One of President Trump’s proudest claims is how successful he has been in creating jobs and growth. Indeed, with typical restraint, Trump has boasted that the US economy, thanks to him, is now in the best shape of all time.
But exactly how strong is the US economy, can it last, and what is most likely to be the US economic situation in two years, at the time of the next Presidential election?
The Recent US Economic Record
Over the decade ending in 2016 the US economy, which led the world into the Great Recession, grew at an annual rate of 1½%, less than half the previous ‘norm’ of 3%. Most recently, however, growth in US output and employment seem to have picked up, thus providing some support for Trump’s claims. Over the twelve months ending in September, GDP in the US was 3% higher than a year earlier, and particularly in the last six months economic growth accelerated, with GDP increasing at the relatively fast annual rate of 3¾% – hence Trump’s boasting.
But perhaps the proudest boast by President Trump has been the reduction in the US unemployment rate to only 3.7%, with the number of jobs increasing quite rapidly over the last twelve months by 1¾%. On the other hand, employment participation in the US, as measured by the ratio of employment to the working-age population, is still 4 percentage points lower than in it was back in 2000. In fact, if US employment participation had increased by as much as in Australia during this century, then the US unemployment rate would be almost 12%, not less than 4%. So, the apparently low US unemployment rate really reflects the fact that many American men and women have become so discouraged that they have given up looking for work. The irony is that many of these people, who have lost all hope of a job, are Trump supporters, and he has done nothing for them so far.
In addition, another fact that we don’t hear Trump boasting about, is how this growth in employment has come at a cost to productivity. In the US productivity has only grown at an average annual rate of 1% since the GFC, although over the last twelve months the increase in US productivity has been slightly higher at 1¼%. But most importantly this subdued rate of productivity increase since the GFC is only half the previous US rate of increase.
Clearly US policies have been better at maintaining job growth relative to economic growth, and overall economic performance of the US has not been as good as it used to be.
Why has US Economic Performance deteriorated?
A key reason for the slow growth in productivity has been weak business investment. Investment growth in the US is now picking up a little, but the OECD in its latest May Economic Outlook considered that in all countries, “the upturn [in investment] remains weaker than seen in past cyclical expansions, and the growth of the net capital stock remains below the pre-crisis pace”.
Six months ago, the volume of US business investment was predicted by the OECD to increase by 5½% in 2018-19, mainly in response to a return to full-capacity, tax reforms and favourable financial conditions. But this forecast investment recovery was not particularly strong, coming after a decade of weak investment growth, and now it has been revised downwards because ‘Trade tensions are starting to bite, and are already having adverse effects on confidence and investment plans’ (OECD, 20/09/18). Furthermore, the impact of the Trump tax cuts has mainly been to bring forward investment, as the tax cuts incorporate a temporary concession that allows US companies to fully expense their investment over the next few years. However, that bring-forward of investment then risks a subsequent decline in investment when those time-limited concessions are withdrawn.
Profits in the US have been exceptionally high for some years now, but this has not been reflected in a commensurate increase in business investment. Instead, share prices reached record levels, partly in response to extraordinarily low interest rates, and also because so much of the higher profits were spent on buying existing financial assets through mergers and acquisitions and in buybacks of existing shares. Thus since 2013 US corporations have returned more funds to shareholders than they have spent on real investment, and in the first six months following the Trump tax cuts, US companies more than doubled the amount of share buybacks – much more than the increase in their investment in new real assets.
The fundamental problem, according to two former Governors of the US Federal Reserve Bank, Ben Bernanke and Alan Greenspan, is that this lack of investment in new assets is because of a shortage of good investment opportunities, and this shortage of good investment opportunities will continue so long as aggregate demand lags the growth of potential output. But this stagnation of aggregate demand is likely to continue so long as wage growth remains relatively weak and inequality is increasing. So a critical question is the future outlook for wage increases and the dispersion of those wage increases, as this will be a principal determinant of the outlook for jobs and growth over the medium term ahead.
