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Macro comment: Trump against trend

The stock market fell slightly at the end of the first quarter when Trump and the Republicans' plan to overhaul Obamacare failed to materialise. Doubts are emerging as to whether Trump will be able to deliver on his promises of tax reform and more public investments. Many of his deregulation efforts may also fizzle out. A more fundamental problem, however, is that the US economy has entered a period of low trend growth. This started around 2005, prior to the financial crisis and the 2008-2009 recession, and it is difficult to see what Trump can do to reverse it.

Low trend growth explains why the recovery has been so weak. If the US had quickly crawled out of the recession and then grown at its pre-2005 trend rate, which was 2.9 percent, GDP would be 18 percent higher than it actually is. But GDP has grown just 2.1 percent per year since the trough in 2009. Since some of this has been catch-up growth, there is reason to believe that trend growth is lower than two percent, probably as low as about 1.5 percent.

Why the weaker trend growth?

Why this weakness? Around 2005 the economy received a blow to its ability to make itself more efficient. During the decade prior to 2005, efficiency – i.e. the economy's ability to transform labour and capital into goods and services – grew on average 1.7 percent per year. From 2005 onwards, efficiency growth has just been 0.4 percent per year. Low efficiency growth causes weak growth in labour productivity, implying that higher employment has a limited effect on GDP. It is unclear what has caused the negative shift, which occurred in several advanced economies. Is it a measurement problem that caused structural changes in the economy? So far research does not indicate that it has become more difficult to measure efficiency now than it was prior to 2005.

Another reason for weak trend growth is lower labour force participation, something which started around the turn of the millennium. The labour force participation rate was 67.5 percent of the adult population in 2000. Since then the participation rate has fallen and now stands at 63 percent. If it had still been 67.5 percent, 11 million more people would be in the labour market now. Even taking into account weak growth in productivity, this would have provided a significant boost to GDP.

Down to demographics

The fact that labour force participation has not increased after the recession indicates that the main reason is demographic. The US population is aging. The proportion of the population with the highest participation rate, those between 25 and 64 years of age, is now growing 0.8 percent per year. That is half the growth rate seen during the three decades prior to 2005. With the unemployment rate at 4.5 percent, GDP will no longer be noticeably pulled up by higher employment.

Unsurprisingly, investments fell during the 2008-2009 recession. Investments have picked up, but at a slower pace than has typically been the case following a recession. The reasons are weak efficiency growth and a lower labour participation rate. When the economy produces fewer extra goods and services by using more capital, investments ease off. Also, fewer new workers imply less need for capital.

If the US does not open its doors wide to immigrants, little can be done about demographics. It will thus be more important than ever to try and push up efficiency growth. That is easier said than done, however. What can Trump do to reverse the trend? Expansionary fiscal policy – i.e. more public investments and tax cuts – may have a positive effect on GDP, but there is little to indicate that it would pull up trend growth. Deregulation, such as a simplified tax system, may have a positive effect on trend growth, but a strong broom is needed to instigate persistently higher efficiency growth. Protectionism, on the other hand, would weaken efficiency growth, as higher tariffs act as sand in the economic machinery. As I view it, there is scant reason to believe that policies will cause trend growth to spike. It is highly uncertain what Congress will legislate, and the effect of potentially positive legislation is unclear.

Not written in stone

Nevertheless, this does not mean that GDP trend growth cannot be reversed. Perhaps weak efficiency growth has little to do with policy. It may be that the economy strives to adopt new technology and that over time it figures out how to operate more efficiently – as was the case in the 1990s. In 1987, Nobel Prize winner Robert Solow, the economist who first untangled the reasons for sustained growth, said that the computer age could be observed everywhere except in economic statistics. A few years later, efficiency growth accelerated.

Trump is currently struggling with the trend, but the outcome is not written in stone – and it is not always determined by policies.

This macro comment was originally published in our first quarter Market Report



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