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Squaring up to a low growth world- Part One

Squaring up to a low growth world- Part One Anthony Harrington

There wasn't much of an outcry in the media when the US Congressional Budget Office told the Senate Budget Committee and the House Budget Committee that instead of achieving 3.0% growth in 2013 as had been widely reported, the CBO expected the US economy to grow by no more than 1.5% by the end of this year. That is way below trend for the US economy. The CBO put the cause down to "fiscal drag" caused by a mandatory tightening of Federal fiscal policy in 2013 - mandatory, that is, as scheduled under new legislation to cut the US deficit.

Reduced Federal spending and the expiration of the 2% point cut in the Social Security payroll tax, plus increases in tax rates on income above certain thresholds, will all have a dampening effect of around 1.5% in total on the economy, the CBO says.

As a result unemployment in the US will continue to run at around 7.5% through 2014, giving the US its sixth consecutive year with unemployment at or higher than 7.5%, the worst performance in terms of jobs for 40 years. Moreover, though the CBO sees some bright spots, such as a pick up in the US housing market which may well drive growth in the economy at large, and which could see growth returning to 3.5% in 2014, it warns that the gap between potential GDP (what the nation is capable of producing on a sustained basis) and actual GDP won't close till around 2017. This would be almost a round decade after the onset of the global financial crisis in 2007.

This would be depressing enough as a view of the likely course of the US economy, but Jeremy Grantham, co founder and chief investment strategist at GMO (Grantham, Mayo Van Otterloo), with $97 billion in assets under management, argues in a November 2012 Newsletter that the good old days of the US enjoying trend growth in excess of 3% a year are not just "hiding behind temporary setbacks", they are gone forever!

"Going forward GDP growth conventionally measured for the US is likely to be only 1.4% a year, and adjusted growth about 0.9%," he says.

So why does Grantham believe that the US is now structurally unable to get back to trend growth of 3%? Simple. Growth in GDP has to come from somewhere, largely from greater productivity either through increased use of labor or increased use of technology. But Grantham points out that the US population growth is set to "bob along at less than half a percent" instead of the 1.5% a year seen in the 1970s. This means that man-hours worked annually are likely to be growing at only 0.2%, hardly a massive boost to GDP. Moreover productivity improvements are seen at their best in manufacturing, and manufacturing now only accounts for around 9% of the US economy. Not good. You would have to leverage that 9% pretty phenomenally to have a significant impact on GDP growth, particularly since the manufacturing sector is in decline and is headed for only a 5% share of the US economy by 2040 or so, Grantham says.

The following paragraph from the GMO newsletter on the impact of demographics on growth is worth pondering:

"The demographic inputs peaked around 1970 at nearly 2% a year growth (there are many ways to do these calculations, each yielding slightly different results).  They fell to about 1% average growth for the last 30 years and demographic effects are now down to about 0.2% a year increase in man-hours where they are likely to remain until 2050, with possibly a very slight downward bias.  Unusually for things economic, these estimates are much more likely than the typical estimates to be quite accurate, for much is derived from the existing population profile and social trends, which, like birth rates, change very slowly.  The only variable that is quite likely to jump around unpredictably is the U.S. immigration policy."

By this last point GMO leaves the door open for the US to suddenly decide that it can import a large amount of youthful, energetic labor from South America or elsewhere just by changing its immigration policy. However, that is such an emotive issue for the US that it is hard to see any government surviving the introduction of an "open doors" policy on immigration. The demographic issue is hard enough to get around, but GMO says that there are two further structural issues that will simply confirm that growth will be very hard to find going forward. The first of these is diminishing resources and increasing pressure to account for those resources properly, including water. The second is the damaging effects of climate change, which GMO sees as adding significantly to costs, especially from 2030 and beyond.  We will pick these two further dampeners on growth up in Part Two.

Further reading on GDP and growth

Tags: CBO , Congressional Budget Office , fiscal drag , GDP growth , Jeremy Grantham , slow growth , US deficit
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