Noah Smith “The Sanders Case for More Spending and Faster Growth“:
[…] However, in the recent debate surrounding the economic proposals of presidential candidate Bernie Sanders, a small number of economists have started suggesting a very different justification for stimulus. Their idea: Stimulus does something more fundamental to the economy by raising long-term productivity.
It started with a paper by economist Gerald Friedman of the University of Massachusetts-Amherst, which analyzed Sanders’ economic plans. Sanders wants a lot more government spending; Friedman says that this spending will raise growth so much that the proposals will pay for themselves. Though Paul Krugman, Austan Goolsbee and other economists have ridiculed this plan as being implausible — the mirror image of failed Republican promises that tax cuts would be self-financing — there have been a number of defenses as well, including some from very unlikely sources. If Friedman and others are right, it would upend most of mainstream macro, and would force a dramatic reconsideration of economic policy.
The notion that fiscal stimulus, in addition to raising employment, also boosts productivity growth was first suggested in 1949 by a Dutch economist, Petrus Johannes Verdoorn. According to what’s known as Verdoorn’s law, all you have to do is boost gross domestic product growth — for example, by fiscal stimulus — and productivity will soar as well.
Narayana Kocherlakota “Growth Begets Growth: Reflections on Total Factor Productivity“:
In terms of evidence: As I describe here, the most striking evidence [for Verdoorn’s law] comes from the Great Depression in the US. Total factor productivity fell dramatically at the beginning of the Depression and was in fact 15% below its normal trend by 1933. Over the following three years, in conjunction with the various forms of demand stimulus undertaken by the Roosevelt administration, TFP grew more than 5% per year faster than normal. This super-normal growth rate of TFP was a key contributing factor to the near double-digit annual growth in real GDP from 1933-37.
Of course, this is but one short period in US history. But it seems to be illustrative of a more general and systematic pattern. In his 2012 book, Alexander Field (chapter 7) concludes that there is a stable relationship in US macroeconomic data whereby a fall in the unemployment rate of 1 percentage point is associated with a 0.9 percentage point increase in TFP growth. (This kind of relationship is also critical in Professor Friedman’s recent analysis of Senator Sanders’ economic proposals.)
Thus, there is an empirical basis for the proposition that super-normal demand growth in the next few years would generate super-normal TFP growth. There is less support in existing macroeconomic theory, which typically treats the cyclical evolution of TFP as exogenous. My own intuition is that TFP growth is the product of the creation and implementation of ideas. These are investment activities, and businesses should be willing to undertake more of these activities if they anticipate higher demand. This basic intuition lies at the heart of a classic paper by Comin and Gertler (2006) and a more recent (and very interesting) paper by Benigno and Fornaro (2015).
To summarize: there are good reasons to believe that policies that would generate super-normal demand growth in the next four years would also lead to super-normal TFP growth. Taking into account my caveat above, I would (very cautiously) offer the estimate of an additional 1 percent per year for this latter effect. Overall: I see it as possible and beneficial to adopt policies that would lead to 5-6% growth per year over the next four years – which translates into a level of output in 2020 that is about 15% higher than is currently anticipated.
Econospeak “The Sanders Fiscal Stimulus and Verdoorn’s Law“:
There is more on the empirical inquiries that occurred after Kaldor drew attention to this idea [to Verdoorn’s law] in 1966. I have been saying Team Bernie needs to hire economists to model out the economic effects of his policy proposals. This Verdoorn effect might be something worth exploring.