18 october 2019





THE U.S. ECONOMY IS SLOWING DOWN AND THERE IS NOTHING TRUMP OR THE FED CAN DO ABOUT IT




By Raul Elizalde

This article also appeared on forbes.com


The third estimate of U.S. GDP growth was released today, confirming the previous estimate of 2%. This number may look low, but it is actually pretty good considering that analysts at the Federal Reserve Bank of San Francisco (FRBSF) recently estimated the new normal pace for U.S. GDP growth to be between 1.5% and 1.75%. This is a far cry from the 2.4% average of the last 10 years, the 3% that once was considered normal and certainly the 4% that some thought possible after the massive tax cut and spending hike bill of 2017.


Private-sector analysts seem to agree. Economists at Deloitte, a consultancy, think that the U.S. will grow less than 2% in the next few years. While global risks such as the trade war are real, they find “the greatest uncertainty in the US economy to be that generated within the nation’s borders.”


What is keeping the U.S. from being able to grow faster?


The FRBSF analysts consider two factors to measure growth. One is the number of hours worked, and another the output produced each hour. Multiplying both equals total output. Higher total output, therefore, needs to come from one or both of those factors. Neither one looks good.


The first – hours worked – depends on demographic trends about which there is little uncertainty. The U.S. is currently enjoying very low unemployment, which means that there aren’t many workers left to ramp up the total number of hours. Some have suggested that a “hidden supply” of workers will do just that. This is wishful thinking: the BLS estimation of labor growth shows a clear falling trend. The fact that people are living longer and working later in life is not enough to increase the number of hours worked, according to the FRBSF paper.

source: Federal Reserve Bank of San Francisco


The second factor – hourly output – is also known as productivity. Given the limits on labor growth, any meaningful boost to GDP will have to come from “much faster productivity growth than the United States has typically experienced since the 1970s”, according to the paper.


Big jumps in productivity require technological leaps, like the railroad, the transistor, or the internet. These are very rare; outside of them, productivity grows slowly. The only real innovation in the last few decades was the internet, which certainly pushed up productivity in the 1990s.

source: Federal Reserve Bank of San Francisco


Can we expect another technological revolution to make productivity soar? The promise of artificial intelligence is yet to materialize in similar ways. So far, technological advances seem directed towards better forms of entertaining and advertising rather than improving output. In any event, the FRBSF assumes that there is no way of telling whether a tech revolution is likely, so it uses the 2004-2018 average for productivity growth. All considered, they arrive at a growth forecast barely above 1.5%. Meaningfully higher rates don’t seem achievable under reasonable assumptions.


On our end, we looked at seven decades of GDP growth data to shed some light on the trend growth potential for the U.S. economy. After stripping out recessions, which can be caused to externalities that may not reflect productive capacity (such as oil shocks or a derivatives-based financial crisis) we calculated the 10-year average GDP growth rate. It shows a clear, steady decline and a close relationship with productivity.


Can the economy be revived by other means, such as further tax rate cuts?


Supply-side economists maintain that lower taxes spur economic growth, but the evidence for such claim is scant. When we superimposed the 10-year average of the highest income tax rates for individuals onto our data we found that, surprisingly, GDP fell along with tax rates. While this analyst dislikes paying taxes very much, he finds it hard to argue that another round of tax rate cuts could have a discernible impact on growth or productivity.

source: Path Financial LLC


The new normal, then, points in the direction of slowing growth. For policymakers, one possible course of action is to accept this state of affairs and stop trying to push growth to unattainable levels.


In pursuit of faster growth, central bankers have depressed interest rates to unprecedented levels – even below zero – which so far has yielded few rewards. Distortions, however, are plenty: inflated stock prices, ballooning debt and growing inequality. This has painted those in charge in a corner: Stay the course and run the risk of exacerbating those distortions, or abandon the effort and risk a market crash for stocks and bonds.


Is there a way out? There are two possible scenarios for this story to end well. One is that policymakers develop a radical policy to deal with these challenges and implement it with exquisite finesse amid broad political support. Another is that a new technology revives growth by transforming the way we live or do things.


We can pretty much discard the first scenario for reasons we find obvious. The second is more plausible and it may not require a far-reaching technological revolution. It could be as plain – and monumental – as revamping the energy infrastructure. Transforming how energy is produced and transmitted could substantially reduce the cost of goods and services and catapult productivity to a higher level.


This is just an example. We are not futurists, and like the FRBSF analysts we cannot predict where technology is headed or whether it can be a catalyst for faster growth. But such are the stakes. The stock market senses this too, as it reacts nervously to daily headlines but still seems to believe that the technology sector – which had twice the return of the general market in the last 5 years – might hold the key to a new era. Looking past the next inevitable recession, that may be the only way for the economy to experience a revival of growth.


Questions? Talk to us.