(Maybe ) you can reform your way to growth

by tribsantos

Dietz Vollrath has a post doubting John Cochrane’s defense of the possibility of 4% growth. Vollrath’s argument is that  even a “massive” increase in potential GDP would only increase growth by some 0.4 percentage points, so that growth would only be 3.3%. The problem with the argument is that it assumes what it is trying to prove. How do we know if an increase in potential GDP of 18% is massive? We hardly ever think in terms of potential GDP, which makes it very hard to think intuitively about what is a realistic change and what is not. Growth, on the other hand, is something we are used to thinking about everyday, and as Cochrane points out, there have been several instances of 4% GDP growth at different times in US history, so that should give some idea about what is massive after all.

Vollrath argues that the US does not have room for the kind of change seen in China after reforms. I agree and I suspect that Cochrane would agree too. But China has not been growing 4% a year. It has been growing at an average of almost 10% for 25 years. Plugging in the numbers in Vollrath’s own formula, we have that reforms in China increased potential GDP by 4.5 times! That is 9 times the increase suggested by Cochrane – and by Vollrath’s own account the change was achieved by reform.

If we look at a list of countries by GDP per capita PPP (and assume that on average countries are at their potential) we are reminded of how wildly per capita gdp may vary. Singapore’s income is 130 times the income of the Central African Republic and more than five times the world average. Now you might argue that I’m not making a fair comparison by comparing the US with Singapore or the CAF – it would be better to compare the US with its peers. But that would be a circular argument. Of course the US has income very close to that of its peers, that’s what makes them peers.

Also, the US has policies that closely resembles that of its peers. Most notably, none of the countries in Europe – the usual suspects for comparison – adopts policies that come anywhere close to the level of economic liberalization that Cochrane suggests. In fact, I can think of only one country that is somewhat similar to the one suggested by his blog post: Singapore. Their income per capita? 82k or 151% that of the US. That’s awfully close to the 53% increase in potential GDP which would be required for the US to achieve 4% growth. This is what I call a funny coincidence.