Business Investment, Productivity, Labor Force Declines Are Recipe For Slowing Economy: Economist Nick Perna

by: Harlan Levy


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Economist Nicholas Perna, a former visiting economics professor at Yale University, is the economic adviser to Webster Bank. and managing director of consulting firm Perna Associates.

Harlan Levy: What did you take away from the second-quarter Gross Domestic Product report?

Nick Perna: It was rather disappointing, up 1.2 percent. It was less than half of what a number of people were expecting. The first quarter was up 0.8 percent, and we are running well below the 2 percent that the Federal Reserve seems to have as a target for GDP growth.

If you want to be a little bit upbeat you can say much of the sluggishness was due to a decline in inventory, and that can be made up this quarter by restocking the shelves.

There was a rather rapid growth of consumer spending in the quarter. But there were a few disturbing features below the surface. One was that yet again business investment in new plants and equipment fell. So did state and local spending. What's disturbing about the plant and equipment is that's how you get productivity gains. This doesn't bode well for future productivity growth.

So why is business investment so sluggish? Some people point to over-regulation. Others say it's uncertainty. There is a lot of that, but the third thing that is very interesting is that a number of studies suggest that what U.S. businesses have done to increase profits and decreased the volatility of profits is, among other things, cutting back on investment spending, stock buybacks, and not hiring. They don't expand capacity in order to keep prices up. They buy back shares in order to keep per-share profits up rather than use the money to invest in plant and equipment.

This is bothersome, because it has a number of consequences. It makes it difficult to get future productivity gains, and it feeds into this inequality problem. Businesses are protecting or boosting their profits by not expanding and not hiring.

What seems to be happening with GDP is that it's more of the same slow growth that we've had ever since the end of the recession. There are so many reasons: restrictive national budget policy, excess supply of uncertainty. But if you look forward you start to worry about the longer-term determinants. We're in the longer term. We've got slow demographics and slow productivity growth.

The demographics are fairly certain. Everybody who will be in the U.S. labor force for the next 16 years has been born. Unless you get a lot of immigration, you're going to get slow labor force growth.

A number of serious researchers are concerned about the future of productivity growth. One is my MIT classmate Robert Gordon, who's spent his life on this. His latest book documents both the history of productivity and points to a fairly bleak future.

H.L.: So what's your prediction for GDP growth for this quarter and the year and the implications?

N.P.: The second half we should be able to do a little bit better than in the first half. It's unlikely that we'll be cutting inventories. It's quite plausible to get 2 percent or maybe 2.5, maybe in the second half.

That's still pretty mediocre growth if you add in the first half. The full year would be slower than last year.

The implications are, No. 1, could we have a recession? There are so many things that can hobble growth. We don't know the outcome of the election, and that could generate a good deal of uncertainty. I think one of the best things you can say about Hillary is that you'll know what her economic policies are and that they're very similar to what we have. It's hard to know what Trump's policies will be. That could be very disconcerting for business and consumer confidence.

Then we have Brexit. So far the effects on the U.S. have been a little bit positive, because the vote ended up causing money to flow to the U.S., keeping interest rates up. But most serious researchers will say that if fully implemented, Brexit will slow growth in Europe and therefore in the U.S.

The one thing that is of growing concern is this whole terrorism threat. The terrorists seem to be finding even more horrific ways to frighten us.

All of this is why the Fed has not rushed in and raised interest rates. Maybe they'll do something in September. During last week all they did was keep the door open without saying they will do something in September. If we get some good jobs numbers and GDP numbers, maybe before the end of the year a rate hike will happen. But against this backdrop of sluggishness and uncertainty, you don't want to raise rates when the rest of the world is easing. That would strengthen the dollar and weaken our exports

H.L.: What's your take on consumers?

N.P.: Consumer spending has actually been fairly decent in the second quarter. It's helped by low interest rates and gas prices, and the stock market is doing well. My guess is that the average person in assessing the economy from what they read in the paper and experience at the gas station is helping to boost consumer confidence. They don't pay a lot of attention to the gyrations of the GDP.

Also, we've got a fairly high savings rate by historic standards, which means there's room for a further expansion of consumer spending.

Have consumers fully factored in the news on Brexit? Do they know what that means? It'll be interesting to see what happens to consumer sentiment as the election gets closer. I have a feeling that it won't boost consumer confidence, because it will get confusing about who's better and what's going on.

H.L.: What's your prediction?

N.P.: One approaches this with great trepidation. I'd rather predict the 10-year Treasury rate 170 years from now.

There are a number of methodologies. Ray Fair of Yale looks at things like how well the economy performed in the year before the election. What he says is that the Democrats won't get much more than 45 or 46 percent of the popular vote. That means Trump wins.

The website Predictit offers future contracts in elections and other things. As of Friday morning, you could buy a futures contract for Hillary to win for 66 cents, and you'd get a dollar in November if she wins. For Trump to win it cost 34 cents, and you get a dollar if he wins. What this market is saying is that the odds of Hillary winning are almost twice as high as Trump.

This is people putting money where their mouths are, no different from people betting on where oil prices will be or pork bellies. If you buy Trump at 34 cents and in the next couple of months it goes to 70 cents, you can sell it at 70 cents and make a profit.

Unlike Fair's model and other models, this takes into account many of the complexities like personalities and electoral votes. The election process is very complex this time. I'm surprised that Predictit doesn't get more attention than surveys of people who don't have to put their money where their mouths are. What I don't know is how big Predictit's market is.

H.L.: What did this week's manufacturing reports tell you about what has been considered a declining weak sector?

N.P.: It has been improving in the U.S. The big thing to worry about is what happens with the dollar exchange rate. I'm a pessimist about the dollar. Once things get clearer in Europe, you'll see the dollar start to come down in world markets, which will be good for manufacturing in the U.S.

I'm not sure Brexit will ever be implemented. And instead of worrying about national indebtedness in Italy, people are worried about the health of Italian banks. This too shall pass.

We're in a situation where the dollar is strong, because everyone else looks so risky. Granted that we have a pretty strong economy relatively and strong institutions, but the rest of the world, especially Europe, will be in better shape than it is now. That means the dollar will fall as the euro rises in value.

I'm keeping my fingers crossed, because if the Brits go blindly into Brexit, then the euro may further weaken, which means the dollar would get stronger. That's unlikely, but there's a chance it will happen.

H.L.: Is the job picture changing or remaining barely positive?

N.P.: The numbers the last few months have been very volatile. Part of that had to do with a Verizon (NYSE:VZ) strike in May. But most of the months so far have had slower job growth than last year, in part because we're approaching full employment. The Fed has been advising us to lower our sights as to what we think a decent employment growth number would be. So if you see numbers at or slightly below 150,000 new jobs per month, that would not be of concern. Below 100,000 would be a concern.

H.L.: Where do you think the stock market is going?

N.P.: My usual stock answer is that we really haven't gone anywhere for a couple of years. As you look forward, a couple of negatives would make it hard to get increases. I think interest rates will be a bit higher in a year, which is bad for stocks or doesn't make the case for stocks to go higher. And with the slow economy it's hard to get good profits. All the things that businesses use to grow profits are pretty much tapped out. Consider yourself fortunate if you can hang onto the gains you've had.

The problem with the bond market is that if you buy a pile of 10-year Treasuries that yield 1.5 percent, if interest rates go up, you'll be sitting on a portfolio worth less than you paid for it, unless you hold them for a long time.

I don't even buy green bananas at my age.

The U.S. Treasury bond is risk-free or as close to 0 percent risk. However, that's credit risk. Today you face interest-rate risk.

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