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U.S. GDP Growth is Slowing. Should We Worry, or is Growth Overrated?

GDP growth is slowing. The latest release from the Bureau of Economic Statistics shows that U.S. real GDP slowed to 1.9 percent in the third quarter of 2019, down from 2.0 percent in the summer and 3.1 percent last spring.

By conventional reasoning, the slowdown is bad news. After all, doesn’t a rising tide lift all boats? Alas, it does not.

The story as told by the data

As I have detailed in previous posts, recent GDP growth has been accompanied by a steady increase in inequality and an actual decrease in the real incomes of the poorest fifth of American households:

What is more, trends in the inequality of wealth are even gloomier than those for income. The real net worth of the bottom half of the population has fallen in the past 30 years, despite a 52 percent increase in real GDP per capita. During the Great Recession, soaring debts and falling home values completely wiped out the net worth of the average household in the bottom half of the income distribution. The debt-to-asset ratio of these households remains high above historical norms despite ten years of recovery.

But income and wealth are only part of the picture. Many other things affect our quality of life, including health, environmental quality, access to education, inclusiveness, and personal freedoms. Those things can’t be measured in dollars and cents, but that doesn’t stop people from trying to measure them.

One of the best attempts to track these many sources of human welfare is the Social Progress Index (SPI), published annually by the Social Progress Initiative. Each country’s overall SPI score is compiled from 50 separate indicators. Some of these are subject to objective measurement, such as homicide rates or years of schooling. Others are based on more subjective surveys or expert assessments, such as an index of perceived corruption (from an international survey by Transparency International) or perceived acceptance of gays and lesbians (based on a Gallup World Poll). Here is a link is for the complete SPI methodology and data sources.

Despite the name, the SPI is not a “progressive” project in the sense that the term is used in American political discourse. It encompasses indicators of institutional quality, political rights, religious freedoms, and freedom of speech that are valued across the political spectrum.

The United States scores well, but not spectacularly, on the SPI. Some 25 countries rank higher, including seventeen members of the European Union, plus Switzerland, Norway, Iceland, Canada, Australia, New Zealand, Japan, and South Korea. The U.S. falls farthest behind the top 25 in the categories of health, personal safety, environmental quality, and inclusiveness. It leads the others by the greatest margin in access to advanced education.

The fact that the top 25 are all high-income countries makes it clear that a strong economy does help in achieving high SPI scores, but the relationship of GDP to SPI is not as simple as one might think. Consider the following chart, which shows the relationship of GDP per capita to the SPI for a broader sample of 141 countries,* including many of the poorest in the world. The top 25 shown as orange dots in the chart are selected by income, rather than SPI scores, although most fall into both groups.

Three things stand out in the chart:

1. The overall relationship between GDP per capita and the SPI is strong. Countries are grouped tightly around the trend line. The coefficient of correlation between the SPI and the log of GDP is 0.92. (A correlation of 1.0 would indicate a perfect fit.)

2. The relationship is nonlinear. The wealthier a country, the smaller is the effect of an additional $1,000 of per capita GDP on noneconomic measures of wellbeing.

3. The relationship between GDP and the SPI is tighter at the bottom of the income scale than at the top. For the poorest 20 countries — those as poor or poorer than The Gambia ($2,318 per capita GDP) — the correlation between the SPI and the log of GDP per capita is 0.90. For the wealthiest 20 countries — those as wealthy or wealthier than New Zealand ($35,628 per capita) — the correlation is just 0.27.

Overall, then, the data lead us to reject the hypothesis that a rising tide lifts all boats, at least for countries that are already wealthy. In the United States, growth of GDP, in recent years, has been accompanied by rising inequality of both income and wealth. The Social Progress Index is not available for as many years as data on income and wealth, but it is ominous that the U.S. SPI score has slipped from 84.74 in 2014, when the index was first published, to 83.62 in the 2019 release. The fact that the cross-country association between GDP and the SPI is low for high-income countries strengthens the conclusion that further growth of GDP per capita buys relatively little in terms of human welfare if your country is already rich.

Where do we go from here?

The data that we have reviewed do not show that economic growth, by itself, is actually bad. What they do show is that a narrow focus on growth of GDP, at the expense of equality, health, education, personal freedom, and environmental quality, is not the smartest way to achieve a better quality of life. Look again at our chart and compare two possible strategies for the future.

One strategy would be that followed by the current administration, which has made an all-out effort to get GDP growth up to 3 percent per year. Unfortunately, that policy has been implemented in a way that risks undermining key elements of the quality of life, by making it easier to pollute our country’s air and water, reversing progress toward broader access to health care, and cutting taxes for the wealthiest households. At best, if that strategy worked perfectly (which it is not doing), it would move the country to the right along a trajectory well below the GDP/SPI trendline. Even a decade or more of growth along such a path would leave the United States with a quality of life well below that of our high-income peers.

The other path to the future would accept slower growth of one or two percent per year in per capita income, while addressing social and environmental problems directly. It would involve policies strengthening, rather than weakening, environmental standards; broadening access to health care; and strengthening early childhood education while making access to America’s highly rated system of higher education more affordable. To the extent that such policies put a strain on the budget, they could be accompanied by a reversal of recent tax cuts for the wealthy. If such a strategy were successful, it could, over time, move us in the direction of countries like Switzerland or Norway, which have both higher GDP per capita than the United States does now and higher scores on the Social Progress Index.

The choice is ours.

*Footnote: GDP per capita as shown in the chart is adjusted for inflation and is stated at purchasing power parity to remove distortions caused by exchange rates. Data on both GDP and the SPI are available for a total of 148 countries. Seven outliers are omitted from the sample shown in the chart. Four of the omitted countries are Gulf oil states that have very high GDP per capita but low SPI scores. Three additional countries — Ireland, Luxembourg, and Singapore — are omitted because high shares of foreign workers and/or foreign ownership of businesses mean that their GDP data greatly overstate the actual incomes of their citizens. If the seven omitted countries were included in the chart, the relationship between GDP and the SPI would be substantially weaker, with a correlation of 0.72 for the complete 148-country sample rather than 0.92 for the 141 countries shown in the chart. In fact, including the outliers would misleadingly suggest that GDP growth has a negative effect on the quality of life for high-income countries, rather than the weak positive effect shown in the chart.

Economist, Senior Fellow at Niskanen Center, Yale Ph.D. Interests include environment, health care policy, social safety net, economic freedom.

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