Article / 20 July 2016 at 23:37 GMT

Government spending can't buy the new American Dream

Managing Partner / Spotlight Group
United Kingdom
  • No one single data variable can capture the spirit of an economy
  • Growth in real gross domestic product is a sensible choice as main indicator
  • Since 2006, US real GDP growth per capita averaged 0.4% vs the 2% historical trend
  • Recovery after the 2008 recession has been relatively lukewarm
  • The answer is not in greater government spending
  • Supply-side policies and corporate rethinking is what is required

By Stephen Pope

Ask a range of professional economists and they are likely to give a different weighting to any data variable that can measure economic health.

The performance of an economy is usually assessed by considering the achievement of several economic objectives. These can be both long-term in nature, such as sustainable growth and development, or short-term, such as the stabilisation of the economy in response to sudden and unpredictable events such as exogenous shocks.

 Insufficient wage growth and the worrying rise of income inequality will have serious implications for US and indeed global economic growth potential. Photo: iStock

To assess how well an economy is performing against such objectives, economists usually exploit a wide range of economic indicators. These measure macroeconomic variables that directly or indirectly enable the judgement of whether economic performance has improved or deteriorated.

Thought process

Following these indicators is critical for policy makers, both in terms of assessing whether or not to intervene and then, afterwards, for determining if the intervention has worked. It would be next to impossible to choose just one indicator for a modern, complex economy. However, I would contend that the annual growth rate of real gross domestic product, (GDP YoY) would be a sensible choice as the main indicator. 

It measures total income produced within an economy, adjusted for the overall level of prices. Even if we had a general agreement as to the merit of that statistic, one can debate about the pros and cons of using “factor cost” or “value added”, and so the discourse is effectively endless.

If we take the largest economy, the US, since 2006 the growth rate of real GDP per capita has averaged a rather anaemic looking 0.4% per year, compared with the historical trend rate of 2.0%.

Source: US Bureau of Economic Analysis

Let’s give that a little colour. At 2.0% growth gross incomes double every 35 years. In contrast, at a rate of 0.4%, the time to achieve a doubling of income would stretch to 160 years.

The chart above clearly shows how low GDP growth fell during the last recession. However, even though the downturn was deep it should not be the sole item blamed for the current prevailing lower rate compared with the long-run average.

Why so? Economics and the management of a complex modern economy is far from simple and the explanation for poor long-run performance is more than just one line of econometric modelling.

There were deep recessions in 1980 and 1982; in the latter period US unemployment rate peaked at 10.8% even though the policies of the Reagan administration saw 10-year average GDP growth by Q1 1989 (an inherited data point for George HW Bush) back at 2.1%.

We have to be a little more skilful than just leaning on one metric. The wider evidence shows that the recession of 1982 was followed by a recovery marked by its vigour. In contrast the recovery post-2008 has been rather lukewarm. 

James Bullard, President of the Federal Reserve Bank of St. Louis, has said that the idea that essentially zero interest rates are, after seven and a half years, stimulating the economy "...strains credulity,..." .

Reading the recovery

The US economy added 287,000 jobs in June, which was far better than expectations following two months of disappointing job growth. That came just a matter of days after the Federal Reserve released notes from its June meeting when it decided for the fourth time this year not to raise Federal Funds.

It was last December when the Fed raised rates for the first time in almost a decade, to a range of 0.25% to 0.5%. The latest delay in nudging funds higher was seen as being based on the slowing job growth and the fear factor surrounding the UK referendum on its relationship with the European Union (EU).

The employment gains in June followed a very weak May and were not given any backup from the household survey. Job growth in second-quarter 2016 averaged just 151,000, and before the Fed can freely move on rates the US has to show further gains in manufacturing and construction as well as broader gains in services.

In June, hourly earnings went up by 2 cents to $25.61 per hour. The annualised rate of wage growth for the past 12 months has reached 2.6% but this is below the target set by President Obama of 3.0%. Wage growth goes beyond being a microeconomic cost, carrying negative consequences for a firm.

