Monday, May 11, 2015

Anemic Economic Growth Since The Great Recession And Some Causes

The March trade deficit grew to $51.4 billion which has many economist now predicting subsequent revisions to first quarter GDP will show the economy contracted for the first time since contracting -2.1% in the first quarter of 2014.  In the first quarter the advanced reading on GDP or economic growth was reported at .2% which was below an expectation of a Q1 growth rate of 1%. The large increase in the trade deficit is being attributed to resolution of the West Coast labor dispute resulting in a spike in imports and to U.S. export headwinds due to the strong dollar.

From The Blog of HORAN Capital Advisors

In our Spring 2015 Investor Letter, we discussed the recurring weakness seen in the first quarter GDP reports since the end of the financial crisis. A larger issue is the slow pace of economic growth that has occurred since the end of the financial crisis in the 2009 and why has this been the case?

From The Blog of HORAN Capital Advisors

As can be seen in the below chart, GDP growth averaged 3.46% from 1950 through March 2009. However, since March 2009 GDP growth has averaged nearly 40% less at 2.13%.

From The Blog of HORAN Capital Advisors
GDP is defined as:

GDP = C + I + G + (X - M)


C = private consumption
I = gross investment
G = government spending
(X - M) = exports - imports

How have the various components of GDP fared after prior recessions?
  • Personal consumption expenditures as a percentage of GDP are above pre-recession levels.
From The Blog of HORAN Capital Advisors

  • Gross investment, residential and non residential, continue at levels below levels reach prior to the most recent recession.
From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

  • I noted the impact of the the trade deficit on GDP at the beginning of this post so let's look at the government input component of GDP. The below charts detail government revenues and expenses on an absolute dollar basis (first chart) as well as a percentage of GDP (second chart).

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

As the above chart shows, tax revenue as a percentage of GDP is above its long term percentage. On the other hand, government expenditures remain above the long term average as well. At the same time, the tax rate continues to climb. A recent article in the Wall Street Journal notes,
"The overall effect of the 2013 tax hike was not minor. The highest income-tax rate on small business income has risen to almost 42% from 35%. That’s a 20% spike in the small business tax for successful companies. When the government takes more, there is less to plow back into the business or invest elsewhere."

"This may help explain the paradox that even as American businesses today are generally efficient and highly profitable, they aren’t reinvesting in new plants, equipment and technology or hiring more workers at the pace they normally would [emphasis added]. Business investment was up last quarter—a hopeful sign—but over the recovery the trend has been sluggish."

"A comparison with the Reagan years when investment taxes were cut tells the story. From 1983 to 1988, private investment averaged 12% of GDP, one-third faster than the 9% since 2009 under Obama. In the aftermath of the Kennedy, Clinton and George W. Bush capital-gains tax cuts (1998-2006), the investment rate rose sharply and immediately."
Another headwind facing businesses is the increased regulatory burden on business. As the below chart notes, new regulations are up more than double under President Obama's tenure in office as compared to the Bush administration.

From Blog of HORAN Capital Advisors 5 2015

This mismatch between government tax revenues and expenses is an issue that needs to be addressed sooner versus later. The deficit spending taking place is resulting in the government's debt burden growing at an unsustainable level. The charts below clearly show the rapid increase in the debt level on an absolute basis as well as a percentage of GDP spiking higher since the last recession.

From The Blog of HORAN Capital Advisors

The interest expense on the government debt is projected to double in five years and triple in eight years. The interest expense alone will double the current deficit all else being equal.

From The Blog of HORAN Capital Advisors

In summary, the increased tax burden on businesses and the higher regulatory burden for businesses is constraining business reinvestment as well as businesses desire to increase hiring levels. Included in the increased regulatory burden is the continued cost impact of the Affordable Care Act. I believe Scott Grannis, who maintains the blog Calafia Beach Pundit, stated it well in a post in 2012,
"Here's another way of appreciating what has happened in recent years. The private sector has been working very hard to increase its efficiency and its output, and that shows up in the record level of corporate profits, both in nominal terms and relative to GDP. But instead of allowing or encouraging the private sector to plow those profits back into the economy in the form of new plant and equipment, new jobs, and new technologies, the federal government has effectively borrowed all the corporate profits generated since 2009 and distributed the money to the unemployed, to the poor, to favored "green" industries, to unions, to state and local governments, and to "make-work projects," among other things."

In order to get the economy on a growth track that is more indicative of historical growth patterns, less of a burden by government will need to be placed on small businesses.

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