circle’s Free Enterprise Brief and watch the following videos:

  • Swedish academic and medical doctor Hans Rosling demonstrates the economic evolution of 200 countries over 200 years
  • AEI presents how individuals and society alike benefit from economic growth.

 

Why It Matters

Economic growth generally refers to growth of the gross domestic product (GDP, discussed more below). GDP is commonly used as a measure of the size and health of a nation’s economy, but can sometimes feel like a vague and nebulous term on its own. A growing economy is also related to a number of indicators that can hit closer to home: employment and the labor force; household income, wages, and standards of living; assets and investments; retirement benefits, social safety net programs, and financial security. Economic growth affects what people spend their money on, and how much of it they have to spend, on a daily basis. As our nation finishes its first decade out of the Great Recession, it is an interesting time to assess where we have been, where we are now, and what the future looks like.

Putting it in Context

Gross Domestic Product

Gross domestic product (GDP) is defined as “a measure of economic activity in a country. It is calculated by adding the total value of a country’s annual output of goods and services.”

The U.S. GDP per capita (meaning GDP per individual, or how prosperous a country feels to each of its citizens) is one of the highest in the world. Only a few countries with much smaller populations, such as Switzerland, Norway, and Ireland, have higher GDP per capita.

  • United States:  $62,641
  • Australia: $57,305
  • Sweden: $53,024
  • Germany: $48,195
  • Canada: $46,210
  • United Kingdom: $42,491

The Wall Street Journal explores GDP, how fast it should grow, and what it doesn’t cover:

 

History

As noted above, shortly after the onset of the Industrial Revolution and the birth of the United States, economic growth skyrocketed, especially where free enterprise was allowed to flourish. Rapid economic development following the Civil War paved the way for the modern U.S. industrial economy, and most Americans “enthusiastically embraced…the risk and excitement of business enterprise, as well as the higher living standards and potential rewards of power and acclaim that business success brought” (US Embassy).

Much of the prosperity was lost in the Great Depression (1929-1940), and rebuilding the economy involved major changes that came in the form of President Franklin D. Roosevelt’s New Deal,  including more government involvement and sharing of power amongst government, business leaders, and workers.

After recovering from the Great Depression and World War II, the realization of the need to structure international monetary arrangements (in the form of the International Monetary Fund and the World Bank) to secure an open, capitalist international economy helped transform the U.S. into a global economic powerhouse.

U.S. economic growth has been interrupted by recessions and economic troubles, but none of these setbacks has been enough to hamper U.S. economic growth’s overall upward trend (as the graph shows). Professor Brian Domitrovic dives deeper into U.S. economic history and its role as a global economic powerhouse post-WWII in this episode of Learn Liberty from the Institute for Humane Studies:

 

Keys to Economic Growth

The Index of Economic Freedom highlights the following keys to economic growth: 

The Rule of Law: Respect for the rule of law (especially property rights) is a critical precondition for economic growth. When governments do not secure property rights, extra-legal economic activity (such as the black market) thrives, and economies stagnate and decline.

Competition and Openness: Competition spurs innovation, promotes consumer welfare, and can keep corruption in check. To foster economic growth, government cannot close off new entrants that bring competition to markets. For this reason, antitrust laws are in place to address mergers that may “‘lessen competition’” or “‘tend to create monopoly’.”

Technology: When other input factors such as capital and labor are held constant, technological progress is a main driver of long-run growth.

Effects of a Sluggish Economy

Business and Consumers: When companies face weak economic growth, they do less hiring, and the unemployment rate rises. When fewer people are employed, they do not have a stable source of income and are less likely to make nonessential purchases. This in turn creates a cycle of cost cuts and layoffs as business revenues declines. Businesses also have fewer opportunities to grow or don’t get off the ground at all because banks and private investors are reluctant to lend money.

Society: Decreased economic productivity represents a human tragedy. For most people, work allows them to support themselves and their families, gives them independence, and provides an outlet for productive activity. People lose much of their identity when they lose their jobs. An analysis in the journal Lancet Psychiatry found that unemployment was responsible for 45,000 suicides around the world between 2000 and 2011, and unemployment is correlated with increased rates of drug and alcohol abuse.

Government obligations: Almost everyone believes the government has an obligation to provide a safety net for those in need, including those who need temporary assistance due to economic hardship or health problems. But it is important that this net be carefully designed so as not to trap people in dependency on the government. See The Policy Circle’s Poverty Brief for more.