Instead we must look to the macro scale as wages are a major source of aggregate demand. Wage growth can generate demand growth and hence productivity growth, which drives efficiency. In contrast, insufficient wage growth and the worrying rise of income inequality will have serious implications for US and indeed global economic growth potential.

One point about the US economy now as against even five years ago is the fact that with technological progress one is no longer seeing a like for like case of product improvement. Nowadays a smartphone can act as a camera, diary, email station, GPS and web browser. One no longer needs several separate items. Such quality improvements and new products are so different from what was the norm just a few years ago that it is quite easy to see that GDP data can be underestimated. Maybe, and please do not dismiss this thought, it is that the statistical database is at fault.

One issue that holds the Fed back from moving rates too soon is the election in November. National opinion polls suggest that most Americans think the country is on the wrong track as they feel they are not realising their aspirations.

Across the US there is frustration as workers, even if they feel reasonably secure in their work, are not actively expanding their debt profile. Private sector debt to GDP has fallen from 162% in 2008 to 138% in 2015. Businesses are slowly trying to wean themselves away from just living for the next quarter's numbers. The sad truth is, however, that there is a recognition of how hard it is to create and sustain momentum. Business and political leaders are now showing greater awareness of how difficult it is to achieve anything that is purposeful and that matters.

US private debt to gdp

This means it is important to change objectives and procedures in line with the evolving nature of society. This requires a new approach to build trust and be creative in making meaningful relationships.

So, after 15 ½ years of the 21st century there is talk of a new American Dream. No longer is it simply enough to have a degree. To increase your chances in 2016 more is required for individuals to have a real chance of achieving their life objectives.

Economic dilemma

The answer is not more government spending on infrastructure, such as roads, bridges and airports. It sounds so simple to say that the government should takes advantage of lower interest rates to make the right investments in public capital. The trouble is all governments from all quarters of the globe do not spend money wisely. The record shows that there is at best a 50:50 outcome of state spending making the economy more productive.

I look more to the free market spirit as against the slow and lumbering hand of the state. If Robert Gordon, author of “The Rise and Fall of American Growth: The US Standard of Living Since the Civil War,” is right and the pace of innovative activity has declined, then more must be done to foster it.

Tax breaks and enterprise zones, i.e. supply-side policies, are far better as engines of economic activity than state intervention.

Supply-side economic policies are mainly microeconomic policies designed to improve the supply-side potential of an economy, make markets and industries operate more efficiently and thereby contribute to a faster rate of growth of real national output.

Most governments now accept that an improved supply-side performance is the key to achieving sustained economic growth without a rise in inflation. But supply-side reform on its own is not enough to achieve this growth. There must also be a high enough level of aggregate demand so that the productive capacity of an economy is actually brought into play.

Firstly, policies focused on product markets where goods and services are produced and sold to consumers. Secondly, the labour market a factor market where labour is bought and sold.
Supply-side policies in product markets are designed to increase competition and efficiency. If the productivity of an industry improves, then it will be able to produce more with a given amount of resources, shifting the Long Run Aggregate Supply curve to the right.

Deregulation or liberalisation means the opening up of markets to greater competition. The aim of this is to increase market supply (driving prices down) and widen the range of choice available to consumers. The discipline of competition should also lead to greater cost efficiency from producers keen to hold onto their existing market share.

This will unleash the dynamic effects of greater competition and that competition forces business to become more efficient in the way in which they use scarce resources. This reduces costs, which can be passed down to consumers in the form of lower prices. A tougher competition policy regime includes policies designed to curb anti-competitive practices such as price-fixing cartels and other abuses of a dominant market position, i.e. sensible intervention to curb some of the market failure that can come from monopoly power.

Government should work with business, not get in its way, so that there can be a steadily growing focus on looking at the “Triple Bottom Line” of “Profit, People and the Planet” as against just the profit, i.e. revenue less cost motive.

– Edited by Susan McDonald
Stephen Pope is managing partner at Spotlight Ideas


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