The Right Cure for What Ails Our Economy

Writing good policy is very much like seeing a skilled intern­ist. First, the doctor decides that you really are sick. Next, he determines exactly what's wrong. Only then does he choose an appropriate prescription. Too much of policymaking ignores these steps, opting instead to focus on what the public supposedly wants to hear, with a prescription tailored toward public relations. Fortunately, the tax plan prepared by House Republicans does not fit this mold and is exactly targeted at the economic ills that afflict our country.

First, let's establish that the American economy really is sick. From 2011-2016, we observed the poorest economic expansion on record. Usually, recoveries from sharp recessions are equally sharp. This recovery was a dud. Barack Obama was the first president without a year of 3 percent real GDP growth while in office. Further, from 2011-2016, annual growth averaged more than a full point less than growth from 1965-2010, a period that includes drag from multiple recessions. Similarly, growth in real personal incomes and wages lagged behind the long-term historic average, and by several measures income inequality increased.

Second, the diagnosis. Three factors drive an economy: growth of the labor force, growth of the capital stock, and what economists call total factor productivity—how much output is produced by each unit of labor and capital. The poor economic performance of late cannot be blamed on the labor market. From 2011-2016, employment expanded rapidly, though the wages paid by those jobs were decidedly subpar. But from 2011-2015 (the last year for which data are available), capital formation plummeted—by almost 50 percent compared to the average annual growth rate observed from 1965-2010. Total factor productivity declined even more, from a long-term historic average of 1.1 percent to just 0.4 percent, a plunge of nearly two-thirds.

Productivity growth arises when individuals move from the jobs they're used to into new jobs that allow them to better apply their talents. Such a change almost always involves receiving a raise because the new, more productive use of a person's time affords them greater compensation. Creating these more attractive jobs depends on the birth of new businesses. These businesses often explore fresh market niches and must do so successfully to avoid being swallowed up by the competition. So, by definition, they are more productive. Investment is directly linked to this process since new businesses frequently require the latest state-of-the-art capital to take off.