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Individuals Will Face Slow Wage (And Jobs) Growth, Hence Limited GDP And Discretionary Income Growth (Article 6 Of 10)

by: BeatlesRockerTom
BeatlesRockerTom
Long only, value, Reit-focused, long-term horizon
Summary

Multiple factors can drive individual wage income growth, making it difficult to make accurate long-term predictions. Supply/demand and productivity are generally considered primary drivers of wage growth.

Wage growth in the long run is generally aligned with GDP growth, which is predicted by the CBO to slow from 2.2% for 2017 to a rate of 1.9% from 2021-2027.

In recent years productivity has slowed, and there are questions as to what degree it may increase in the future and whether it is being properly measured.

Retirements of the 76 million Baby Boomers will dampen workforce growth, hence GDP. Consumer debt at an all-time high leaves less borrowing, hence, spending capacity.

The bottom line is that these drivers will be modest at best, limiting consumer discretionary income growth and GDP growth.

Note: This article is the sixth in a series of ten articles addressing the future of slow GDP growth, high Federal debt, and strained household finances.

There exist no perfectly accurate measures for predicting the rate of future wage inflation nor of jobs growth. Multiple factors, such as technological obsolescence, workforce participation, demographics, GDP growth, productivity, and inflation, drive wage projections. The effectiveness of the Phillips Curve as a predictor of wage inflation based on supply and demand is in question. Yet, each of these measures is inherently difficult to predict individually, no less in terms of how their interaction might affect job and wage growth. Add to this the difficulty in projecting out ten or more years, plus the unpredictability of the global economy and the impact it can have on America's economic growth.

But we can examine some of the key drivers of wage and job growth (workforce participation, demographics, GDP growth, technological obsolescence, consumer borrowing capacity, and productivity).

CBO Budget And Economic Outlook 2017-2027

The CBO released an update June 29, 2017, of its federal budget and economic outlook for the next decade. The report factors GDP growth, labor force participation and demographics into the projections.

GDP Growth is estimated to decline from 2.2% in 2017 to 1.9% in 2019-2020, then average 1.9% through 2027.

"CBO estimates that, in real terms, GDP will expand by 2.2 percent in calendar year 2017 and by 2.0 percent in 2018 (see Table 7 on page 21). CBO expects consumer spending and capital investment by businesses to drive that growth." "... the growth of real GDP in CBO’s forecast averages 1.5 percent annually in 2019 and 2020." (Page 8).

"From 2021 on, real GDP is projected to grow at an average annual rate of 1.9 percent, the same rate that CBO estimates for potential output." (Page 10).

Inflation is projected to average 2% from 2017 to 2027.

"CBO expects that price inflation will continue to rise over the remainder of this year. As measured by the price index for personal consumption expenditures, inflation is projected to reach the Federal Reserve’s longer-run goal of 2.0 percent by 2018." (Page 8). (No projection is explicitly stated for 2019-2020, but these two years are sandwiched between years with projected growth of 2.0%).

2021-2027: "The rate of inflation, as measured by the price index for personal consumption expenditures, remains at the Federal Reserve’s longer-run target of 2.0 percent." (Page 10).

Labor Force Participation. The CBO projects the unemployment rate will drop to 4.2% by 2018. From 2021 to 2027, the labor force is expected to grow at an average rate of 0.5% annually, "... constrained by slow population growth and by the aging and retirement of the baby-boom generation."

2017-2020

"CBO expects the labor market to continue to tighten over the next two years. The primary measure that CBO uses to assess the degree of slack in the labor market is the estimated shortfall between employment and potential employment. Potential employment is the number of people employed when unemployment is at its natural rate - the rate that arises from all sources except fluctuations in aggregate demand - and when labor force participation is at its potential rate. (Aggregate demand is the overall demand for goods and services in the economy.) CBO estimates that the employment shortfall will be eliminated by the end of 2017, even though labor force participation will be below its potential rate, because unemployment will be below its natural rate.

In early 2017, the unemployment rate fell below 4.7 percent, and it continues to drop. (By CBO’s estimates, 4.7 percent is the natural rate of unemployment.) CBO projects that the unemployment rate will decline to 4.3 percent by the end of 2017 and then to 4.2 percent in early 2018." (Page 8).

"The projected demand for workers will encourage more people to participate in the labor force, temporarily offsetting the projected decline in participation arising from such factors as the ongoing retirement of baby boomers. In CBO’s forecast, the rate of labor force participation (the share of the civilian noninstitutionalized population age 16 or over who either have jobs or are available for work and actively seeking employment) remains relatively constant over the next two years.

