In his State of the Union address last Tuesday, and in speeches across the country since, President Obama has emphasized that Washington needs to "do more to help the entrepreneurs and small business owners who create most new jobs in America." He's right. And he should start by rethinking his own administration's policies.
The remarkable productivity growth that has enabled the U.S. to become the wealthiest country on earth has slowed considerably in recent years. The productivity of U.S. workers has grown at an average annual rate of about 2.5% since 1948, but has averaged only about 1.1% since 2011—less than half the historical rate. Monday's stock-market plunge on news of slowing manufacturing growth in January only underlined the urgency of restoring U.S. productivity growth.
The implications are enormous. If productivity growth rates this low persist for a decade, as they did in Japan in the 1990s following a severe recession, then U.S. living standards will only increase by about 12% between now and 2024 instead of 28% at the historical rate.
But even if productivity growth returns to its historical average, as it did in Japan by around 2002, U.S. GDP would remain permanently depressed by about 8% or more relative to trend. Japan's GDP remains below trend more than 20 years after its severe recession in the early 1990s. This is not because of deflation as some have argued, but because Japan has not managed to restore that lost decade of productivity growth.
The most recent period of rapid productivity growth in the U.S.—and rapid economic growth—was in the 1980s and '90s and reflected the remarkable success of new businesses in information and communications technologies, including Microsoft, Apple, Amazon, Intel and Google. These new companies not only created millions of jobs but transformed modern society, changing how much of the world produces, distributes and markets goods and services.
Rising living standards in the future will depend on the continued success of these businesses but also on the next generation of success stories. Getting the U.S. economy back on track will require a much higher annual rate of new business startups. Sadly, the annual rate of new business creation is about 28% lower today than it was in the 1980s, according to our analysis of the U.S. Census Bureau's Business Dynamics Statistics annual data series.
Why is the startup rate so low? The answer lies in Washington and the policies implemented in the wake of the 2008 financial crisis that were, ironically, intended to grow and stabilize the economy. These include but are not limited to the mammoth Dodd-Frank financial reform law, auto bailouts, green energy subsidies, the $800 billion American Recovery and Reinvestment Act, numerous antibusiness National Labor Relations Board decisions, and of course ObamaCare.
This explosion in federal regulation, intervention and subsidies has retarded productivity growth by protecting incumbents at the expense of more efficient producers, including startups. The number of pages in the Federal Code of Regulations peaked at nearly 175,000 in 2012, an increase of more than 7% in President Obama's first three years.
These policies must substantially change in order to increase the incentives to take on the considerable risk of starting a new business. There are several key policy shifts, some of which the president touched on in his address, that would make a difference.
ObamaCare is slowing economic recovery in many ways, ranging from implicitly increasing tax rates on individuals to hindering business growth by creating incentives for small business to remain below 50 employees or to only hire part-time workers. In larger businesses and corporations, uncertainty about the future of health-care costs is holding back investment and hiring.
Statistics suggest that new banking regulation may be significantly hindering small business lending. In July 2013, the Office of Advocacy of the U.S. Small Business Administration reported that small business loans (those less than $1 million) declined about 10% between 2010 and 2012. Reforms that reverse this trend are needed.
Reform is also required to make it easier for immigrants to start businesses. About half of the most successful high-tech startups in the U.S. were either founded or cofounded by immigrants. But U.S. law restricts immigration for people with the skills to start the next Intel. The current H1-B visa program for skilled workers is capped at around 65,000 workers, and the most recent year's application for this visa was oversubscribed within one week.
This problem is so acute that Silicon Valley-based startup incubator Blueseed plans to launch a cruise ship next year to be docked 12 miles off of San Francisco in international waters so immigrants can start businesses without needing residency. Immigration reform is the biggest free lunch facing policy makers, yet its fate remains uncertain in Washington.
Increasing productivity also requires a competent, well-trained workforce. But many of our public schools are not sufficiently preparing students to be competitive in today's job market. Only about a third of our students are proficient in math and science, and performance has improved little if any despite more spending on public education.
Considerable research suggests that merit-based pay, as well as tenure reform that gives schools the ability to dismiss poorly performing teachers, would have a major effect on student performance. More states should look to New Jersey, which recently passed teacher-tenure reform and expanded school choice, and is strongly pushing for merit-based pay and more educational accountability.
To his credit, President Obama has acknowledged that U.S. tax policy requires extensive reform. The U.S. has the highest corporate tax rates among advanced countries, and the marginal tax rate on the highest earners in some states, including federal, state, and local taxes, are as high as 60%. Our research shows that these tax rates, if sustained, will permanently depress both employment and investment, but there appears to be little likelihood of reform soon.
In the absence of meaningful policy reforms, productivity will remain below its historical trend, and the low employment and weak economic activity of the past five years will continue.
Mr. Prescott, the 2004 Nobel laureate in economics, is a professor of economics and director of the Center for the Advanced Study in Economic Efficiency at Arizona State University, where Mr. Ohanian, a professor of economics at UCLA and a senior fellow at the Hoover Institution, is associate director.
