How economists think about growth

The slow growth that has gripped the nation since the Great Recession remains our biggest economic problem.

But to fully understand the issue it is helpful to think about growth the way economists do. This is radically different than how it is typically portrayed in the media.

The typical newspaper or TV description of economic growth reads like an accounting ledger. So, measurements of consumer spending, business confidence or stock prices dominate the media reports. These things are to economic growth as the sniffles are to a cold. They are symptoms which might be treated but are not causes of economic growth or the lack thereof.

Economists approach economic growth in some version of a model that has five broad elements to the equation. These are technology, total productive capital and its quality, and total labor and its quality. In order for the economy to grow, one or all of these things must increase. So, let’s think about them in order.

Technological growth in this model represents broad changes for production, not just new gadgets. Electricity, just-in-time inventory or statistical process control (lean six-sigma) are examples of technology that impact economic growth.

We’ve enjoyed several decades of growth in this area, but there are some influential economists who think many of the most transformative technology changes are behind us. I’m not sold on that notion yet, but I am certain there’s no new technology that will lift us from our doldrums in the coming generation.

We must look elsewhere for deliverance.

Capital is really the productive assets of a society, including both the public goods, such as roads, and the private ones, such as business plant and equipment. Improving the quantity and quality of this growth factor is the reasoning behind capital gains tax cuts and the raft of business tax abatements that form such a large share of the tax environment in Indiana.

Ironically, these tax cuts on private capital may also limit expansion of productive publicly owned assets, such as roads and schools.

Labor is the quantity of available workers and their quality in the workplace. With employment growth an important political bellwether, the focus of much state policy lies in increases the number and education of workers within a state.

Any economist talking about economic growth will be thinking about this growth equation. That is why we hint at policies such as research and development tax credits, while stressing infrastructure, education and a growing workforce. The hope is that these policies will boost economic growth.

In a labor intensive workplace, like a law office, if you want to double production, you probably have to double the workforce. In a capital intensive business, like an auto assembly plant, you may double production wholly through the purchase of new capital and technological improvements. This leads to policy problems that affect the U.S. and Indiana alike.

Both our state and federal tax laws tend to merit capital at the expense of labor. Here in Indiana, this imbalance is worsened by the propensity of local governments to give outsized tax abatements to a select few, typically large, businesses each year. This disadvantages other taxpayers, either through higher taxes or fewer public goods, further reducing the quality and quantity of workers in the economy.

One small step towards bettering our growth prospects would be in a more harmonious tax treatment of capital and labor in our economy. Indiana should become a leader in this, especially now that it is a lot harder to find workers than it is to build a new, tax incentivized business in the state.

Michael J. Hicks is the director of the Center for Business and Economic Research and an  associate professor of economics in the Miller College of Business at Ball State University. Send comments to letters@dailyjournal.net.