Further tightening of the labor market will boost the growth of wages and salaries over the next two years, in CBO’s view. After growing at an average annual rate of roughly 2.4 percent from 2015 through the first quarter of 2017, the employment cost index for workers in private industry is projected to increase at an average annual rate of 3.0 percent for the remainder of 2017 and 3.3 percent in 2018." (Page 10).

2021-2027

"CBO anticipates that, on average over the projection period, the potential labor force will grow by about 0.5 percent per year - less than in the past, when baby boomers and women joined the labor force in large numbers. Labor force growth over the next decade will be constrained by slow population growth and by the aging and retirement of the baby-boom generation. CBO also projects that potential labor force productivity will grow by about 1.3 percent per year—about the same as the average rate since the early 1970s." (Pages 10-11).

"The unemployment rate settles at 4.9 percent, which is just above CBO’s estimate of the natural rate." (Page 11).

John Hussman, in his April 2, 2017, article from Advisor Perspectives, cites the BLS's projected workforce growth rate at 0.3%/year.

"On the labor side, the U.S Bureau of Labor Statistics (BLS) projects that the U.S. labor force - the number of people working or looking for work - will reach 163.8 million in 2024. As of February 2017, the U.S. labor force stood at 160.1 million. Accordingly, the growth rate of the U.S. labor force is projected to average just 0.3% annually over the coming 7 years."

"To illustrate what’s going on, the chart below shows the 10-year growth rates of the U.S. working age population, the civilian labor force, and civilian employment since the 1960s. It’s clear from this chart that the central tendency of the “labor force” contribution to U.S. GDP growth has been steadily declining, having peaked in the 1970s and early 1980s."

Payroll Tax receipts confirm the slowdown and are a multiplication factor of projected wage incomes. Hence, wage incomes are expected to slow in the coming period through 2027.

"Payroll tax receipts decline by 0.2 percentage points relative to GDP over the next decade, primarily because an expected continued increase in the share of wages and salaries received by high earners would cause a greater share of earnings to be above the maximum amount subject to Social Security payroll taxes. (That amount, which is indexed to growth in average earnings for all workers, is $127,200 in calendar year 2017.) The resulting reduction in payroll taxes relative to GDP would offset roughly three-quarters of the expected increase in individual income tax receipts stemming from the greater share of wages and salaries accruing to high earners." (Page 4).

Productivity

Ray Dalio, in this article from Advisor Perspectives, addresses the decline in productivity.

"Over the long term, what raises living standards is productivity - the amount that is produced per person - which increases from coming up with new ideas and implementing ways of producing efficiently. Productivity evolves slowly, so it doesn’t drive big economic and market moves, though it adds up to what matters most over the long run." Here's Dalio's U.S. productivity charts and stats, with GDP growth since the Great Recession reflecting the impact of slow growth coming out of a financially driven recession, as Rogoff and Reinhardt's economic studies (book - This Time is Different) had predicted.

In the article cited earlier, John Hussman feels the productivity shortfall, when considering peak employment, could result in an even lower forward GDP growth if the employment rate drops.

"Presently, the Federal Reserve estimates the central tendency of long-run real GDP growth to average just 1.85% annually. Understand that even a 1.85% average economic growth rate in the coming years already builds in some optimistic assumptions. See, even if U.S labor force growth grows at the projected rate of 0.3% annually, this growth will transfer to a similar rate of employment growth only if the unemployment rate remains constant at the current 4.7% level. Meanwhile, with labor productivity growing at only about 0.5% annually, well below the post-war average of 2%, the baseline expectation for U.S. GDP growth, given no change in the present trajectory, is actually just 0.3% + 0.5% = 0.8%"

More info from a Bloomberg article titled "Productivity."

"A nation’s productivity is calculated by dividing what it produces by the labor it took to provide those goods and services. What’s confounding economists is why productivity growth has slowed in many countries during the last decade, even as other economic gauges have improved. There’s a lot of disagreement on why - a mismatch between jobs and skills? Fewer innovations? Aging populations? Measurement problems?"

"Some analysts think today’s statistics aren’t capturing the benefits of advancements in information technology, like global positioning systems and mobile communications."

To summarize, while traditional measures of productivity seem to show a decrease in the rate, others believe technological advancements are not being reflected in the productivity measures.

How Will Technological Advancements Impact Jobs?

John Mauldin addresses three potential outcomes of technological changes which could impact job growth in his article dated June 14, 2017, titled "Where's My Productivity, Dude?"

In his article, he reprints an article by PIMCO's Matthew Tracey and Joachim Fels.

