The gap between the actual and potential gross domestic product narrowed dramatically during the second quarter of the year. Real GDP grew by more than 12% on a year-over-year basis while nominal GDP in current dollar terms grew at a nearly 17% yearly rate.
The output of the economy in the second quarter is now above its December 2019 pre-pandemic level—a remarkable achievement.
That was enough to reduce the already shrinking first-quarter output gaps by substantial margins of 38% in real terms and 57% in nominal terms.
What’s more, the output of the economy in the second quarter is now above its December 2019 pre-pandemic level in both real and nominal terms. In many respects, this is a remarkable achievement that will influence the direction of policy when addressing significant economic and financial stress.
Despite the incredibly fast recovery, this is still no time for complacency. There is still a gap between actual and potential GDP to be filled as well as a future of diminished competitiveness to be overcome.
In our latest estimation of “full-employment” nominal GDP—which takes into account regaining the lost output of discouraged and disadvantaged workers no longer in the labor force—the gap between actual and potential GDP has been reduced to $117 billion.
Using the Congressional Budget Office’s March estimates of potential GDP—defined as what the economy is capable of producing at that moment—the gap remains at $260 billion.
In the short term, the implication is that to maintain potential GDP growth at sufficient rates of increase, attention needs to be given to the millions of displaced workers who are not contributing to the economy—either out of concern for infection or because of skill deficiencies as reported in a recent survey of manufacturers by the Richmond Federal Reserve.
As to long-term implications, the CBO estimates that the growth rate of potential real GDP will continue decelerating from 2% per year to 1.5% over the next three decades.
That’s not encouraging in terms of income and wage growth in the consumer sector or for the competitiveness of U.S. business within the global economy. The economy needs a positive productivity shock as it had during the late-1990s technology boom.
Investment in productivity
There are signs, however, that other forces have been set in motion—unintended consequences of shocks from the trade war and the pandemic that could arrest the slide of the economy into a stagnation like the kind that has long gripped Japan.
Investing in infrastructure: First, there is renewed confidence that the government will rebuild the physical and intellectual infrastructure needed to compete with our trading partners. The potential $1 trillion infrastructure project carries with it the possibility of improved productivity that will lift the longer-term growth of the economy.
Investing in productivity: Second, there is hard evidence within the last four quarters of GDP data that business has taken to heart the need to invest in its productivity.
During the pandemic and now into the recovery, total investment—which includes both residential and business capital outlays—has benefited from negative real interest rates fostered by monetary policy. The increase in investment is such that its growth has exceeded that of personal consumption, which has been propped up by government income assistance that is scheduled to end soon.
As has been widely reported, the housing market has been rock solid since the onset of the pandemic as families searched for more room in the suburbs. But business investment has followed suit to the extent that investment in equipment has been growing for four consecutive quarters.
These investments in productivity—equipment and intellectual property—might just mark a retooling of business. But there is also the potential for a turning point in the economy, just as the wave of postwar industrialization created the impetus for four decades of prosperity and the dominance of the U.S. economy among its trading partners.
Those days of dominance are long gone, however, and no amount of wishing that things were that good again will bring them back. We need to do better than the 1.8% potential growth that was the long-term trend before the pandemic.
What is needed is for business to continue putting capital into productivity-enhancing investments in technology and automation. And to continue investing in research and the intellectual capital of the workforce.
The events of the past year demand recognition that automation has left behind a substantial portion of the population whose well-being was held in less regard than financial gain. The human toll of the pandemic and the economic shutdown have shown what still needs to be done.
For more information on how the coronavirus pandemic is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.