Download Low Unemployment Could Stymie President Trump`s Stimulus Plan

As seen on Forbes.com
Low Unemployment Could Stymie
President Trump’s Stimulus Plan
January 2017
by Bruce McCain, Chief Investment Strategist, Key Private Bank
The market reactions after Donald Trump’s election suggest that investors believe his policies will produce significantly faster
economic growth. But can major new infrastructure spending, lower tax rates, and regulatory overhaul generate strong
growth? Probably not at this stage of the economic cycle. While anticipated policy changes may provide some improvement,
tightness in the labor markets will likely restrain any strong surge of growth.
For economic growth to accelerate, the economy must
have the resources needed to satisfy new demand. When
resources are in short supply, increased demand tends
to drive prices higher rather than meaningfully increase
growth. After seven years of economic recovery, with
signs of rising inflation already starting to appear in some
areas, a surge of policy-induced demand might do more
harm than good.
Labor is an essential input for most economic activity,
and so the supply of labor limits how fast the economy
can grow over the longer term. Early in a new cycle,
when unemployment is high, an economy can exceed the
sustainable growth rate. Once the pool of surplus workers
has been drawn down, however, strong new demand
forces employers to bid wages up. Even then, they may
not be able to attract and retain all the help they need.
Economists posit that two factors determine how fast the
economy can grow without major inflationary pressure.
The first is the rate at which the labor force grows. As more
people go to work, the amount of goods and services
produced increases.
As the huge group of baby boomers retires from the
workforce, their departure is limiting the size of the labor
force and the potential growth of the economy. In the
late 1970s, as the Baby Boom generation entered the
workforce, labor force growth added roughly 2.5% to the
growth potential of the economy. Now, under the pressure
of retiring baby boomers, the labor force growth is only
0.7%. Based solely on labor force expansion, the growth
potential of the economy is almost 2% lower than it was
when baby boomers entered the workforce.
The second way to support sustainable, noninflationary
growth is through improving labor productivity. Even if the
labor force does not grow, the economy can expand as
long as the existing workforce increases the goods and
services it produces.
Unfortunately, however, labor force productivity has
declined. The retirement of the boomers could be one part
of this. Experienced workers are often more productive than
new workers, so a large number of retirements could reduce
productivity. Since the generation that follows the baby
boom (the “baby bust” generation) provides a much smaller
number of workers, we may be facing a particularly acute
shortage of experience as boomers leave the workforce.
Productivity improvement also often depends upon
technological innovation and the willingness of employers
to invest in those new technologies. Until the next major
technological revolution becomes implemented, productivity
improvement may remain low.
Over the last 60 years, productivity increases have added
2% to 3% to the overall growth potential of the economy.
More recently, that number has fallen to 0.6%. That means
the economy’s potential for expansion based on productivity
improvements alone is 1.5% to 2.5% less today than it was
in the past.
Low Unemployment Could Stymie President Trump’s Stimulus Plan
1 of 2
Economists add the labor force growth and productivity
improvement together to determine the overall sustainable
growth rate. That total suggests the economy can currently
grow only about 1.2% without generating stronger inflationary
pressure. Apparently, even the anemic 2.1% growth
achieved since 2009 is more than we should expect from
the economy on a sustainable basis. Even though the
economy was able to grow 3% or 4% net of inflation over
long periods of time in the past, this framework indicates
the current economy probably cannot.
Bear in mind, too, that the labor shortages do not develop
uniformly across all segments of the economy. Large
numbers of unemployed manufacturing workers cannot help
to alleviate a shortage of doctors or skilled machine tool
operators. As with the economy in general, major shortages
of labor in a few professional areas may limit the ability of the
overall system to produce goods and services. For example,
a major shortage of doctors would impose enormous
limitations on the healthcare system’s ability to treat patients.
Some of the anticipated policy changes would be more
constrained by labor availability than others. Regulatory
reform, for example, probably depends less on the labor
supply than the other anticipated policy changes and might
even allow some companies to become more productive.
Reduced regulation may not lift the economy dramatically,
but it should help.
Lower tax rates could encourage some additional spending
and investment. Yet tax reform promises both winners and
losers so the net economic incentives to spend or invest may
not change very much. Moreover, with unused capacity in
many industries, “repatriated money” and other tax savings
are more likely to go into share buybacks or acquisitions
than into construction and other economic expansion.
Infrastructure projects and other federal spending seem most
likely to conflict with emerging labor shortages. Construction
managers have already reported difficulty finding enough
skilled labor. A major infrastructure program might simply
make that situation worse. Bear in mind, too, that signs of
more rapid wage growth in some of the skilled areas might
be all it takes for the Federal Reserve to begin forcefully
slowing the economy with higher interest rates.
At this point, effective government spending probably needs
to be much more limited and much more targeted than it
could be earlier in a cycle. Will the administration’s changes
add to growth? Most likely it will deliver some, although the
political reality is that it will probably deliver less stimulus and
require longer to take effect than many anticipate. Additional
growth would also face headwinds from the natural slowing
of an aging cycle and potentially be exacerbated by the
adverse demographic trends. We hope that some of
what the incoming administration can implement will help
increase the rate of economic growth. Realistically, though,
we must realize that we are at a point in the economic and
demographic cycles where strong stimulus programs may
generate less growth and more inflation.
About Bruce McCain
Bruce McCain is the Chief Investment Strategist for Key Private Bank, where he monitors the economy and the
financial markets and serves as part of the team that formulates investment strategies for clients. He supplies
frequent insights to media throughout the region and around the country. His comments and interviews have
been featured in such publications as The New York Times, The Wall Street Journal, Investor’s Business Daily,
and Business Week, as well as on television outlets such as CNBC and Bloomberg TV. He is also a regular
source for wire services such as the Associated Press and Reuters and is a Contributor on Forbes.com. Bruce
joined a predecessor of Key in 1987, after spending six years on the business faculty of the University of Iowa’s Henry B. Tippie College
of Business. Bruce earned a PhD in Business Administration from the University of California at Berkeley, and undergraduate degrees in
Psychology and Accounting from Boise State University.
Low Unemployment Could Stymie President Trump’s Stimulus Plan
This material is presented for informational purposes only and should not be construed as individual tax or financial advice. KeyBank does not provide legal advice.
©2017 KeyCorp. KeyBank is Member FDIC. 170123-184286
2 of 2