"Broadly, we envision three possible scenarios for global productivity. The first is that our weak-productivity status quo - call it secular stagnation - persists. We all have a sense of what this paradigm means for economies and markets because we have been living through a version of it for years. The future effect of secular stagnation on interest rates is ambiguous - though we note that a continued global trend toward populism, absent a productivity rebound, could put a higher inflation term premium in nominal yield curves (causing curves to steepen).

The other two (more optimistic) scenarios both involve a productivity rebound; the resulting economic gains, however, manifest differently between them – and that’s because productivity growth can occur in two ways. Either innovation reduces required inputs for a given output (through efficiencies and cost savings), or innovation boosts output for a given input."

To recap, the three options are:

1) Secular stagnation will continue. That is, roughly 2% annual GDP growth versus the 3+% we've experienced over past decades.

2) Technology productivity will improve to the point fewer humans are needed to maintain the same level of output. GDP expansion continues, and we benefit by working less yet enjoying increased GDP.

3) Technological innovation will boost work output (hence GDP).

Note that the authors consider the last two scenarios as positive for productivity output, and hence GDP growth and economic prosperity (presumably equating to improved incomes/standards of living). (Note that they label scenarios 2 and 3 with somewhat ambiguous names of "Technological Unemployment" and "Productivity Virtuous Cycle", respectively.)

Mauldin comments further at the end of the article, and addresses an expectation of rapid advancements which could displace workers in a short time frame:

"So, what should we expect going forward? Secular stagnation or a productivity rebound? Our crystal ball isn’t that good. But whereas many market participants are coalescing around a secular stagnation baseline view, we are decidedly less convinced. In fact, we see a growing risk that we collectively underestimate the global economy’s pent-up productivity potential. It wouldn’t take a leap of faith to envision some variant of our “Technological Unemployment” productivity rebound (putting aside, in this note, its potentially serious social consequences)."

Then he cites a concern: "If future innovation displaces low-skill labor first, as we suspect it will, the impact on employment could indeed be negative - absent herculean worker-retraining efforts."

"All of us might wish for a virtuous productivity cycle like the one they describe as scenario number two, and that is what has happened in the past. People left the farms and went to the cities to work in the factories and then moved on to other jobs. Technology created new jobs in the process of destroying past jobs. It was in the height of this process that Schumpeter wrote his famous “creative destructio[n]” paper.

The problem with that scenario playing out in the future is that we literally had generations of time to adapt. If we had tried to go from 80% of the people working on farms in 1880 to 2% in 10 or 15 years - less than a generation - it would have been far more disruptive than the actual 20 generations it took. People had time to change.

I am far more concerned about today’s 'technological unemployment.' Automated cars are just the tip of the iceberg. The Council of Economic Advisers thinks that 60% of lower-paying jobs will be automated in the next few decades. Where will these people go to work? Yes, we can retrain them for other work, but are they willing and able to be retrained? Will they be willing and able to move?

Given the nature of the change that I see coming, I think that income inequality will actually grow. In my upcoming book I will put a mathematical formula to it and demonstrate that in the future income inequality will be worse, no matter how you cut it. And increased taxes are going to slow down growth and reduce employment opportunities. There are no free lunches."

In short, Mauldin's concern is that technology's pace of growth will be more rapid in the coming era than during the agricultural-to-industrial revolution. This means more workers will be displaced in a shorter time frame, and we will have less time for retraining en masse for workers to reenter the workforce into higher-paying jobs.

There is no doubt that technological progress will continue its unending march forward. Amazon is experimenting with automated checkout, which eliminates the need for cashiers. The company is opening a grocery store with no cashiers and no checkout lines.

"There are roughly 3.4 million people employed as cashiers in the US, according to the US Bureau of Labor Statistics (BLS). There are a further 4.5 million employed as retail salespeople, and 2.4 million employed as laborers that restock and move cargo around. Amazon already uses robots in its warehouses to move cargo around and bring items to humans to prepare for shipping. It’s also working on creating robots that can scan shelves for items and prepare those goods for shipping themselves. Reverse that process, and those same robots could theoretically be used to restock the shelves of an Amazon Go store. In the near future, a store like this could potentially be run almost entirely without humans, barring those employed to prepare the food - although even that could be automated one day." Do we think brick-and-mortar retail facing secular sales erosion to the internet might be driven to cut cashier labor costs in order to restore profitability and competiveness with Amazon?

There is some discussion that autonomous vehicles could displace jobs ranging from taxi and Uber drivers to truck drivers.

This article at Bloomberg addresses the potential for technological job displacement.

This McKinsey article cites the wage risk due to automation.

"However, almost every occupation has partial automation potential, as a proportion of its activities could be automated. We estimate that about half of all the activities people are paid to do in the world’s workforce could potentially be automated by adapting currently demonstrated technologies. That amounts to almost $15 trillion in wages."