 

The Role of Government

Government Spending

Most government goods and services are not bought or sold on the private market, so it is difficult to assess the effect on GDP. One view maintains there is a “government spending multiplier;” when the government buys $1 worth of goods or services, whoever receives that $1 will spend some of it, which leads to an increase in GDP. Others argue government spending can “crowd out” economic activity because it could replace rather than supplement private sector spending, resulting in a decline in GDP. The money the government spends comes from private individuals and enterprises through taxes, so the core question becomes: Who spends the money more efficiently to create the society we want, taxpayers or the government?

Fiscal and Monetary Policy

Fiscal policy refers to tax and spending policies controlled by the President and Congress. In general, fiscal policy provides for public needs and keeps the books balanced, such as decisions regarding tax reform or the federal budget.

Monetary policy is the wheelhouse of the U.S. central bank, called the Federal Reserve, which is considered independent from the executive and legislative branches (St. Louis Fed). Such actions include buying and selling financial assets to adjust interest rates and influence the supply of money in circulation. These are the big macroeconomic endeavors that balance the entire economy, making sure jobs and wage growth are steady without overheating the economy or causing inflation (Investopedia, The Week). 

For more on the difference between fiscal and monetary policy, see this explainer from the Federal Reserve:

And here’s some background on the Federal Reserve, why it was created, and why some would like it eliminated.

The Big Debate

The role of the government in our economy is heavily debated, and tends to focus on economic equality and growth. Can government design programs to solve all of our salary and economic woes? Or should government only step in to help solve problems that arise in the quest for every American reaching his/her American dream?

Proponents of a strong government role in creating economic equality believe that economic growth is not always the most accurate measurement of overall welfare. They place more emphasis on the government’s role in redistributing income and regulating the economy with the goal of ensuring “a ladder of opportunity is widely available” (Rice University). By supplying members of society with equal opportunities for economic success, policies that reduce inequality may build social support that allow the economy to function.

Most economists will agree that this is a point of diminishing redistributive returns. As this chart demonstrates, increases in equality correlate to decreases in economic output. Cuba provides an example of strong equality driven from low economic output.

Proponents of less government involvement point to unintended consequences from government policies aimed at reducing poverty, which “can injure incentives for economic output.” Government regulations can stifle competition and make it more difficult for businesses to take risks and invest in developing products and services they think people will want. Instead of one person or group of elected or nominated officials, the marketplace is the best organizer of resources, and the trial-and-error process of bringing new products and companies to market is more likely to yield progress for all.

 

Current Challenges and Areas for Reform

During the 2000s, economic growth was slower than in previous decades and the recovery from the crash of 2008-09 was slower than previous recoveries. However, the growth rate is nearing 3%, with a 2.9% average between January 2018 and January 2019, up from 2.3% in 2017 and 1.7% in 2016. Even though some economists still view this as a low growth rate, July 2019 marked 10 years since the Great Recession and the longest economic expansion since 1854. What are the key indicators of this expansion?

Employment

The unemployment rate accounts for individuals who want to work, but haven’t found a job. People who are unemployed but not actively searching for work are not included in the unemployment rate. Low unemployment means there are more job openings than there are available workers, which generally makes employers raise pay to attract new workers or keep current employees. Higher wages gives people more spending power, and more investment in labor can boost production, both of which can increase GDP.

In September 2018, the unemployment rate dropped to 3.7%, the lowest since 1969, and has stayed at or below 4% in the past year. As of September 2019, the rate was 3.5%, representing 5.8 million unemployed persons. There are still 4.7 million part-time workers who want full-time work, and 1.2 million people who have been looking for work for more than six months. Qualifications for certain jobs may be affecting this: A 2019 survey of the National Federation of Independent Businesses found 26% of small businesses “cited the difficulty of finding qualified workers as their single most important business problem.” At the same time,  about 8 million Americans (about 5.3% of all workers) were working more than one job as of September 2019 because their full-time job did not pay enough. Young people, who were hit hardest by the slow recovery, still have an unemployment rate that is more than double the national rate.

Some economists are concerned the low unemployment rate is related to the low labor force participation rate, which measures the active members of the economy, those who are working or actively looking for work. The rate reached a 38-year low of 62.4% in September 2015 and has remained close since; it was 63% in July 2019. Many economists reply that an aging population means there are more people retiring than there are entering the workforce, and more people spending more time in school means a shorter productive period in the workforce.