The Future Outlook for US Wage Growth
The OECD forecast in May that US wage rates would increase by 3% in 2018 and by 3½% in 2019. This forecast would certainly provide for a stronger increase in US wages than the 2% average annual rate of increase experienced between 2007 and 2017, but this forecast pickup in the rate of wage increase assumes that there has been little or no change in the relationship between unemployment and wage rate increases. However, there is a lot of debate among economists about whether wages will respond by as much to a lower rate of unemployment as they used to.
As the OECD noted in the latest (2018) issue of its Employment Outlook, “At the end of 2017, nominal wage growth in the OECD area was only half of what it was before the Great Recession for comparable levels of unemployment”. Even those economists who are more optimistic about future wage growth tend to concede that inflation expectations and productivity growth are lower these days, and both these factors have pulled down the rate of wage increase in most developed economies. While, on the other hand, there are many economists (like me) who think that there have been more fundamental changes in the developed countries’ labour markets. In our book, Fair Share, Stephen Bell and I argue that technological change has led to loss of middle-level routine jobs, and this has weakened the bargaining power of workers, resulting in lower rates of wage growth. Others argue that legislative changes have weakened the power of trade unions and in some countries the social safety net has also been deliberately weakened. But whatever the cause, there is considerable concern that wage increases are likely to continue to be insufficient to support the increase in aggregate demand that will be necessary to prevent continuing economic stagnation over the medium term in many advanced countries, and particularly the US.
Furthermore, even if a recovery in the average rate of wage increase is sustained, there is the further problem of the distribution of wage increases. The last thirty or more years have been marked by increasing inequality of earnings, and nowhere more so than in the US. Thus, while the average rate of wage increase in the US may have seemed to be adequate prior to the Great Recession, the reality is that the real wage of the typical American male was no higher in 2015 than it was 45 years ago. In addition, the latest data suggest that this inequality in the rate of wage increase in the US is continuing, and that bodes ill for the sustainability of economic growth.
Financial Imbalances and their Impact on Future Economic Growth
The other critical risk for the US economy, apart from sluggish wage growth, is the looming financial imbalances, that are already present and expected to increase further. Most importantly, in 2017 the general government deficit in the US was already running at 3½% of GDP, and due to Trump’s unaffordable tax cuts, this deficit is expected to increase to 5½% of GDP this year and to more than 6% of GDP next year. Frankly these deficits are unsustainable. They will result in a blow-out in the current account deficit on the balance of payments, which is expected to increase from less than 2% of GDP in 2017 to more than 3% in 2019, and this increase is despite the increase in tariffs that Trump has initiated.
The Federal Reserve Bank has already started to increase interest rates in response to the increase in spending and lower taxes, and this increase can be expected to proceed significantly further. Higher interest rates are already leading to a fall in share prices, which have declined by 15% since there peak earlier this year, but further substantial falls can be expected. At their peak, the ratio of share prices to the present value of expected future returns (the P/E ratio) reached extraordinarily high levels, because such calculations are very sensitive to the level of interest rates, which for the first time in more than a century fell to as low as zero. However, the opposite side of that coin is that as interest rates climb back to more normal levels – and they still have a way to go – then further falls in share prices can be expected. And this time there will be even more upward pressure on interest rates if the US is to attract the foreign borrowing needed to sustain its fiscal and current account deficits. This upward shift in interest rates will then, as we have already seen, put upward pressure on the exchange rate, and thus further damage the production and job prospects in the US traded goods sector (ie manufacturing and agriculture), which will again hit Trump supporters hard. And the final irony is that the biggest source of this foreign capital has been China, and the risk is that China will withdraw or at least reduce its support for America’s unsustainable policies that are damaging China in particular, and the world in general.
The world economy at present is particularly unstable, and much of this instability reflects the contradictions in US policies and its failure to deal with the inequalities that are the underlying cause of the economic stagnation it has experienced for more than a decade. Unless the US economic strategy changes, and that seems most unlikely under President Trump, it is highly probable that at the time of the next US Presidential election the US economy will be widely regarded as being in very poor shape. In other words, Trump is likely to be much more vulnerable than is presently expected.
Michael Keating is a Visiting Fellow at the ANU. Previously he was the Head of the Departments of Employment & Industrial Relations, Finance, and Prime Minister & Cabinet.