Larry Kudlow

No one seems to have hit on it yet, but there are many reasons why the current economic recovery could easily develop into an eight- or 10-year boom, much like the prosperity cycles of 1982-1990 and 1992-2000. Back at the beginning of each of those recovery waves, few saw the prosperity coming, either. The naysayers, in particular, were completely blind to the potential of a capitalist, market-based U.S. economy driven by science and technology gains.

Today, however, pessimists have little excuse not to see the potential for a multiyear, inflationless, low-tax-rate, low-interest-rate growth cycle -- the key to which is in the amazing productivity story.

In the two decades prior to the technology boom, the ravages of high inflation, skyrocketing interest rates, over-regulation and high marginal tax rates contributed to a measly 1.5 percent average annual increase in productivity, or output-per-hour. But over the past eight years, the application of innovative technologies -- spurred by a wave of capital investment -- has generated a 3.2 percent yearly gain in productivity through boom and bust. This productivity miracle has made the U.S. economy incredibly efficient. It has also enabled businesses of all sizes to slash costs and raise profits. The workforce has never been better equipped, and real wages keep rising.

Economists calculate the nation's potential to grow by adding productivity gains to average population growth rates. In the United States, population tends to rise at a 1 percent rate, so the new-era Internet economy is capable of growing in a sustained long-term fashion at roughly 4.2 percent a year (3.2 percent productivity plus 1 percent population growth). In the old-economy era, America's capacity to grow was only 2.5 percent a year.

Over the next 20 years, the difference between 4.2 percent and 2.5 percent amounts to $6.4 trillion in higher national income. In budget terms, at an average 20 percent tax rate, roughly $1.3 trillion in new revenues will turn deficits into surpluses. At the same time, more growth, investment and work will operate to hold back inflation and interest rates.

While inflation is primarily a monetary phenomenon -- a lower dollar value caused by too much money chasing too few goods -- higher productivity and faster economic growth raise the supply of available goods and services that can be purchased with the same quantity of money. Hence, the existing money supply becomes less inflationary in a growth-producing, productivity-enhanced economy.

Larry Kudlow

Lawrence Kudlow is host of CNBC’s “The Kudlow Report,” which airs nightly from 7 p.m. to 8 p.m.

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