Income and Wages

Median Household Income is the dollar amount that divides the income distribution into two equal parts, so that half of all households have incomes above that amount, and the other half have incomes below that amount. Families, on average, saw five consecutive declines in median household income between 2008 and 2012. This resulted in increased financial stress on families. Many middle-class families were also demoralized during the slow recovery, finding it difficult to maintain their standard of living due to long hours and stagnant wages.

The positive trend of the past few years has finally brought the average income up: figures for 2018, released September 2019, put the median household income at $63,179, a slight increase from 2017.

What has been the actual rate of wage growth? Average year-over-year wage growth has been approximately 3.2% since the end of the recession, and in recent years has been concentrated at lower income brackets. An analysis from Indeed, a Goldman Sachs analysis of BLS data, and a New York Times analysis of Federal Reserve data all indicate wage growth is strongest for workers in low-wage industries such as retail stores and supermarkets, and is slowest for higher-wage industries such as law firms and telecom companies. Some economists also add that “the changing nature of work,” such as through the gig economy, automation, and digitization, are keeping wages low.”

Taxes

Taxes are collected by state and federal governments to pay for the services they provide, like roads, law enforcement, and schools. The idea that taxes affect economic growth is supported by a 2008 study from the Organization for Economic Cooperation and Development, which found high corporate taxes tend to be the most harmful to economic growth, followed by personal income taxes. An analysis of post-World War II tax changes from Cornell University found reductions in income taxes increase GDP per capita. Think of it this way: “If the government took 100% of your income, surely many people would simply not work…And if the government lowered the 100% tax rate to, say, 80%, it seems very likely that at least some more people would work and the government would take in more revenue” (Time). For more evidence on taxes and economic growth, see this compilation of studies from the Tax Foundation.

In the U.S., the federal individual income tax has seven rates that in 2018 ranged from 10% to 37% depending on the tax bracket. The federal income tax rate has varied widely, reaching a height of 91% for the top rate in the 1960s to a low of 23% after the 1986 tax reform under the Reagan administration (The Tax Policy Center).

In 2018, the worldwide average corporate tax rate had been lowered to 23% from the 1980 average of 39%. The U.S. previously had one of the highest effective corporate income tax rates in the developed world, ranking 4th in 2017. After the Tax Cuts and Jobs Act passed in 2017, the U.S. federal top corporate income tax rate fell from 35% to 21%; it now ranks 83rd out of the Tax Foundation’s ranking of 208 separate tax jurisdictions.

The Tax Cuts and Jobs Act

Passed in December 2017, the Tax Cuts and Jobs Act (TCJA) was the biggest tax overhaul in the U.S. in 30 years. About 80% of taxpayers received a direct tax cut, even though many don’t believe they did. Part of the tax overhaul involved the Treasury Department changing its withholding tables, meaning many tax cuts “came in the form of larger paychecks throughout the year but smaller or no refunds at filing” (Tax Foundation). Wages also rose slightly faster than before the TCJA passed (Tax Policy Center).

The Tax Policy Center estimated a .5% income increase for the bottom quintile and a 2.9% increase for the top quintile. This makes it seem as if the tax cuts were not evenly distributed, but as the chart below shows, the story may be quite different. Those who fall into the lowest tax brackets generally do not have a tax bill due at the end of the year, and may even have a negative income tax as a result of refundable tax credits distributed from the taxes paid by higher earners (Tax Foundation). Therefore, when a tax cut occurs, it naturally will show a higher cut for those paying higher taxes each year.

 

In regards to corporate tax rates, a Congressional Research Service Report released in May 2019 found the corporate tax rate cuts were spent mostly on stock buybacks that benefited shareholders, and a smaller percentage went to increasing wages and investments. 

The law’s design is for long-term economic impact, so it’s difficult to say what the overall economic effects are. Additionally, “the tax cuts didn’t occur in a vacuum,” and many benefits could have been offset by other economic happenings, including trade disputes with China (see more below).

Federal Debt and Deficit

The federal debt is the total amount of money the U.S. government owes, accrued over time. Current U.S. debt is over $25 trillion, meaning the U.S. debt is larger than its GDP. At the beginning of 2020, debt held by the public (government borrowing from the private sector and foreign governments) was over $17 trillion. The remaining debt is intergovernmental debt, owed to another arm of the federal government. In particular, Social Security holds almost $3 trillion in debt.

