President Trump and his advisers have long argued that their agenda of tax cuts, deregulation and new trade deals would deliver sustainable growth of 3%, far above the sub-2% that independent economists think possible.
Lo and behold, the economy grew exactly 3% in the 12 months through September. Mission accomplished?
Not yet. The key word is “sustainable,” a rate that can in theory go on indefinitely without exhausting finite resources, such as labor, or requiring one-off stimulants. A dissection of what went on in the economy in the past year suggests that the bar hasn’t yet been met.
Running out of workers
If unemployment is falling, then the supply of available workers is shrinking and the economy is running ahead of its long-run sustainable pace, also called potential growth. In the year through September, the unemployment rate dropped half a percentage point to a 49-year low of 3.7%. Mr. Trump justifiably trumpets that milestone as good News, but it runs counter to the claim that 3% growth is sustainable: To keep this up, the unemployment rate would have to go negative in eight years, a mathematical impossibility. In any case, the Federal Reserve would apply the brakes long before to prevent inflation erupting.
To sustain such brisk growth without pushing unemployment lower requires a bigger labor force, which did expand by 844,000 (or 0.5%) in the year through September. But that was far outstripped by nonfarm payrolls, which expanded by 2.5 million, or 1.7%.
The labor-force participation rate (those working or looking for work as a share of the working age population) has hovered at just below 63% since 2014. That is a big improvement over the steady declines in prior years but not good enough: To sustain the current pace of job creation without running out of workers, participation has to go up.
Tax cut demand boost has happened, supply boost elusive
The sweeping personal and business tax cuts that Republicans passed last year and took effect in January should show up in two ways. First, as take-home pay goes up, people should spend more, generating a demand stimulus. Second, a lower tax rate on profits and the ability to write off new equipment immediately, instead of over several years, raises the return on new projects. That should encourage companies to invest, raising worker productivity, the economy’s capacity to supply goods and services, and its growth potential. Lower taxes might encourage some people to work more too.
The demand stimulus has happened. In the first quarter, after-tax incomes jumped 1.8%. At first, Americans saved the tax cut: Saving jumped to 7.2% of disposable personal income in the first quarter of 2018 from 6.3% in the fourth quarter of 2017. Since then, it has fallen back to 6.4%, as Americans spent their tax cut.
Eventually this boost will fade. Even without another tax cut Americans could further reduce their saving, but as with unemployment, saving can’t fall forever.
Lower tax rates probably will eventually raise investment and potential growth, but it is hard to pinpoint that effect amid countless other forces at work. Capital spending slumped in 2015 and has since reaccelerated in great part because mining, oil and gas investment collapsed then rebounded. That reflects the gyrations of global oil prices and a brief slowdown in China. Excluding mining, oil and gas, business spending on structures such as offices, factories and stores did jump in the first quarter, perhaps because of the tax cut, but then cooled. Spending on equipment doesn’t seem to have responded: It was solid from early 2017 but has weakened in recent months.
Markets giveth & taketh
Stocks, bonds, interest rates and the dollar all influence economic performance. Rising stocks, for instance, encourage households to spend, while a cheap dollar helps exports and low interest rates boost housing. Economists at Goldman Sachs, who have compiled these financial conditions into a single index, estimate that easier financial conditions helped bolster growth throughout 2017, led by surging stocks. In 2018 that contribution ebbed, as stocks plateaued and then in recent weeks dropped. Combine flat to lower stocks with higher bond yields and a generally firm dollar, and Goldman estimates financial conditions are now subtracting from rather than adding to growth, and that drag will peak in mid-2019.
There is good news on long-term growth, if not as good as the administration hopes. Okun’s law, an economic rule of thumb that teases out potential growth from changes in output and unemployment, suggests potential averaged a little over 1% from mid-2009 through mid-2017 and has since picked up to almost 2%.
For that, thank productivity, or how much each worker produces in an hour: It rose 1.7% in the year through September, according to Macroeconomic Advisers, the best since 2014.
Further improvements may be in store: The oft-promised payoff of robotics, artificial intelligence and other technological breakthroughs is long overdue. Despite worries over tariffs and wobbly stocks, business (especially small-business) confidence remains high, thanks in part to Mr. Trump’s pro-business agenda. The Federal Reserve seems to believe unemployment can go somewhat lower without triggering inflation.
So sustainable growth may top 2% in coming years. But absent another tax cut, oil boom, bull market or some other stroke of luck, a slowdown from the last 12 months’ 3% pace seems inevitable—no matter the outcome of next week’s midterm election.
Write to Greg Ip at [email protected]
Source : WSJ