Sunny Forecast

An economist's view of the world generally boils down to “every silver lining has a cloud.” Our reputation as dismal scientists, fair or not, makes us especially grateful when we find something to be optimistic about. In that vein, there's one development over the past decade that makes even us feel brighter about the future: the acceleration in productivity growth. Productivity measures economic output per hour of work, and thus offers a basic measure of how fast living standards can rise.

Since the mid-1990s, productivity has been growing at least 1 percentage point faster per year than it was over the prior few decades. This genuinely happy news is particularly relevant to one of today's most pressing political issues, as faster productivity growth will help to fill the Social Security financing gap.

Now that even the president seems to understand that private accounts won't restore solvency to the system, talk has turned to tax increases, benefit cuts, and raising the retirement age. But before we go there, we need a better fix on the impact of faster productivity growth.

Last month, the Social Security trustees released their highly influential report on these matters. They ignored the reality of faster productivity growth, and in doing so, gave us an overly pessimistic estimate of the income that the economy will generate over the forecast horizon.

Starting in 2004, the trustees began basing their estimate of future productivity on the simple average of productivity growth during the last four complete business cycles, covering the years 1966 to 2000. While looking at complete business cycles is defensible (productivity varies a lot depending on where the economy is in the cycle), focusing exclusively on the past four seems rather arbitrary. The middle two cycles in their calculation -- the '70s and the '80s -- saw dismal productivity growth of 1.2 percent and 1.3 percent per year, respectively, driving the trustees' pessimistic forecast of 1.6 percent for the future.

Had they instead used, say, the simple average of productivity growth over the past 10, 20, 30, 40, or 50 years, they would have come up with a higher estimate. Had they used the simple average of all complete business cycles since 1947, they would have come up with a higher average. In short, based on past economic history, the trustees' numbers look far too pessimistic.

There's a further problem with the trustees' backward-looking method of forecasting: It fails to account for the recent productivity benefits associated with our greatly increased use of information technology. More often than not, economists are hard-pressed to explain why productivity growth waxes or wanes, but as productivity expert Dale Jorgenson recently wrote, the post-1995 acceleration of productivity is “well documented and widely understood.” This is important, because if the growth surge were a mystery, embedding it in our projections would be reckless. But given the safe assumption that our utilization of information technology will continue to enhance efficiency, ignoring the new trend is to err far too much on the side of caution.

Economists' confidence in the persistence of the new productivity growth regime is evident in the consensus of our productivity forecasts, all of which are well above the 1.6 percent used by the trustees. For example, Jorgenson's latest forecast for the next decade, as well as that of president's own economists, is well above 2 percent per year.

Due in part to this unnecessarily cautious productivity assumption, the 2005 trustees' report forecasts the 75-year actuarial deficit in Social Security as a bit over 0.6 percent of gross domestic product. A rule of thumb is that each 1-percent increase in the productivity forecast reduces this deficit by a little more than 0.3 percent, so using the Bush administration's own projections of productivity growth would reduce the Social Security shortfall by a third.

That still leaves a gap that needs our attention, but acknowledging the best evidence on productivity makes it seem, correctly, a lot more manageable. With faster productivity growth, we can continue to provide social insurance to our elderly, widowed, and disabled citizens, with less sacrifice than would otherwise be the case. In a debate characterized by lots of misinformation about impending crises, we shouldn't ignore this significant economic bright spot.

Jared Bernstein is the senior economist and Josh Bivens is an economist with the Economic Policy Institute, a nonprofit, nonpartisan think tank in Washington, D.C.

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