The federal deficit refers to the annual difference between government spending and government revenue. In September 2019, the Congressional Budget Office (CBO) announced the U.S. deficit topped $1 trillion for the first 11 months of the 2019 fiscal year (the fiscal year runs from October 1 to September 30). Compared to 2018, revenue in the first 11 months of the 2019 fiscal year into the government’s coffers increased but was offset by increases in outlays for Social Security, Medicare, and Medicaid.

The federal debt and federal deficit have impacts all Americans can feel. As the national debt increases, the likelihood that the government cannot pay a debt increases, which means treasury securities (bills, notes, and bonds through which citizens and non-citizens essentially lend money to the government) are riskier investments. Some economists note investors aren’t worried about the debt and continue to borrow, and say the debt should be sustainable as long as interest rates remain low. Others argue that debts we accrue now will just need to be paid later, likely in the form of reduced benefits for services such as Social Security.

Student Debt

In 2008, before the recession, outstanding student loan amounts were about $580 billion. That number has more than doubled to $1.5 trillion in 2019. In 2018, the Levy Economics Institute of Bard College published a study estimating that cancelling the nation’s student debt ($1.4 trillion in 2018) could boost GDP by over $100 billion annually for the following 10 years, and lift the burden of debt from hundreds of thousands of Americans.

Others think cancelling student debt would essentially be a giveaway and doubt debt forgiveness would fix the underlying problems in the higher education system, namely high prices and lack of accountability on loans. They argue implementing loan caps, requiring an “ability-to-pay standard,” and restructuring repayment plans would prevent people from taking on unmanageable debt in the first place, and potentially force colleges to charge reasonable rates to attract students.

It’s all Connected: Other Areas Impacted by Economic Growth

The Stock Market

When it comes to GDP and the stock market, the two are often indicators for each other and for investors. The stock market does not directly affect economic growth but still makes an impact by “influencing financial conditions and consumer confidence.” When stocks are highly valued and people are more optimistic about the economy, companies can borrow more money at cheaper rates “to expand operations, invest in new projects, and hire more workers,” all of which boost GDP. The opposite is also true: “steep market declines can wipe out portions of people’s savings and retirement accounts,” as was the case during the financial crisis in 2008 (NY Times). For more on the stock market and the alphabet soup of stock exchanges, check out this guide from The Skimm. For more on the stock market and its relationship to GDP, see this explainer from CNBC:

 

Trade Concerns

While renegotiation of NAFTA (our trade agreement with Canada and Mexico) into a new agreement (USMCA) was in the news for many months, it has since died down. The new agreement was signed by each country in 2018, and was ratified by the legislature in Mexico in June 2019. We are now waiting to see if the Canadian Parliament and the U.S. House of Representatives will ratify the agreement (CSIS).

In Europe, new tariffs made headlines in October 2019, when the World Trade Organization “authorized President Trump to impose tariffs on about $7.5 billion worth of European goods,” in response to illegal government subsidies the European Union provided to European aircraft manufacturer Airbus. The tariffs will mainly affect agricultural (including French wine and Italian cheese) and industrial products. The EU is awaiting WTO approval to retaliate with its own tariffs based on a similar complaint that U.S. aircraft manufacturer Boeing has also received illegal government subsidies. 

China has been sucking up most of the air due to the so-called “trade war” since the Trump administration began using tariffs at the beginning of 2018 to negotiate fairer trade practices (For more on the basics of tariffs and why the focus is on China, see The Policy Circle’s Trade and Tariffs Deep Dive.)

In September 2019, the latest set of U.S. tariffs hit Chinese goods, affecting technology including TVs, smartwatches, and headphones, and more tariffs affecting the consumer market are scheduled for December 2019. The countries agreed to restart stalled trade talks in early October 2019, the 13th round “in a series of on-and-off negotiations” that began in January 2019. The goal is to reach a negotiated trade agreement before any more tariffs are applied. 

Compared with 2018, imports from China in 2019 are down 12.4% and exports to China are down 17.3%. Other countries, such as Vietnam, are benefitting as companies move distribution from China; the U.S. is importing 40% more from Vietnam in 2019 compared to 2018. Meanwhile, China’s economic growth numbers for 2019 have been the lowest in 27 years, which is likely to have global economic repercussions.

In the U.S., farmers are bearing the brunt of the trade complications, and businesses have mixed feelings about the so-called trade war: in one survey, small business owners said they were optimistic about their finances, as tariffs are only one aspect of economic outlook. Others have indicated the uncertainty tied to tariffs is making it hard to plan.

