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America’s Growth in the Decade Ahead

CAMBRIDGE – Although the strength of the US economy in 2010 remains uncertain, it is important to look ahead to its likely performance in the coming decade. The rise of GDP over the next ten years will reflect the very positive effect of the eventual recovery from the current deep downturn, combined with a below-trend rise in the economy’s potential output at full employment. When I add up all the key components, I conclude that the coming decade’s annual growth is likely to be about 1.9%, roughly the same as the average rate over the past ten years.

To understand why, let’s start with the cyclical recovery. I’ll make the optimistic but plausible assumption that the economy will fully recover over the next decade, lowering the unemployment rate from the current 10% to about 5%. That return to full employment will also reduce the number of people who, discouraged that no jobs exist for those with their skills, have stopped looking for work (and are therefore not counted as unemployed).

That cyclical recovery of employment will cause GDP to rise by about 13% over the next decade, or an average of 1.2% per year. That represents a substantial turnaround from the past decade, when the unemployment rate rose from 4% to 10% and the labor-force participation rate fell from 67% to 65%, reducing GDP by about 1.6% per year.

The full rise in GDP will combine the 1.2%-per-year cyclical rebound with the increase in potential full-employment GDP. The growth of potential GDP will reflect the structural rise of the labor force, the increase in the capital stock, and the improvement in multifactor productivity (i.e., the change in the output that results from improvements in technology rather than from increases in labor and capital.) Although there are uncertainties about each of these components of growth, their performance in the coming years is unlikely to be as good as it was in recent decades.