Sunday, June 29, 2014

Why Has Projected Rather than Actual GDP Flattened?

Real GDP isn’t what it should be.

Is this because the actual economy is on a flatter path than we’re projected to be on? Or is it because the projected path has gotten flatter, and we’re approaching it normally?

The CBO revised its opinion in spring 2014 to be consistent with the latter.

There are actually quite a few non-policy reasons why this might be true. But then there’s Obamacare: could this also reduce potential GDP?

Here’s a back of the envelope calculation from Greg Mankiw (quoted in full):

The Affordable Care Act added "about six percentage points to the marginal tax rate faced, on average, by workers in the economy."  So estimates the University of Chicago economist Casey Mulligan

Given that labor income was already taxed by income and payroll taxes, that figure indicates the return to working fell by about 10 percent. If we apply a plausible aggregate labor supply elasticity of 0.5, this in turn suggests a decline in labor supply of about 5 percent. In the long run, as the capital stock adjusts, a fall in labor supply leads to a proportionate fall in output. So we end up with a 5 percent fall in long-run potential output.

That calculation is very, very rough, but it does indicate that the ACA could well be a significant reason why the economy is not returning to its old growth path.

Update: Casey emails me that he believes the GDP effect will be smaller than this (about 2 percent or a bit more) because the impact on less skilled workers is greater than that on more skilled workers.  As a result, the mix of skills will change, and GDP will fall by less than total hours worked.

Note that this would be a permanent reduction in the level of potential real GDP. This says nothing about growth rates, so we would recover that loss with time. However, the transition from a slope with one intercept, to the same slope with a lower intercept (which is what Mankiw is talking about) would require a period of transition of a few years during which growth rates would be lower.

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