How To Encourage Economic Growth

13396_dennislockhart How To Encourage Economic Growth WORD ON THE STREET: There is an ongoing debate about the extent to which the causes of weak labor markets are structural or cyclical. The cyclical view maintains that the problem is just a deficit of aggregate demand and, with a quicker pace of growth, much of the problem will be solved.

A sense of urgency is appropriate for this goal. If policymakers are too patient, what started as cyclical problems can evolve into structural problems.

I think faster growth would indeed improve employment conditions significantly, so let me summarize the prospects for growth in the American economy.

Since the end of the recession and the beginning of recovery in the summer of 2009, the U.S. economy has experienced average gross domestic product (GDP) growth of 2.1%. This is better than in many other advanced economies but is still very sluggish.

For 2013, I'm forecasting a continuation of this basic picture. I expect full-year GDP growth to be between 2% and 2.5%. I could be wrong, but I don't expect 2013 to be a breakout year.

There are several ongoing causes of this weak growth. Households continue to either reduce or contain their debt levels. This constrains retail sales, home sales and purchases of consumer durables that often require financing. The one major exception has been autos. The average American automobile is more than 11 years old, so new car sales, supported by credit availability, have been strong and are rising.

The financial system, the centerpiece of which is the banking system, is going through a gradual process of repair, so credit flows are constricted in comparison to the years before the recession. Bankers have also tightened credit standards in response to recent experience. At the same time, bankers continue to report that most categories of credit demand remain weak.

Business spending – including investment spending – has been restrained by a very cautious attitude on the part of decision makers. They cite uncertainties related to the federal government's fiscal situation as a primary concern, along with the sovereign debt crisis in Europe.

Productivity growth has also slowed. At the end of the recession and the beginning of the recovery, productivity gains were substantial as employers streamlined their workforces while maintaining or growing top-line revenues. Recently, it appears that much of the potential associated with company restructuring, head count reduction and cost cuts have already been exploited.

There are some hopeful signs in the recent data on the U.S. economy. The housing sector – which was hammered in the recession – appears to be coming back. We have a vibrant hydrocarbon energy sector. Our auto manufacturing sector is improving, and the equity markets have been quite buoyant recently.

In the near term, I think growth prospects will depend on the removal of short-term obstacles to growth. Chief among these is finding workable solutions to immediate fiscal problems and the uncertainty these challenges generate. To some extent, the U.S. is behind Europe in tackling fiscal problems, but further along in economic recovery and stabilization.

Gazelles at play

Recently, in both the U.S. and Europe, there has been increasing focus on the role of young, growth-oriented firms – so-called ‘gazelles’ – as a major source of employment growth. In my view, some misconceptions and misrepresentations have crept into the conversation, so I want to take some care to explain our current understanding of some of the characteristics of firms that, on net, are job creators, at least in the U.S.

I would argue that gazelles as a group, while unquestionably an important contributor to the growth of jobs, should not be portrayed as a savior. It's important, I think, that policymakers not exaggerate any single source of job creation in pursuit of healthy employment markets.

My colleagues and I learned a number of things as we conducted research on employment and job creation. We started with the premise that small businesses, generally, are the key source of jobs. This claim was frequently made by candidates in the recent political cycle. While small firms are important, we found that it's not accurate to say small businesses are disproportionately responsible for job creation.

Almost all U.S. businesses, by number, are small. But we shouldn't confuse the number of firms with the number of jobs. In 2010, for example, businesses with 100 or more employees accounted for less than 1% of firms, but close to 50% of private-sector employment.

While today's larger, mature businesses are important as employers, they were not born large. So, we looked at the age dimension of firms in explaining job creation. The premise was that it is younger firms, almost all of which are small, that disproportionately create jobs.

We found that the role of young firms in job creation is easily overstated. For instance, the claim is often made that new firms alone account for all net job creation. This is true in what you might call an accounting sense. That is, the number of jobs created by new firms about matches or exceeds the net number of jobs created by all firms.

But this fact ignores the reality that established firms that are growing create many more jobs each year than do new firms. It's just that established firms that are downsizing are responsible for destroying a lot of jobs as well. New firms haven't been around long enough to downsize. In fact, as a group, young firms between one and five years old destroy more jobs than they create because of the high failure rate.

Moreover, we found that many small firms are not established with an objective to grow and add employees. The landscape of small, young businesses is heavily populated with ‘mom-and-pop’ businesses. They play an important social role, but are not a major source of jobs beyond the initial number of employees at establishment.

In our investigation, we then looked at the argument that it is the relatively small subset of small, young, fast-growing firms – the gazelles – that drive job creation. It's clear that gazelles do contribute significantly, but it's the growth dimension, not the age or size dimension, that matters most.

That is to say, fast-growing mature firms also account for a lot of job creation. And heavy emphasis on technology and bioscience industries – so popular among economic development professionals – may also be misplaced. High-growth firms emerge in a number of industries, some decidedly low tech. All in all, it's not so obvious that the likely source of high-growth firms can be identified.

The recent recession significantly constrained the growth opportunities of companies. By one definition of fast growth, there are about a third fewer fast-growing firms in the U.S. economy now than compared to the mid-2000s, and they are adding about half as many jobs as compared to the earlier rate. It may seem like an obvious point, but one still worth emphasizing. Innovation and entrepreneurial activity are most likely to achieve maximum impact in terms of job creation in a context of general economic growth.

Policy lifesavers?

What can policy, broadly speaking, do to foster growth, innovation and job creation? At a high level, three things.

First, policymakers can remove obstacles to growth – for example, uncertainty regarding the fiscal path of government, policies that discourage new business formation and disincentives to invest. Second is positive, pro-growth policies. Examples include investment in human capital and critical infrastructure.

And finally, there is a role for monetary policy. In my view, monetary policy can deliver appropriately favorable interest rate conditions, always in a context of low and stable inflation. Monetary policy plays a critical role in creating the most favorable conditions for other policy actions to do their work.

The term ‘silver bullet’ has become a popular way of capturing the idea of a single, straightforward solution perceived to have extreme effectiveness. My bank's experience in trying to understand the role of small businesses, small-growth businesses, young businesses and mature-growth businesses in job creation illustrates a key point. In the pursuit of economic growth and increased employment, there is no silver bullet.

Rather, the policy community should be pursuing an effective mix of policy elements (with focus in areas such as new business formation, labor rules and regulatory efficiency, to name a few) that together catalyze a virtuous circle of innovation, growth and employment.

Dennis Lockhart is president and CEO of the Federal Reserve Bank of Atlanta. This article is adapted and edited from a Feb. 12 speech delivered at IE Business School in Madrid, Spain. The original text is online.

(Photo courtesy GSU)


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