The bottom line as to how technological advancements may have an impact is that both job and wage growth for the newly created more technical jobs will increase. However, such gains may be offset somewhat by the jobs displaced by technological growth. This may particularly impact those with entry-level jobs that might be more susceptible to displacement and those unable to qualify for newer jobs because of a skills gap.

Boomer Retirements And Record Levels Of Consumer Debt Will Further Restrict Consumer Spending, And Hence GDP Growth

Boomer Retirements and the Comparison with Japan

As Baby Boomers born between 1946-1964 retire, 76 million will eventually leave the workforce. If the average retirement age, for illustration, is 65, by 2029-2031 (depending on whether the Boomer generation starts in 1944 or 1946), the last of the 76 million Boomers will have retired, as a ballpark illustration. Looking at the aging demographics in Japan and the impact on their stagnating economy, are there similarities in the future for the U.S.?

Here's an article explaining Japan's secular stagnation; this despite all efforts by its central bank to flood the economy with money. It's a David Kotok reprint of a Jeff Uscher article. In short, the gist of the article is that in Japan, as Boomers have retired, younger replacement workers have received less pay.

Regarding the Japan stagnant growth issue and possible similarities in the U.S., here's an excerpt from an article by Steve Blumenthal citing a presentation by Mark Yusko given at John Mauldin's May 2017 annual conference.

Yusko's general theme is to predict slow growth ahead for the U.S. primarily because of aging demographics (and a possible recession a year from now). Here's the excerpt drawing a direct correlation of Japan to the US.:

  • "No chance they are going to unwind their balance sheet.
  • And here’s why I know this - I don’t need to predict the future, we already know the future… everything that happens in Japan happens in the U.S. 11 years later.
    - Their market peaked in 1989, our market peaked in 2000.
    - Their bonds got downgraded from AAA, our bonds got downgraded from AAA 11 years later.
    - We know that 11 years ago the Bank of Japan’s balance sheet was 26% of GDP, precisely where the Fed balance sheet is today.
    - Today the BOJ’s balance sheet is 90% of GDP... That’s where we are going.
    - There will be NO unwinding of the balance sheet.
    - There will be NO selling of bonds. They are going to buy them all and then they are going to try to do (what was described the day before by several presenters) the 'Jubilee.'"

Per the Jeff Uscher article referenced above, couple replacement workers earning less with retirees living on less annual income, compared to when they were drawing a paycheck. Hence, there is less consumer disposable income available for goosing the annual GDP, thus the reason for Japan's secular stagnation. (There is more to the story, but this is the core of it.) It remains to be seen how these two factors might impact the U.S. and whether Mark Yusko's strong convictions will occur. (Since Yusko's May presentation, the Fed has announced it will begin balance sheet unwinding.) As Boomers retire, when coupled with all other factors, 76 million Boomer retirements are but one more reason for expecting slower GDP growth in America.

How does record household debt impact future consumption, GDP growth, and wage growth?

While deleveraging of the 2008 pre-recession debt has occurred, at the same time consumer debt has now reached an all-time high ($12.73 tillion), as credit card, mortgage, student, and auto loan borrowings have increased since 2008-2009. (Household debt will be addressed in much greater detail in article 8 of 10.) U.S. households now have as much debt as they had in 2008.

We can draw these conclusions: 1) Borrowings since 2009 have accelerated spending, hence goosed the economic expansion; 2) Additional borrowing capacity has been narrowed - there is less borrowing capacity remaining going forward than there was at the beginning of 2009; 3) A greater percentage of household income will be dedicated to debt payments; and, 4) With employment at or near peak levels (4.4% unemployment in August 2017), there is less capacity for new job expansion, which could otherwise goose borrowing and spending; 5) As 76 million Boomers look to retire, those that can afford to do so may be inclined to take on less consumer debt in retirement. All this adds up to less spending capacity looking forward than looking back to 2009.

Summary

When you consider the CBO's projection for slow economic growth between now and 2027, increased Boomer retirements (generally resetting their incomes to lower levels in retirement), record high consumer debt leaving less future borrowing and consumption capacity, and couple that with the potential for technological job obsolescence which could proceed at a more rapid pace, these factors place some restraint on the rate of future increases in GDP, job growth, and hence, wage growth.

Bottom Line

Slowing spending as Boomers retire, plus record consumer debt levels, combined with the possibility of technological job displacements are some of the factors supporting a CBO-predicted slowing of annual GDP growth to 1.9% beginning in 2021 through 2027. Wage growth will likely reflect level of GDP growth over the long term.

Disclosure: I am/we are long EQIX, COR, CONE, MSFT, O, STWD, JCAP, HASI, UNIT, HD, LOW. 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.