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The Boom Is Coming, and Sooner Than You Think

A. Gary Shilling is president of A. Gary Shilling & Co., a New Jersey consultancy, and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.”
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I disagree with the economic pessimists who believe, as I outlined in yesterday's column, that persistently slow growth will be the norm for years to come.

Yes, huge federal government deficits and debt are a major drag. It's also true that budget surpluses aren't likely to materialize to shrink the $17 trillion-plus national debt, even if growth resumes.

Nevertheless, there is a strong possibility that government debt relative to gross domestic product will fall appreciably, as it did after World War II. Back then, deficits were relatively small, so GDP outran gross federal debt. The debt-to-GDP ratio dropped from 122 percent in 1946 to 43 percent 20 years later.

The ratio fell even further in the late 1960s and 1970s as inflation, caused by rapidly rising federal spending on Vietnam and Great Society programs, pushed taxpayers into higher tax brackets and filled government coffers. Higher corporate-tax revenues also resulted from under-depreciation and inventory profits.

A more recent example of a reduction of the federal debt-to-GDP ratio came in the 1990s under President Bill Clinton. Robust nominal growth of 5.5 percent a year caused deficits to shrink so much that small surpluses existed in fiscal years 1998 to 2001. Federal tax receipts rose 7 percent on average, faster than nominal GDP, and outlays grew slower, at 3.6 percent. The dot-com bubble lifted individual income-tax receipts at an 8 percent annual rate and corporate taxes by 8.3 percent a year.

On the outlays side, national defense spending fell 0.2 percent a year as the Cold War ended. Medicare spending jumped 7.2 percent annually but was only 7.8 percent of outlays in the 1990s. Social Security spending climbed 5.1 percent a year, less than social-insurance receipts.

In contrast, in the 2000-2012 years, nominal GDP growth slowed to 3.9 percent while anti-recessionary tax cuts and rebates shrank federal receipts' annual growth to 1.6 percent. Outlays climbed at an average 5.8 percent rate, driven by Iraq and Afghanistan spending and by Medicare outlays. Not surprisingly, the resulting huge deficits drove gross federal debt-to-GDP to 103 percent in fiscal 2012.

The message is clear: Rapid economic growth pushes down the federal debt-to-GDP ratio directly as the denominator rises. Rapid growth indirectly affects government debt, too, as taxpayers get pushed into higher tax brackets, corporate profits grow faster than the economy, and tax cuts and government spending on social-welfare programs are curtailed.

Conversely, slow economic growth, as in the 2000-2012 period, pushes up the ratio directly. It climbs even more as the weak economy spawns tax cuts and counter-cyclical outlays.

So the resumption of rapid economic growth is the answer to the federal debt problem. Of course, the 800-pound gorilla in the room is the need for greater Social Security and Medicare outlays for retiring post-war babies. So far, Congress and the Barack Obama administration prefer gridlock to solving the looming entitlement-spending explosion. The more time passes, the more disruptive the solution must be. I believe, however, that Washington will do the necessary thing when there is no other choice.

As for the Reinhart-Rogoff argument -- that high government debt depresses GDP -- my view is that government debt doesn't depress economic growth, as they contend, but the other way around. Slow growth depresses tax revenue and raises government social spending, causing deficits and debt levels to rise.

Robert Gordon, the Northwestern University economics professor I mentioned in yesterday's column, isn't the first to posit that everything worth inventing has been invented. In his 1843 report to Congress, Patent Office Commissioner Henry Ellsworth said: "The advancement of the arts, from year to year, taxes our credulity and seems to presage the arrival of that period when human ingenuity must end."

I believe much of today's new technology -- the Internet, biotechnology, semiconductors, wireless devices, robotics and 3-D printers -- is in its infancy. Collectively, they have the potential to rival the rapid growth and productivity-generating effect of the American industrial revolution and railroads in the late 1800s. Mass-produced autos and the electrification of factories and homes, which led to electric appliances and radio in the 1920s, offer yet more examples. Today, only a third of the world's population is connected to the Internet but 90 percent live within range of a cellular network.

Sure, productivity (output per hour worked) grew by only 1.5 percent from 2009 to 2012, but that's normal after a severe recession. I expect it to return to a 2.5 percent annual growth rate -- or more -- after deleveraging is completed in another four years or so. Even in the 1930s, productivity averaged 2.4 percent a year, higher than in the Roaring '20s. In the 1930s, much of the new technology from the 1920s -- electrification and mass production -- was adopted despite the Great Depression.

Rapid productivity growth offsets slower labor force advances. The decline in the labor-force participation rate is likely to slow in coming years once normal economic growth resumes. The rate has fallen as baby boomers retire and discouraged workers drop out of the labor market or stay in college.

Solutions to the crisis in higher education may also promote productivity. The poor job market for debt-laden college graduates is forcing Americans to realize that smart people go to college, yet college doesn't make them smart. They now know that just any college degree won't guarantee a well-paid job.

In this environment, top institutions will continue to attract the best and brightest. Many of their students will go on to graduate and professional schools, often in other fields. These schools will continue to be well-financed.

Middle-tier schools, however, will need to be more focused on providing students with careers. They must emphasize science, technology, engineering and math -- the most in-demand majors. And they'll need to convince applicants that their education is a profitable investment.

Community colleges with ties to apprenticeship programs that prepare students to be skilled mechanics or operators of sophisticated equipment will also be in demand. Middle-tier colleges and community colleges that understand their markets may prove to be significant in advancing productivity.

Once private-sector deleveraging is completed, real GDP growth will probably return to its long-run trend of about 3.5 percent, and perhaps more. Productivity improvements and labor-force growth will likely resume. And the slow-growth-forever crowd will need to find a new theory.

Corrects reference to size of national debt in second paragraph. This is the second article in a two-part series.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

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