Don't Expect Economic Growth To Take Off

by: John M. Mason


The supply side of the US economy keeps informing us the economy is just not going to grow very fast and we can't focus on the demand side and be optimistic.

Labor productivity is down year over year, labor force participation remains around a 40-year low, and the age demographics of the labor force is changing, all pointing to lower growth.

These all seem to be structural factors that little or nothing can be done about in the short run and may be something we just have to live with.

Know what doesn't sound good to me about the jobs growth data that was released last Friday and that the stock market responded very positively to? "In the second quarter " of 2016, "hours worked increased faster than output," reports Ben Leubsdorf in the Wall Street Journal.

In other words, labor productivity fell for the third consecutive quarter, "the longest slide in worker productivity since the late 1970s…" Year over year, labor productivity was down 0.4 percent, "the first annual decline in three years."

The annual growth rate in labor productivity in the 2007 through 2015 period was 1.3 percent, "just half the pace seen in 2000 through 2007." The compound rate of growth in labor productivity through the seven years of the current economic recovery was 0.89 percent, or just a little less than 1.0 percent annually.

Given that the compound rate of growth of real GDP during the seven years of recovery was 2.07 percent, the growth of the labor force works out to be just 1.18 percent.

One should note that the labor force participation rate was at 66.0 percent at the start of the Great Recession, was 65.5 percent when the current economic recovery began, and is now 62.8 percent. This last figure is around the lowest the labor force participation rate has been since the late 1970s. The labor force participation rate was at its highest level at the start of the year 2000 when it was over 67.0 percent.

Labor productivity has declined in parallel with the decline in the rate of labor force participation, an interesting coincidence... or, is it. The rate of growth in the economy has also followed this decline in labor productivity and labor force participation.

Two other factors seem to be interesting in trying to understand these data. First, there has been a business investment that has not been as robust since the beginning of the 2000s as before this time.

There was the popping of the technology bubble in the stock market that began in March 2000 and net business investment never seemed to be as vibrant after this date. During the current economic recovery, capital expenditures did not recover to match the period between 2001 through 2007, and the last two years or so have seen net business investment slow down even more.

Corporations facing a lot of uncertainty and very low interest rates decided to concentrate on financial engineering rather than industrial advancement. Thus, the emphasis has been on raising dividends and stock buybacks... plus a little M&A.

Many analysts claim that this lack of focus on capital investment has resulted in expenditures that did not incorporate as much increase in worker efficiency as had been done in the past... hence, contributing to the falling productivity numbers.

A second interesting factor may also have contributed. Greg Ip in the Wall Street Journal presented another picture of what is happening in the labor market. Mr. Ip writes about the pickup in retirements of an aging population and how this has affected labor productivity. "New research has identified that rapid retirements deprive companies of critical experience and knowledge, which undermines productivity across the economy."

He reports on research that shows "on average, every 10 percent rise in the share of a state's population over the age of 60 cut per capita growth in gross domestic product by 5.5 percent."

"First, as more workers retire, the labor force grows more slowly. This... explains one-third of the 5.5 percent growth hit."

"But the bigger effect was through reduced productivity of the remaining workers... everyone became less productive in an aging state... all else equal, experienced workers are more productive. One study found that productivity peaks at age 50, when productivity is 60 percent higher than for the average 20 year old."

What is most important in all this information is that the things being discussed here are "supply-side" factors. That is, job growth, labor force participation rates, labor productivity, and labor force demographics impact the ability of an economy to grow faster... or, slower.

Many analysts and journalists look toward the demand side of the economy to explain whether or not the economy will grow more rapidly. A lot of emphasis these days goes to what is happening with regard to consumer expenditures because this spending makes up about two-thirds of all GDP. This focus comes from the emphasis given to the demand side of the economy in Keynesian macroeconomic analysis.

The alternative view is that, in recent years, the supply side of the economy is dominating the expansion of the US... and, other countries. Some of the changes presented above, like the labor force participation rate and the demographic makeup of the work force, are the dominating factors in the economy right now. Maybe restructuring needs to take place in these areas before the economy can move at a faster pace in the future.

Maybe this is why we see economists and journalists get so excited about current pieces of information, like the jobs report last Friday, but then have to back off when numbers on industrial production... down, year over year... and real GDP growth... up only 1.2 percent, year over year... are released.

Maybe the economy is going through a long period of economic restructuring and it needs to get through this period before economic growth is going to pick up. Maybe, this is the "new normal" for the current time.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.