Wednesday, June 22, 2011

Some Thoughts on US Economic Growth

Here is an updated chart from a previous post (Real GDP Growth in the US and Japan: A Closer Look at Consumption, Government Spending, Net Exports, Investment, and Inventories).

US: Contributions to Percent Change in Real Growth Domestic Product (2005/Q1 - 2011/Q1)

(click to enlarge)

Note that 2010-2011(Q1) does not look all that different from 2005-2007!

I don't know where to from here. I think a "double dip" is very possible but if I had to guess, I don't think a new recession is the most probable scenario in the near term. But that depends on difficult factors to predict such as whether current US congressional antics really are only short term theater as many allege, and the potential size of negative demand shocks from the rest of the world (China, Europe, other various housing bubble countries like Australia and Canada, etc).

I believe a common mistake is to consider high oil prices to be one of the drags on growth. Rising oil prices are certainly a drag on growth, but stable oil prices (once lagged effects of previous changes have dissipated) are growth neutral, as I understand it. Even the generally excellent Calculated Risk might have gotten this wrong in a recent outlook post where he says "Also the recent decline in oil and gasoline prices will help, although $100 oil is still a drag on the economy." However he could be correct if he considers a drag on the economy to be a separate phenomenon from a drag on economic growth. (If you think I'm the one who's gotten this wrong, please let me know!)

Similarly, deleveraging is not a drag on growth unless the rate of deleveraging increases. Deleveraging is just one determinant of the household savings rate. A stable household savings rate is growth-neutral. However, deleveraging does reduce the likelihood of a falling savings rate and the associated boost to GDP growth that such a shift would provide. So in terms of current economic growth (i.e., ignoring impacts on future growth), steady-state deleveraging is the absence of a positive rather than an actual negative.

Note that this post only focused on GDP growth... clearly we still have crisis levels of unemployment and underemployment that policy makers should be actively working to address!


  1. I'd say that the crucial factors are housing and unemployment. Residential RE is in the process of bottoming, but probably still has a bit to go on the downside. It will be some time before housing actually recovers after it has bottomed through, due to the high level of inventory. With a weak housing market and historically low housing value, consumer credit cannot provide the usual boost to growth in a recovery. Add to that stagnating incomes in the all but the upper quintiles and where is the consumption going to come from? Ane without increasing effective to demand sending a signal to invest, where is investment going to come from?

    Unemployment seems to be intractable due to a shift in US capital abroad, reducing capex in the US. The investment in new capacity in the US is going to increased automation, which increases productivity but doesn't do anything for employment. Thus, owing to a shift in the use of capital, labor in the US is at a disadvantage. Add to this an anti-labor bias at both the federal and state leves, and the unemployment/underemployment situation looks bleak.

    While a recession is unlikely given the present trajectory, the economy is fragile and a shock could easily destabilize things. There are several directions shocks could come from.

    Caution ahead.

  2. Hi Tom,

    Thanks for the excellent comments, I think you get to the core of the issues and I largely agree with what you say.

    Housing is a crucial issue because as you suggest it is usually an engine of growth. Bill at Calculated Risk estimates that new residential construction will start adding a small positive to GDP growth some time this year (it has been subtracting for years). He has been too optimistic before, but I don't see any reason to doubt this as the most probable outcome as of now. But certainly the inventory overhang will keep growth driven by housing well below "normal".

    To your second factor, unemployment is obviously a critically important issue too. However, aside from the tragic human costs, it largely represents our failure to support aggregate demand sufficiently to achieve potential GDP... it doesn't actively drag on GDP. (Well, there are exceptions, like unemployment benefits running out!)

    I don't recall seeing a good analysis of the degree to which large unemployment itself impedes normal economic growth from gradually gaining traction (albeit starting from a position of substantial underemployment). Perhaps it does, but how much? The flows of borrowing have been going up during the "recovery" which suggests that new entrants to the workforce may be having at least some success buying their way into the job market (by going into debt for school, first car, first house, etc, thus adding aggregate demand that funds them getting hired into the employment market).

    As to productivity gains and whether they can add to growth in this environment, I recognize that capital is seeing an extraordinary portion of these gains, and I'm frankly surprised we've had the strength of growth we've had so far in the recovery. But maybe the marginal propensity to spend at the top end by buying additional output made possible by productivity gains isn't as low as I may have presumed??? Or maybe something else explains the traction that consumption has had in adding to economic growth (blue segments in the graph above). (Credit expansion as previously discussed is part of it too.)

    Certainly the situation is fragile and I agree there are multiple potentially large downside risks.

  3. And I think the biggest downside risk as a result of US housing right now is that the reverse wealth effect of lower home values could drive the household sector to attempt to raise its savings rate. Post housing bubble, I was surprised to see the savings rate stop rising well before the historical average of 8%. Perhaps it will resume rising???

  4. hbl, I am concerned about the middle class in this dynamic. Cullen Roche posted IT’S A V-SHAPED AND L-SHAPED RECOVERY with a chart showing how capital is doing very well and labor (middle class) is not. (Here is am including top management with capital since their super-sized income is really rent.)

    Corporate profits are rising due to cost-cutting, especially labor cost. Gains from increased productivity are not being distributed but are going mostly to capital. The corporations that are doing very well are doing well because their international operations are carrying them.

    MIddle class income is stagnant, and middle class wealth has been reduced by the fall in housing and equities, while they are being squeezed by higher prices for food and gas.

    US prosperity has been based on the middle class sharing in the wealth since WWII. That seems to be over. So while the return to capital may continue to grow, I don't see a path for the vast middle to participate through income.

    So the US may continue to "grow," but growth is not synonymous with prosperity.

  5. Tom,

    I absolutely agree with all your points. One of the reasons I was [in hindsight] too bearish coming out of the depth of the recession is I thought the extraordinary corporate profits and high wealth disparity would be unsustainable, as the middle class would get squeezed as you say. And the situation may yet prove to be unsustainable, but it's hard to tell from the top-level macro data alone. (It was much easier to tell in mid 2000s because of the obvious housing bubble!)

    So there probably are scenarios in which growth could continue without contraction (despite being much slower than needed), and I agree that's not the same as prosperity.

  6. hbl, Dr. Housing Bubble has been making a good case that residential housing is overpriced relative to middle class incomes. Those prices have to fall or the whole economy has to inflate. It's difficult to see how growth can go anywhere before there is much further correction in housing. In this scenario, the US is looking at either an extended period of low growth (stagnation) aka Japanification, or a debt-deflation depression if other forces come to bear at the same time.

  7. Tom, I haven't followed Dr Housing Bubble in a while and I'm a bit surprised to hear that analysis since I haven't been reading it elsewhere. Not that it couldn't be correct, but plenty of other generally astute observers seem to disagree about current levels of price to income etc.

    The micro trends are harder to get data on than the macro ones. For example I've definitely worried during this "recovery" about the extent to which people would run through their savings and whether that would collectively threaten growth (not that I am happy about the individual hardships either!) But there aren't a lot of solid predictions that I've seen based on that type of data.

    Did you see my post on Japan's stagnation? They haven't had lower growth than other large countries other than during their late 1990s austerity -- if you measure using real per capita GDP. That explains why their unemployment levels haven't been bad compared to other nations.

    But I'm not trying to sound too sanguine, I know the economy sucks for many many people. I'm just trying to focus on the topic of growth dynamics.