<b>Ruchir Sharma:</b> Why Donald Trump can't make it 1981 again

Falling population growth means every class of countries needs to adopt new math of economic success

As if Donald J Trump’s victory wasn’t surprising enough, the economic reaction has been even more stunning. Despite forecasts of a stock market meltdown if he won, the market registered one of its strongest post-election rallies in more than a century. Now the euphoria is spilling into the wider economy, with business confidence skyrocketing and consumer confidence hitting a 15-year high. Much of this excitement is inspired by a growing consensus that Mr Trump could be the most-business friendly President since Ronald Reagan.

Indeed Mr Trump’s advisors say that over the next decade, their plans for tax cuts and deregulation could push the average annual growth rate back up to 3.5 per cent — the same as during the Reagan presidency. Mr Trump says the country can grow even faster. His backers dismiss sceptics as defeatists and have insisted there is “no law of nature or economics” that would prevent the US from reviving the boom of the 1980s.

Only there is such a law. The forces that underlie economic growth have weakened significantly since the Reagan years, worldwide. No nation, no matter how exceptional, can try to grow faster than economic forces allow without the risk of provoking a volatile boom-bust cycle.

The potential growth rate of an economy is roughly determined — and limited — by the sum of two factors: Population and productivity. An economy can grow steadily only by adding more workers, or by increasing output per worker. During the Reagan years, both population and productivity were growing at around 1.7 per cent a year, so the potential US growth rate was close to 3.5 per cent. In short, Reagan did not push the nation’s economic engine to run faster than it could handle.

When Mr Trump and his advisors promise to make America great again, they are in effect envisioning Reagan 2.0, while overlooking how much has changed. In recent years, America’s population and productivity growth have fallen to around 0.75 per cent each, generously measured, so potential economic growth is roughly 1.5 per cent, less than half the rate of the Reagan era. Any policy package that aims to push an economy beyond its potential could easily backfire — in the form of higher deficits and inflation.

The population and productivity formula is well known and undisputed — yet widely ignored amid the current euphoria.

In the last 1,000 years, no economy has ever broken free of the limits imposed by population growth. Before the late 19th century, global population growth did not exceed half a per cent, and global economic growth did not exceed one per cent for any sustained period. Before World War II, population growth increased to one per cent, and economic growth accelerated to about two per cent. After the war, the baby boom pushed population growth toward two per cent, and economic growth rose to nearly four per cent for the first and only time in world history.

Now, as families around the world have fewer children, global population growth has fallen to about one per cent. The baby boom has gone bust, and the best any nation can do is contain the economic damage. With the US population growth rate falling — last year to the slowest rate recorded since the 1930s — it is extremely unlikely that any President could juice the economy to grow at a steady 3.5 per cent or more over the next decade.

Slow population growth undermines the economy by delivering fewer young people into the work force. Nations can partly compensate by raising the retirement age or admitting more immigrant workers. Mr Trump, however, has no such plans. His advisors focus instead on bringing back the many American workers who have given up on finding jobs and dropped out of the labour force. But this strategy can have only limited effect. The main reason fewer workers participate in the nation’s labour force is not that they are discouraged, but that they are over 55, the age when many people stop working or work less.

In general, commentators who believe the US can go back to the 1980s focus not on population but on productivity. They argue that Reagan-style tax cuts and deregulation can increase investment in new plants and equipment, and substantially raise output per worker. But productivity is much harder to measure and forecast than population.

Rather than enter that foggy debate, then, let’s assume Mr Trump’s team can more than double US productivity growth to the rate achieved in the Reagan era, 1.7 per cent. Given the irreversible fact of slowing population growth, that productivity miracle would still raise the potential growth rate of the domestic economy to only around 2.5 per cent. If that doesn’t sound so different from 3.5 per cent, consider that every percentage point of growth in the domestic economy is worth more than $100 billion — the difference between feeling pretty good and Great Again.

Illustration by Ajay Mohanty

The nub of the problem here is nostalgia for a bygone era. The post-war world grew accustomed to the rapid growth made possible by the baby boom. Not every country with rapid population growth enjoyed a steady economic boom, but few economies boomed without it. And for most countries, the era of population growth is now over.

The pressure of falling population growth means that every class of countries needs to adopt a new math of economic success, and bring its definition of strong growth down by a full point or more. For developed nations like the US, with average incomes over $25,000, any rate above 1.5 per cent should be seen as relatively good.

Comparing US growth unfavourably to China’s, as Mr Trump has, makes little sense because poorer countries always tend to grow faster. If your starting income is lower, it’s much easier to double it. But slowing population growth is also weighing on countries in China’s income class, and for them the baseline for economic success should also be revised downward, to around four per cent.

The risks of excessive ambition are real. In recent years the actual growth rate of the US economy has been about two per cent, which is disappointing in comparison with the 1980s, but far from horrible, given its diminished potential. Often, if a country pushes the economy to grow much faster than its potential, it will start to suffer from rising debts and deficits. Inflation will rise, forcing the central bank to raise interest rates aggressively, which can prompt a recession. This risk is particularly high at a time, like the present, when the US is already running the largest deficit ever recorded at this stage of an economic expansion.

It will be difficult to persuade people to accept the reality of slower growth. Voters in many countries are already turning to populists who are promising miracles and attempting nationalist economic experiments. The coming era is likely to bring more such experimentation and diversion, but the new math of slower growth will remain.
 

Ruchir Sharma, author of ‘The Rise and Fall of Nations: Forces of Change in the Post-Crisis World,’ is chief global strategist at Morgan Stanley Investment Management

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