Sunday, March 19, 2017

GDP Growth Above 3% Is Attainable

One component of the Trump administration policies is to improve the growth rate of the economy through an infrastructure spending policy, reducing taxes and regulations and increasing spending on rebuilding the military. While campaigning he stated his policies would return the economic growth rate, GDP, to 3%. A number of economists, along with the Federal Reserve, indicate moving the growth rate of the economy to 3% will be a difficult task. To put the 3% growth rate into perspective though, up until and through the financial crisis, the long run GDP growth rate was nearly 3.5%. Since the financial crisis though, the growth rate has averaged 1.8%.

The result of this slower pace of growth has been the creation of an output gap of about 15% or $3 trillion. This gap represents economic output that has been lost due to the economy growing below its long run trend rate and likely a partial cause of a lower employment participation rate.

The Bureau of Labor Statistics defines the participation rate as, "the percentage of the population that is either employed or unemployed (that is, either working or actively seeking work.)" Certainly the impact of baby boomer retirements is having some impact on the lower participation.

If the participation rate remained at its pre-financial crisis level, the unemployment rate would equal 9.2% versus the currently reported 4.7%. Some data does suggest the participation level should be higher and in fact the above chart shows the participation rate is increasing. As the next chart below shows, only the 55-year and over age group has a participation rate higher than where it stood pre-financial crisis.

The just noted review of the employment picture is important as economic growth can be approximated by adding together growth in the labor force to productivity. Fidelity recently released a paper noting the headwinds to economic growth caused by a maturing labor force and stagnant productivity growth. Below is a chart included in the report that shows the breakdown.

I am not convinced the true unemployment rate is the low 4.7% that is being reported. The fact the broader participation rate is improving, along with the lower participation rate for the 25-54 year old age group, does suggest there is a discouraged portion of the population coming back into the labor force looking for employment. In terms of actual numbers, the total unemployed in the 16-54 year old age group equals nearly 6.3 million individuals and another 1.7 million marginally attached to the labor force and not counted as unemployed.

The lack of growth in productivity is another factor constraining economic growth, but is it being calculated correctly. There are mixed views on the reasons behind a lower pace of productivity growth. As an example, a recent Brookings Institution report notes,
"One possible measurement error arises because standard output and productivity measures exclude Google and Facebook and thousands of other computer or phone applications that are funded by advertising. Consumers do not pay directly when they use these apps and so they do not add to final expenditure. The cost of a smartphone and its service are paid for and so these go into output but the part supported by advertising is not."
What? Okay, this has how it has been done historically. The paper goes on to note,
"Productivity is meant to capture changes taking place in the production and business part of the economy and is not intended as a measure of consumer welfare."
So as manufacturing employment has fallen from 20% of employment to 5% of employment, the productivity calculation excludes important parts of the technology side of the economy. In the paper's conclusion, it is noted more study needs to be done in this area. I would think so!

Back to faster economic growth and improving growth to 3%. As noted at the beginning of the post, one of the Trump administration policies is a $1 trillion public private infrastructure program. Studies have shown these infrastructure programs can be stimulative to economic growth. The private part of the public private partnership tends to reduce overall financing cost and enhances the economic multiplier effect. Without getting into all the detail, readers might be interested in Pennsylvania's successful public private infrastructure program that is currently ongoing.

A recent paper by the Economic Policy Institute details the impact to GDP resulting from an infrastructure program. If a Trump administration program is an aggressive one, i.e., implemented over four years, below is detail on the potential impact to GDP under various financing scenarios.

In looking at the 'debt' scenario, a first year $250 billion program would add $400 billion to GDP or increase GDP by 2.3%. Fourth quarter 2016 GDP equaled 1.9% at an annual rate. Adding this to the 2.3% infrastructure  benefit, GDP would total 4.2%. The GDP benefit and size of the first year package may be aggressive; however, getting to 3% GDP is certainly attainable.

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