What is... | March 28, 2012

What is the sustainable growth rate?

In fairytale Goldilocks and the Three Bears, the heroine finds three porridge bowls – one too hot, one too cold and one just right. When it comes to economies, a growth rate that is too hot is too high and can lead to high inflation, while one that is too cold is too low and can lead to increasing unemployment.


This is why some economists describe a country that grows at a rate that is sustainable over the long term as a “Goldilocks economy” – neither too hot nor too cold. Like the fairytale porridge, it is “just right”.
The rate is important as it can go some way to signalling future job prospects and even how high or low interest rates might be in years to come.

Changing what is sustainable
In March 2012, China’s Premier Wen Jiabao cut the target rate for annual economic growth from 8.0% to 7.5%.He said the move – considered significant by financial markets – would make “economic development more sustainable and efficient”.
Likewise in March 2012, the president of the Federal Reserve Bank of New York, William Dudley, said he believed the sustainable growth rate in the US was 2.25% much lower than the 3.0% many believed the United States could sustain before the global financial crisis.
In Japan, it is generally accepted that the sustainable growth rate is about 1.0% while in the Eurozone it is considered to be around 1.5-2.0%.

Not so fast
A lower sustainable rate of growth is not necessarily a sign that an economy is in trouble.
Economies in the early stages of industrialisation are likely to have higher sustainable growth rates than wealthier countries. Developing economies are likely to have a large amount of unused capacity and could use machines and technology more efficiently. This was the case for the United Kingdom and the US when they went through their industrial revolutions in the 18th and 19th centuries respectively.
China has been enjoying its own industrial revolution for the past few decades and sustained a higher growth rate than elsewhere. But as the economy in China developed and incomes increased, the ability (and need) to grow as fast has decreased.

Old problem
One reason why advanced economies – such as France, the Netherlands and other European countries – might have a lower sustainable growth rate is that a larger share of their population is elderly and no longer in the workforce. A larger population of pensioners relative to the number of workers means that those employees have to work more effectively to maintain the rate of growth per person.
Wealthy countries also tend to have lower birth rates, which means that over time there are fewer workers to support a growing number of retirees. A blogpost by The Economists’s Free Exchange examined the impact of an ageing population on growth rates in Japan, home to the fastest rising old age dependency ratio.

Sustaining work
Low sustainable growth rates could influence employment and investment opportunities. Someone looking for work in a country with a low sustainable growth rate and an ageing population might find more employment opportunities in, say, healthcare than teaching.
Lower sustainable growth rates also tend to be associated with lower interest rates. It partly reflects the tendency of older people to maintain or increase their savings and can influence investment opportunities.

Using the sustainable growth rate
There can be times when it is appropriate for an economy to grow more or less quickly than its sustainable rate - or in Goldilocks terms to grow at a hotter rate than "just right".
When unemployment is high, growth faster than the sustainable rate will be needed to produce more jobs. When inflation is high, not only slower growth but growth slower than the sustainable rate will usually be required to lower inflation.
Governments may change taxes and spending and central banks tweak interest rates to get a growth rate at, above or below their sustainable growth rate.

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Phil Thornton
Phil Thornton

Lead consultant at Clariti Economics

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