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WebMemo #601 on Economy

October 29, 2004

Past. Present! Future? Economic Growth in America

By and

In real terms, America's economy grew by 3.7 percent in the third quarter, faster than most other developed economies around the globe and faster than the historical U.S. growth rate, since 1970, of 3.2 percent. Chart 1 provides a quarter-by-quarter account of U.S. economic growth since 1992.

This morning's third-quarter "advance" gross domestic product (GDP) report is likely to be a key factor in the upcoming elections. Economic news reflects the policy choices made years ago by Congress and the President. This year, the choice expressed by the two parties boils down to a Republican party that has delivered on tax cuts and Democrats who promise greater attention to deficits. This paper puts the recent growth of the U.S. economy in perspective and looks forward at how the two parties' radically different plans may affect future growth and prosperity.

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Past.

The American economy has grown much faster in recent years than many economists thought possible, especially in the wake of the terror attacks of 9/11. A vigorous public policy response turned the 2001 recession into one of the mildest downturns in modern history dating back to 1947, the year comprehensive official statistics were first recorded by the U.S. Bureau of Economic Analysis (BEA).

Since 1970, GDP growth has averaged 3.16 percent per year, after inflation. During President Bush's first year in office in 2001, the economy slipped into and pulled out of a recession and yet overall output managed to grow slightly. Since 2001, real output has grown at an average annual rate of 3.47 percent. This rapid expansion has been concentrated in the five quarters following the 2003 Bush tax cuts. Since the third quarter of 2003, growth has averaged 4.62 percent.

Present!

Smart tax policy is a key ingredient of economic growth, and the tax policy moves of the last three years have had a marked impact on economic activity. This influence has been particularly evident since mid-2003 when the Bush tax cuts were passed by Congress: these cuts created strong incentives for investment, which in turn spurred the American economic engine.

Investment is one of main components of GDP, and also one of most variable. Many observers believed that the investment boom of the 1990s would cause a long-term surplus of plant and equipment, stifling further expansion. Nevertheless, recent indicators suggest that the information technology revolution was real, and booming orders for computer equipment and software are setting records once again. The average rate of investment growth after the 2003 tax cut has been 14.6 percent, compared to the average since 1970 of 5.9 percent. In real dollars, investment is $774 billion higher per year than it was a decade ago. Investment is a sign of a booming economy, and it is driving the productivity revolution that raises U.S. living standards.

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The overall level of GDP (Chart 2) was $9.89 trillion (in 2000 dollars) when Bush was elected and $9.87 trillion in the third quarter of 2001, when the 9/11 terrorist attacks occurred. Exactly three years later, GDP is $10.88 trillion, a 10 percent real increase. To put that in perspective, just the growth of the U.S. economy over the past three years is larger than half of the entire French economy.

Not only is the present growth path of the U.S. economy faster than the historical average, but it has also been roughly double the European economic growth rate since the 2001 tax cuts. According to OECD data, European economic growth has slowed dramatically since 2000, declining from a growth rate of 3.7 percent in 2000 to 1.6 percent in 2004. In contrast, the U.S. economy has strengthened since the 2001 recession, and in 2004, economic growth again reached boom-era levels.[1]

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Chart 3 compares the growth rates of the United States, Japan, and the Euro zone from 1999 to 2004, in real terms. America had higher living standards to begin with, and it has been growing faster to boot. In Europe especially, bigger and more intrusive government has led to a seemingly permanent state of slow growth, with unemployment rates roughly double those in the United States. Greater government intervention combined with slow growth is a recipe for failure that more than a few European nations have begun to reject but unfortunately, that the United States may be starting to emulate.

Future?

Whichever candidate prevails next week will need sharp knives to attack the real problems driving higher budget Deficits, which are runaway government spending and booming entitlements. So the real question is, how does the U.S. maintain superior growth in the face of this spending binge?

Deficits themselves have not been proven to hurt the economy, but they do signal government spending that will have to be paid for by future generations, often with higher taxes. Lower spending is the only solution to the deficit problem that doesn't sacrifice strong economic growth.

The alternative is a still-larger central government that crowds out investment, saps resources from the private sector, and produces the anemic economic growth that much of Europe now suffers.

Next week, the American voter will choose whether to continue on the current economic path or set out on a different one. George Bush promises to keep taxes low, especially on investment, and even proposes reforming the tax code. John Kerry promises to raise taxes on the richest Americans in order to shrink the budget deficit.

For once, Americans truly have a choice between two distinct economic policies, a choice about the country's economic growth and our own prosperity.

Tim Kane, Ph.D., is Research Fellow in Macroeconomics, and Rea Hederman is a Senior Policy Analyst, in the Center for Data Analysis at The Heritage Foundation.

Show references in this report

[1] http://www.oecd.org/dataoecd/6/27/2483806.xls

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