Interest Rates and the Banking Industry

In response to the trade war, China’s economic slow-down, and falling manufacturing activity in the U.S., Japan, Germany, and the eurozone, the Federal Reserve Bank lowered short-term interest rates for the first time since 2008 in July 2019, and again in September.

Global economic slowdowns and trade tensions have an effect on U.S. GDP, influencing where investments are made and prompting some economists to continue calls for interest rate decreases by the Federal Reserve to “cushion the economy against fears of a broader global slowdown.” President Trump has called for lowering interest rates more, taking advantage of the current strength of the economy and suggesting ideas such as refinancing the debt and aiming for low inflation. Others argue lowered interest rates could signal the Fed expects a deeper economic downturn, which “could have the unintended consequence of triggering a major drop in confidence in the economy.”  Additionally, Most Fed officials are cautious to make sudden and large changes given the trade war with China, as “it involves making assumptions about hard-to-predict geopolitical risks” (WSJ).

 

Conclusion

The U.S. economy may be at a turning point, with some figures illustrating long-term and unprecedented growth while others consistently predict a recession. Regardless, economic growth and, in general, the overall health of the U.S. and global economies affect all American citizens. It is necessary for all citizens to have a strong basis of understanding of economic functions, the keys to economic growth, and the current state of the economy for themselves and their economic security.

 

What You Can Do/Ways to Get Involved

Resources to explore:

Find out who your representative and senators are, and write to them about your interest in our nation’s economic growth. See The Policy Circle’s letter writing guide which outlines how to compose communications to your lawmakers.

Senate Committees

House Committees

You can also engage through philanthropic opportunities and with non-governmental (NGO), not-for-profit organizations. Philanthropy can and should support economic growth. In other words, the goal of giving one’s time, money and talent is to create lasting opportunity for people.

There are many successful private sector-led endeavors that bolster economic growth. They range from women who have been victims of domestic abuse turning their life around and achieving real success to research and investments directing children who are not primed to enter a four-year degree into other options that put them on a career pathway. And impressively, this example of reducing crime rates and rising home values through philanthropy focused on opportunities for kids in preschool and youth in high school.

  • Policies promoting the value of free markets and capitalism. There is a tremendous network of think tanks and research organizations, such as the State Policy Network, that promote free market ideas, policies and philosophy. Policies that promote economic freedom and the right to earn a living, efforts that shine a spotlight on the negative impact of excessive regulation (such as the Institute for Justice), and policies that open the door to quality educational opportunities are the pathway to a better future.  
  • People who need help getting and keeping a job. This could encompass programs for mentoring and training, assistance with finding and keeping housing, daycare and after-school programs and supporting the whole person to promote self-motivation and personal responsibility.
  • Entrepreneurship and business formation. Many people have ideas but don’t know how to turn them into action. Incubators and accelerators, for example, assist entrepreneurs in the journey toward becoming successful companies. Some examples are Endeavor Detroit and Rising Tide Capital. Other options are supporting existing businesses and social enterprises that hire people in vulnerable communities and those in need of a second chance. 

Additional Sources of US Economic Data

Thought Leaders

  • Milton Friedman was perhaps the most well-known advocate of free markets in the last century. A Nobel prize-winning economist, he also wrote for a general audience. Friedman radically changed how the economics profession viewed the Great Depression of the 1930s and the inflation of the 1970s, in both cases showing that mistakes by the central bank were larger factors than market failures.
  • Thomas Sowell is an extremely influential contemporary supply-side economist who also writes articles for popular audiences. He is also well known for his book, A Conflict of Visions, which provides a philosophical treatment of modern politics.
  • Hernando de Soto, a Peruvian economist and president of the Institute for Liberty and Democracy, is known for his work on the informal economy. He argues that sustainable economic growth requires that all individuals have easy access to a strong legal system that protects their property rights.  He argues that respect for the rule of law is critical for developing communities to create opportunity and prosperity. His book, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else, is an excellent primer on why private property rights are so critical.
  • In this touching video by the Values & Capitalism project, learn how an American toy company is fighting poverty in Honduras by giving their workers the means to help themselves.
  • CATO Institute has organized a collection of free-market economists and authors in this online forum to address the question, “If you could wave a magic wand and make one or two policy or institutional changes to brighten the U.S. economy’s long-term growth prospects, what would you change and why?”  To see their answers, click on their photos.

Here are some videos that outline the logic behind a free-market approach:

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