When real GDP growth in the second quarter of this year came in at a resounding 4.2 per cent, President Trump contended that his economic policies had ushered in an economic boom for the United States. Gone were the days of 2 per cent growth that characterized the U.S. economy in the nine years following the end of the 2008–09 recession. Due to his tax cuts and deregulation, the President is confident that the economy can expand at a 3 per cent pace, or even higher, for a long period of time.
We don’t share the President’s optimism that his policies will usher in an era of rapid economic growth. There are simply too many obstacles, including the return of $1 trillion fiscal deficits, capacity constraints, labour shortages, an aging population, trade wars, and rising inflation, that could quickly send the economy back to 2 per cent growth or even lower. However, economists are frequently guilty of focusing on the downside risks to the outlook and avoid discussing potential surprises on the upside, so it is important to at least consider how an economic boom could unfold.
Let’s start with the current expansion. While growth has been steady and lots of jobs have been created over the last nine years, income growth has been weak, and many American families haven’t received a pay raise for decades when inflation is accounted for. The main factor behind the anemic growth in income has been productivity growth—output per hour worked. Over the past five years, productivity growth has barely averaged 1 per cent annually, compared with close to 3 per cent growth throughout much of the 1990s. If productivity growth returns to that 3 per cent range, strong U.S. economic growth would be sustainable despite slow labour-force growth.
According to The New York Times, there are three factors that have the potential to sharply boost productivity growth. The first is what economists refer to as “Solow’s Paradox.” In the mid-1980s, the economist Robert Solow noted that the impact of computers appeared everywhere except in the productivity numbers. It took time for firms to adjust their operations to the new technologies, and the surge in productivity growth didn’t take place until the mid-to-late 1990s. Walmart started using computers to manage supply chains in the early 1990s, but it was years before the rest of the retail industry made the switch. The situation is similar today. The increased use of artificial intelligence, robotics, machine learning, and online shopping hasn’t shown up in the productivity numbers yet, but still could. As was the case in the 1990s, firms must adjust to new technologies before they start to boost the economy’s efficiency. For instance, driverless cars should eventually boost productivity growth, but are currently holding it back, because numerous skilled engineers are working on developing the technology without generating gains in economic output.
The second factor that could boost productivity growth is the steep cut in the corporate tax rate. The lower tax rate comes at a time when equity markets are at record highs and interest rates, while on the rise, remain low by historical standards. This should leave most firms in a position to increase investment spending and add to their capital stock—buildings, equipment, software, and other intangible investments that could help workers become more productive. The evidence, to date, is mixed as to how much the lower corporate tax rate has stimulated investment spending. Business investment spending has increased at close to a double-digit pace in the first half of this year, but much of that gain was due to higher energy exploration, likely linked to the rise in oil prices last year, as opposed to tax changes. It will take a few more quarters to determine the degree to which lower corporate taxes have boosted investment spending. The final development that could increase productivity growth is increasing labour shortages linked to an unemployment rate below 4 per cent. Currently, there are worker shortages in numerous industries including trucking, accommodation, food, the energy patch, and construction. Firms may have little choice but to increase their investment in capital to attain greater output from each hour of labour. The growing use of automated checkout kiosks at retail outlets is a good example of this type of labour-saving investment. Companies could also implement new management practices, something that would show up in total factor productivity gains.
It is possible that a combination of technological change, surging investment spending, and ongoing labour shortages could lead to a boost in productivity growth that sets the U.S. economy on a path to 3 to 4 per cent growth. However, this is a hopeful scenario, and not what we expect in our forecast for the U.S. economy. Yet a productivity spurt like the one that occurred in the mid-1990s can’t be completely ruled out. President Trump’s massive tax cuts will bolster economic growth in 2018 but, in our view, this is short-term gain for long-term pain. Still, we will undoubtedly hear much about his success.
Source: Neil Irwin, “This Could Be a Mid-1990s Moment for the Economy,” The New York Times, September 8, 2018.
Canadian Outlook 2018-19: A Noisy Neighbour Causes More Discomfort
The Conference Board of Canada, November 16, 2018 at 11:00 AM EST
Live Webinar by Pedro Antunes