Finding the Trend

The graph above illustrates the growth in the GDP in the United States in constant 2000 dollars from 1949 to 2006. The data used were from the St. Louis Federal Reserve. I’m going to use that graph as a base for musing a bit on assumptions about GDP growth as a way of explaining my concerns about the current economic downturn.

Those hardy few who are still hoping for V-shaped recession, a recession in which the economy quickly resumes the growth pattern before the recession in a trend something like this:

I don’t think that scenario or even the U-shaped scenario in which growth returns to the previous pattern more slowly is a likely one for reasons I’ll explain later in the post. There are other possible trends. For example:

That’s a scenario in which a new trend is established from the previous dip. If that’s what happens we would experience something more like the U-shaped recession. Still not too bad.

The problem I have with both of these is that they’re naive. Economies aren’t just lines on a graph or bars on a chart. They’re composed of human behavior, decisions, and events. Let’s consider that topmost graph a little more closely. From 1949 to, roughly, 1984 the graph proceeds upward on a fairly stable basis. Then in 1984 things suddenly take off. After the downturn in the early 1990’s the climb upwards resumes at a similar rate until the downturn of the early 2000’s after which in continues to climb a third time.

I would submit that those three inflection points actually represent the beginnings of bubbles, first a stock bobble, then the dot-com bubble of the 1990’s, and, most recently, the housing bubble, the collapse of which’s effects we’re feeling right now. I would further submit that all three of those were largely produced with borrowed money, with leverage.

My working hypothesis from that is that, unless you believe that we’re going to start borrowing like mad again, returning to the heady growth we’ve seen over the last 25 years or magically find some way to grow at that rate without borrowing, we’re unlikely to see that sort of growth. Imagine if we’d just continued growing at the rate at which our economy grew from 1949 to 1984, something like this:

That represents a year-on-year GDP growth rate of a little under 3.25%. I think that’s actually a bit pessimistic since I think that some of that leverage-based froth must certainly have translated into increased economic growth in the underlying economy. However, one thing I think we should keep in mind is that’s not unlike the growth that other developed economies have seen over the last 25 years. It may be that we aren’t quite so special after all.

In this post I’m not trying to lay down the law or make any claims about what actually is happening. What I’m trying to do is more along the lines of a thought experiment. I’m trying to open the floor to a discussion of what might happen.

One last point: I think one’s assumptions are an important consideration when you’re thinking about policy. Right now I think the policy is aimed at the impossible and likely undesireable: returning the growth rate back to 2006 levels.

12 comments… add one
  • Eric Rall Link

    Why are you fitting a linear trendline rather than an exponential trendline? I’d think the sustainable growth potential of the economy would be proportionate to the size of the economy.

  • I’m doing the simplest possible thing, just for visualization purposes (and because I’m not an artist). I do think it’s interesting that a simple linear fit works so nicely until the early 1980’s and that a different linear fit works so nicely thereafter (although I didn’t draw that). That could be explained, as you imply with your comment, by a significantly larger economy after that point. Or it could be explained, as I think is more likely, by a series of artifacts.

    Is there a reason to believe that economic growth should increase with the size of the economy? The experience in other developed economies seems to suggest otherwise.

  • Eric Rall Link

    A 3.3% growth rate matches the curve almost perfectly from the start of the data until the current recession. We see it deviate very slightly above or below the trendline, but it always returns to it. The dot-com bust and the succeeding soft recovery look like a normal slightly-below-trend deviation, and then the financial crisit hits and the actual line dives way below the trendline — it’s by far the biggest deviation from trend of the entire dataset.

    Over relatively short segments, a linear trendline can be a very good approximation of exponential growth, especially a very shallow growth curve like the postwar US economy.

    The limiting factors on GDP growth are population growth and per-capita productivity. Population grows roughly exponentially, and productivity in a first-world country grows roughly with technological growth, which is also exponential.

    In developing countries which have suddenly gained access to first-world technology, or which have had radical institutional shifts which make them more conducive to economic development, they tend to have a different shaped growth curve. Same with first-world countries that have their infrastructure devasted by major wars. In these countries, the limiting factor on productivity growth is infrastructure, and there’s a lot of low-hanging fruit in developing or redeveloping infrastructure where a small amount of capital will enable a large amount of productivity, so these countries go through a period of very rapid exponential growth before their infrastructure catches up with first-world standards and their growth rate slows to the first-world norm of about 3%.

  • As I said in the body of the post, Eric, I don’t have a well thought out idea here, I’m just noodling.

    Essentially, you’ve articulated my point better than I did myself if one addition is made. We achieved roughly 3.3% year-on-year growth over the past 57 years or so. However, for the last 25 years that growth has had a somewhat different character which I think is apparent from the graph. I see management and the management had a target of achieving the 3.3 or so percent.

    You can take the position that the increasingly heroic measures and the historically unprecedented degree of leverage that have been applied, especially in recent years, were irrelevant to the growth or you can take the position that the measures and leverage caused the growth. I don’t see how one can take both positions at the same time.

    That the measures were irrelevant seems incredible. Possible but incredible. I incline to the position that the measures and leverage created the growth and they are unsustainable.

  • Eric Rall Link

    It’s my position that real, sustainable growth is driven by technology and process improvement and private-sector investment, but government intervention has the ability to manufacture a boost to measured GDP. Measured GDP works by adding up what everyone pays for the goods and services produced by the economy, and the government can alter it at will by paying top dollar for useless goods and services. In the short term, this improves measured unemployment (by creating welfare handouts disguised as productive work) and measured GDP, but in the long run it diverts resources away from useful and productive work and slows true economic growth by reducing true productivity.

    To summarize, I pretty much buy Arnold Kling’s “recalculation” theory of the current recession. The phony-baloney stimulus portion of the economy is collapsing under its own weight despite the government’s best efforts to prop it back up, and we’re in the midst of a painful readjustment period as the economy finds useful and productive work for the people and infrastructure freed up by the collapse.

  • Eric Rall Link

    If I’m interpretting what I’m hearing from you correctly, it sounds like we agree about 80% on this.

  • steve Link

    As you note, the change occurred at about 1980. That is when we began deficit spending. We need to pay down the debt. That alone dictates we will see smaller GDP growth.

    Steve

  • Eric Rall Link

    We’ll see smaller growth in measured GDP, but actual production may grow faster than it was before if we pay down the debt by reducing spending (freeing resources for productive uses) rather than by raising taxes.

    Of course, reducing spending by anywhere near enough to balance the budget requires freezing entitlement spending, or at least limiting its growth to sustainable levels, which doesn’t seem to be very politically feasible unless the alternative is something even worse (like defaulting on the debt or massive tax increases).

  • Yes, I think we’re in material agreement, Eric. We articulate it a little differently.

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