“We think some of the more pessimistic researchers underestimate the potential for innovation to continue to permeate throughout the economy.”
We believe the US’ potential growth is mostly a factor of technological progress. Ultimately, we see growth tending to converge towards the growth rate of innovation, especially for an economy that is already considered to be at the ‘technological frontier’. Based on this premise, our estimate for potential average US growth is 2.25% per annum for the next 10 years. This figure is above most mainstream estimates, including those of the Congressional Budget Office (CBO, 1.9%) and the Federal Reserve (1.8%).
We assume labour force growth of 0.6% per annum over the next 10 years, close to the CBO’s 0.5% forecast. The productivity leg is where there is more uncertainty, and where our optimistic bias is most pronounced. We believe productivity growth in the US will pick up modestly over the next 10 years, to 1.5–1.6% per annum. We find it unreasonable to expect productivity to grow by just 1.0% per annum, as has been the case over the past 10 years. We think some of the more pessimistic researchers underestimate the potential for innovation to continue to permeate throughout the economy. We do not think the potential for digitalisation, automation and artificial intelligence has yet been fully realised, such that productivity growth could surprise to the upside in the coming years1.
The strong underpinnings of the US economy remain in place. The US’ top three strengths are its singular combination of top-notch universities coupled with an entrepreneurial ecosystem that facilitates the diffusion of innovation, its relatively liberal labour market and immigration policies, and its financial system, which is particularly successful in connecting entrepreneurs with capital. Additional strengths include its sizeable, federally funded military-industrial complex with important spillovers into the civilian space (think GPS technology) and its sizeable domestic market, allowing firms to reach scalability rapidly. Collective psychology matters too, with high optimism and high risk-taking proclivities, and a strong belief in the ‘American Dream’ inherited from the early settlers. Pension funds that tend to have a default 100% allocation to equities tell us a lot about this distinctive, pro-risk American mentality. This US ‘model’ is not easily reproduced elsewhere.
Given our bullish view that US growth in the coming years will be driven mostly by gains from technology and its diffusion, we have pared down our long-term inflation forecast in our central scenario. Given our view that technological progress will remain a significant dampener on inflation, we now see the consumer price index averaging 1.75% per annum (previously 2.0%) over the next 10 years.
In our alternative, more negative scenario, the US could undergo a ‘populist regime shift’, driven mostly by a deteriorating domestic political environment. In this case, we think that the innovation growth drivers would ultimately be stifled by short-termist, demand-driven policies that end up backfiring on the US economy, driving inflation significantly higher.
1 We share the views of Lee Branstetter, Daniel Sichel in ‘The Case for An American Productivity Revival’, Policy Brief 17-26, Peterson Institute, June 2017