Can We Grow Our Way out of Debt?

This post is mostly going to be thinking out loud–I don’t come to a definite conclusion yet. The U.S. faces both a short-term and a long-term fiscal crisis. The short-term problem is the current  gap between government spending and government revenues. Arguably that could go away if the economy recovers.The long-term  fiscal crisis is the gap between anticipated spending on Medicare and Social Security, and anticipated revenues from payroll taxes.

The question on the table: Could an acceleration of U.S. productivity growth (for whatever reason) enable us to grow our way out of the short-term and long-term fiscal problems? Or, more generally, could an acceleration of U.S. productivity growth boost the U.S. national savings rate, enabling us to save our way out of the fiscal problem?

In the past, I’ve answered this question with an resounding yes. I still think it’s yes, but the answer is more complicated than I thought.

The main reason why it should be possible to grow our way out of debt: An  increase in productivity growth–especially one that is not expected–makes the U.S. wealthier and gives Americans higher incomes. One might expect that could increase savings, especially since  higher-income, richer households are more likely to save (see, for example, the Fed’s Survey of Consumer Finances).  Or to put it a different way, income grows faster than consumption can adjust.

The reasons why it might not be possible to grow our way out of debt:

1) Empirical: During the 1990s and early 2000s, productivity growth accelerated, but consumption accelerated more, so that the savings rate dropped and the trade deficit increased.

2) Empirical: The per-capita cost of health care has grown faster than per-capita GDP in the past (see, for example, the CBOs long-term budget outlook).  Assuming that relationship continues in the future, that implies an acceleration of per-capita GDP growth will actually increase the fiscal gap.

3) Legal: Social Security benefits are keyed to average real wages–so if growth accelerates, and wages rise in response,  so do Social Security benefits. That means it is very difficult to grow our way out of Social Security issues.

Let’s take these in reverse order.

3) Definitely true. As I’ve written in the past, the Social Security formula probably needs to be adjusted so that benefits don’t quite track real wages.

2) The long-term excess growth of healthcare costs is very interesting. It’s been variously blamed on institutions that make it hard to control costs;  the excess cost of new medical technologies;  and environmental and social factors (such as increased weight). I personally believe that it represents economic consequences of the innovation shortfall in life sciences that I’ve discussed before–commercially important innovations in areas such as biotech have been few and far between. I would expect that if the pace of successful innovation in the life sciences picks up, that would bring down the rate of growth of health care costs, but there’s no way to test that until it happens.

1) This is the hard one, as far as I am concerned. Take a look at this chart:

I’ve chart ten-year nonfarm business productivity growth against the net national savings rate (productivity growth on the left scale in blue, net national savings rate on the right hand scale in brown). What we see is that the two lines roughly parallel each other, as we would expect, up until the late 1990s. Net savings starts to rise as the productivity acceleration begins. Then, poof,  productivity growth and net savings go in opposite directions. Despite the unanticipated acceleration of productivity–which boosts output per worker–the savings rate collapses.

Taking this chart at face value is bad news for the “grow our way out of debt” thesis. For one, we had a big acceleration of productivity growth, and the debt problem got worse. To put it another way, we produced more output than expected, and savings went down. Second, it’s hard to imagine that we can get productivity growth up much faster than 3% a year.

But let’s think a bit more about what might explain this surprising divergence. Really, there are four possible explanations:

A) Americans might just be profligate, and quickly ramp up their spending when their income increases (this includes healthcare spending, so it takes in #2 above).

B)The derangement of the financial system and the housing market led people to think that they were richer than they really were (the syndrome of the lottery winner who goes broke).

C) Net savings is mismeasured, and we are really saving more than it seems (spending on education, for example, is counted as consumption).

D) Productivity growth is mismeasured, and the productivity acceleration was really less than it seemed.

If American profligacy is the primary problem, then we are probably out of luck…hard to change. If financial excess is the main problem, then financial reform could be a key factor for helping us grow our way out of debt. If underestimates of savings is the main problem, then we have no problem (because the U.S. is really better off than it seems). If overestimate of productivity growth  is the problem, then what happened was that we thought we were richer than we really were, and this led to overspending. (I suspect, for example, that the models for subprime defaults implicitly depended on real wage growth, which is linked to productivity growth).

I personally lean towards D,  as I’ve written before. But like I said, I’m not as sure as I once was that we can grow our way out of debt…and that’s just sad.


  1. Any potential demographic explanations of the increase in spending? Or productivity for that matter?

  2. Brandon W says:

    “An increase in productivity growth–especially one that is not expected–makes the U.S. wealthier and gives Americans higher incomes.”

    If that is the case, why have American wages dropped in the past decade as productivity has skyrocketed?

  3. Yes, productivity has increased but not real wages. There has been no increase in income to save out of. A considerable portion of this is increased spending on healthcare. As this is done through insurance, there is no means to cut costs on it. Innovation, far from improving the situation will only make it worse because there is no reward for cost saving in the current system, only for spending. It would be nice to say this will change, but it will take further action to do so, action against the special interests that have worked so hard to preserve their preferred privileges. Until there are rewards for cost saving there will be no improvement in health costs. As far as SS goes, it is averaged over 35 years so increasing real wages does help since improvement would do little to increase outlays. There is another problem though and that is general spending. It is not being funded through general taxes but SS taxes. SS can mostly pay for itself, but general spending hasn’t done so for decades. We will have to cut this spending or raise taxes to pay for it, there is no way out of that. Government has been living beyond its means for a long long time and it will have to start carrying its own weight. No one wants to talk about that. Instead they pretend it is a SS problem.

