There is a substantial lack of understanding as to why the US is growing so slowly. Let's take a stab at laying out exactly what the economy is doing that is keeping it from turning the corner.
Conventional wisdom would have you believe that slow growth itself is the problem. With slow growth job creation slows. And with that the unemployment rate lingers high after a severe recession: QED?
The conventional wisdom is based on some real-life observations. But they are only part of the story. And maybe they are the less important part. When we look at the economy and assess how things might have been different we need to keep in mind that when one thing is different many other things might be different too. So making what an economist would call a comparative static assessment is actually a difficult thing. Once you post changing one aspect from history, what other aspects will be forced to change?
In that spirit, look at US GDP growth: it has been weak. From the end of the recession GDP has grown by only 6.2% on balance over 10 quarters. That is only half the usual growth. But, is that the symptom or the disease?
If we turn to the data that partitions GDP into goods, services and structures we find a very curious answer. Spending on goods in this recovery has grown by 21.9% through 10 quarters of expansion. Average growth in this sort of spending is 16.8%. Yes! Spending on goods is the second-strongest at this point in the cycle among the last eight recoveries. It is surpassed only by spending at this point of the expansion in 1969.
Since GDP is mostly goods and services and since goods spending has been strong, it must be services spending that has been weak. In 10-quarters of growth, service sector spending is up by just 2.2%. This compares to an average gain of 8.7%. In the last two recoveries at this stage, services spending grew by an average of 6.7%. Prior to that, the average was 9.7%. This is a huge shortfall with massive implications for job growth. Services job growth is up by 2.5% from recession end and would typically be up by 8.3%. That could be worth 5 million jobs.
The weakness has been in services and since services is the job-creating sector, the job weakness is more a function of an odd composition of demand than of weakness in demand itself. Here I appeal to what would be a proper counterfactual comparison. Had more demand gone into services there would have been more job growth per unit of GDP and more income growth, given that, GDP itself would have been stronger.
A lot has been made of the US loss in competitiveness. And it is true that even with strong demand for goods US industrial output was still a bit weak on the uplift. It is up by 0.5% from the recession-end level whereas it would normally be up by 2.6%. It is short of normal by two percentage points. MFG output is still doing better than it did in the 2001 and 1990 recoveries at this point.
But consumer spending on goods has been half of its norm, rising by 5.5% from the recession-end compared to a norm of 11.3%. Spending on business structures has been weak, falling by 13% instead of rising by 3.6%. Residential investment was flat at the 10 quarter mark, compared to its usual rise of 43%. Exports are up by 24% compared to 17% normally, while imports are up at a nearly normal 24%. Business investment on plant equipment and software is strong, up by 32% compared to 25% normally.
We know that structures are abnormally weak. But the strength in goods demand led by business investment spending is far less well appreciated. On balance the GDP disappointments are in structures, truncating services traditional role as a jobs creator.
The recession has been deep and has brought other unexpected developments. The average drop in the unemployment rate since 1960 at the 30-month of recovery is 1.35pct points. Currently that drop is 1 pct point. That's a relatively small short fall. But the unemployment rate itself is still very high.
The more significant shift is that in the 2007 recession there has been a record increase in 'not temporary' (or 'permanent') layoffs. Temporary layoffs, the usual recessionary impact, were relatively small and they went back down relatively fast to a low level. But permanent layoffs, resulting from a plant closing for good or a company that goes out of business, were much higher than ever before in this recession, peaking at 54% of total unemployment compared to an average share of 40% in most cycles.
This sort of unemployment does not fall very fast. Temporary layoffs on average drop by 35% by the 30th month of expansion but permanent layoffs drop by just 7%. Indeed, in this recovery unemployment related to permanent layoffs has dropped by a very fast 18.3% from its peak rate by the 30th month of recovery; that is the second-best record since the 1970 recovery when records were first kept.
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Our recession has substantial structurally distinctive features. The still-flawed housing sector's weakness may be importantly linked to weakness in the services sector. And that weakness may be a bigger factor than overall demand weakness in explaining joblessness. The final structural feature is the extent of permanent layoffs that will mend only slowly.
Interestingly, while Republicans and Democrats have ideas, no party has ideas on how to get to the root cause of US weakness in services jobs or how to attack the structural permanent layoff problem which is behind the observation we all know about which is the heavy numbers of the long-term unemployed. It's unlikely that this increase is due to extending unemployment benefits as some claim. It's more likely that it stems from the unprecedented number of permanent job losses in this recession.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.