  4. Actually I lean more towards B as an explanation. 40 or 50 years ago you paid down your mortgage at a measured rate and if things got tight you called your creditors and asked for time to pay. The “modern” way is when things get tight you extend the line of credit and keep motoring along (I actually did this). Even worse, people were encouraged to become “leveraged speculators” “unlocking” the paid off component of their mortgage to gamble on rising asset prices (I didn’t do this even though numerous spruikers phoned and visited me to encourage me to do so). Somewhere along the line westerners lost the concept of income and savings and changed to a model which focussed on ability to service debt. Great for the banks, but of course an absolute disaster come retirement time. I don’t think it is any coincidence that the “crisis” comes at the same time as the boomers head to retirement.

  5. SMIA1948 says:

    All the U.S. has to do is to get its long term real GDP growth rate up to 3.5% and the whole problem goes away. Just take the most recent copy of the Social Security Trustee’s report, model the next 75 years in Excel, and see for yourself.

    The Trustees estimate that the “present value to the infinite horizon” of the unfunded liabilities of Social Security and Medicare is about $100 trillion. However, at growth rates above the interest rate on government debt (estimated by the Trustees at 2.9%), the “present value to the infinite horizon” of government revenues is infinity.

  6. Galileo says:

    It is remarkable that you can produce this analysis without mentioning:
    1. the adverse role of government in directly growing consumption itself (more money spent on bureaucrats, teachers (whose productivity has declined abysmally with increased spending on education)).
    2. the fictitious contribution of government to GDP. We count money spent on government employees as (a growing) part of GDP, despite the fact that much of it produces no value and much of it is devoted to imposing regulations that reduce private sector productivity. So true GDP has been going down not up, while government numbers say the opposite.
    3. the extended aging of the population, ie not just people getting older but haing longer lives, unemployed but paid for by someone else.
    4. the positive feedback loop of health innovation, ie it finds ways to prolong lives but only at increased cost. The majority of health care and support cost are incurred for the elderly. So health innovation that prolongs elderly life inevitably increases total costs. I make no value judgment about this, but it is a major and growing factor in the fiscal imbalance.
    5. somewhat related to that, the contribution of health care innovation to prolonging the life of the disabled and those with congenital maladies, eg providing what we regard as a reasonably normal life for a haemophiliac costs a fortune. Again, I make no value judgment about this but you should recognise it makes a significant contribution to growing fiscal imbalance.

    Lots of technological developments make no difference to any of this. A superior iPhone or iPad is just an alternative form of consumption. One area that might make a big difference is robotics. Providing, essentially, a vast body of robot slaves to care for the elderly might produce huge productivity gains in that activity and thus reduce the cost of the elderly that otherwise has to be borne by those individuals who are current producers. Barring that, it is all downhill for the economy until the size and intrusiveness of government, and its support of a client electorate, is absolutely slashed (say 75%).

  7. I could write an essay, or I could simply take this excuse to make 2 points I’ve been pondering.

    1) I was as alarmed as the next person at politicians parroting the phrase “deficits don’t matter” in the 2000’s, as I’m sure they didn’t know what they were talking about — there is, however, a respectable school of monetary theory that convincingly argues that for a nation that creates its own currency, it is true, up to a point.

    Wise use of the funds toward a more self-sustaining economy, delicate juggling that respects the fact that nations are no longer closed systems, and honor are all important considerations. Someone might throw the case of Japan up as a counter-example, but I would argue that the Japanese are just fine, except that the stunningly rich seem to have lost the opportunity to become more so, for now.

    2) There is some math that I suspect nobody is doing, or else they’re not telling us. It seems fair to assume that 80 million baby boomers on Social Security will spend nearly every cent of it, plus they will spend a respectable portion of what savings exists, too. This would surely serve as one heck-of-a stimulus. We’ve seen what over-stimulation of housing and finance does, but that should inform us regarding the future. It suggests that large corporations may not be the best allocators.

    It currently appears that we have structured an economy where there is not enough work for everyone and where productivity improvements greatly exacerbate it. Retiring people from the workforce and letting them have the money they anticipated could fire the economy almost to overheating.

    Take SS away, and the burden on kids and grand-kids is beyond overwhelming — it does conjure up commenter Galileo’s vision of robotic warehouses for the elderly, draining the reserves of working families struggling to find opportunity.

    An alternative vision is also never discussed — the withering small and medium sized towns across America, with housing that is currently almost free in comparison to where there are jobs, would be the perfect place for retirees who have nothing better to do than spend their meager funds and ponder self-determination. The gathering spots and entertainment await the inspiration of those who see the possibilities, not of tourism, but of revitalization of the countryside.

    I see signs of a few awakening to the possibilities — New Orleans chefs in the middle of nowhere, tiny remote micro-breweries, and affairs staged in old park bandstands and empty schools. Don’t forget that this is the generation that created the Internet; they are not usually Internet illiterate. Don’t forget, too, that there is a history of the elderly caring for one another as long as humanly possible, and every enabler of that will serve the broader society well.

    I am an uncurable Polly Anna, and I wish that all the doom and gloom that arrived too late to save most people would run its course and drop us into forward thinking again.

  8. true… you know what they say…You will suffer more pain than any other man can endure, but you will get what you want.

  9. Ahaa, its pleasant dialogue on the topic of this post here at this website, I have read all that, so at this time me
    also commenting here.


  1. […] Can we grow our way out of debt?  (Mandel on Innovation) […]

  2. […] Michael Mandel looks into our looming debt crisis: “The question on the table: Could an acceleration of U.S. productivity growth (for whatever reason) enable us to grow our way out of the short-term and long-term fiscal problems? Or, more generally, could an acceleration of U.S. productivity growth boost the U.S. national savings rate, enabling us to save our way out of the fiscal problem?” […]

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