Download Third Quarter - Wallington Asset Management

Q U A RT E R LY R E V I E W
1 1 1 TH E D I T I O N
2016: T HIRD Q UARTER
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Gross domestic product (GDP) is the total value of goods and services produced by the economy during a given period. GDP growth is usually annualized and seasonally adjusted for comparative purposes. The Atlanta Federal
Reserve expects U.S. GDP to have grown at a 2.2% annualized rate during
the third quarter compared to second quarter GDP growth of 1.4%. U.S. GDP
is currently approaching $18 trillion. Consumer spending accounts for roughly two-thirds of GDP, and the drivers of real (inflation-adjusted) GDP growth
are 1) the growth in the number of workers plus 2) productivity growth in real
output per worker. This can also be defined as real output per hour worked
times the total number of hours worked.
(Continued on page 8)
COMMENTARY
WHAT AILS THE U.S. ECONOMY?
1 1 1 TH E D I T I O N
2016: T HIRD Q UARTER
T
EQUITIES
he Standard & Poor’s 500 (S&P
500) index ended the third quarter
with a 3.9% total return (price
appreciation plus dividends), increasing
its total return for the year to 7.8%. The
index closed the quarter at 2,168.27 after
reaching an all-time high of 2,190.15 on
August 15. After trailing the S&P 500
during the first half of the year, small
company stocks represented by the Russell 2000 Index performed well for the
quarter with a 9.1% total return. This
brought the index’s total return for the
year to 11.5%. The MSCI Europe, Australasia, and Far East (EAFE) index recovered from a 1.2% loss in the first half of the year by generating a 6.5% total return in the third quarter
when denominated in U.S. dollars. Although emerging market equities have exhibited negative returns in
every calendar year since 2012, the MSCI Emerging Markets Index has presented strong returns thus far in
2016 with a total return of 9.2% for the quarter and 16.4% for the year.
While the Utility and Telecommunication Sectors were the strongest in the first half of the year, both struggled in the third quarter with -5.6% and
-5.9% total returns respectively. This
brought the performance of utility stocks
to 17.9% for the year and performance of
telecommunication stocks to 16.1% for the
year. The Technology Sector was the
strongest of the quarter with a 12.9% total
return. Energy Sector stocks have provided the highest total return, 18.7%, of any
sector through the first three quarters of
2016.
According to FactSet Research Systems,
as of September 30, S&P 500 earnings for
the third quarter were expected to drop
2.1% on a year-over-year (YOY) basis. On June 30, analysts still anticipated small growth for the third quarter. Expectations dwindled as 10 out of 11 (Standard & Poor’s broke out Real Estate from the Financial Sector in September to create the 11th category) economic sectors had their earnings estimates revised downwards over the course of the third quarter. Only technology stocks’ earnings estimates were revised upwards, increasing from 0.1% to 1.7%. If reported earnings do not significantly outperform expectations, this
would be the sixth consecutive quarter of YOY declines. The Energy Sector continues to be the main detractor as earnings are expected to decline 67.0% after declining 84.1% in the second quarter of 2016. The expected decrease in earnings for the S&P 500 is in spite of expected revenue growth of 2.6% for the quarter
indicating margins are expected to contract.
The theory of loose monetary policy boosting the economy is based largely around lower borrowing rates
incentivizing companies and individuals to borrow and invest. There are signs that artificially lower rates for
an extended duration are causing a broad misallocation of capital. For example, the Vanguard High Dividend Yield Index Fund is trading at its highest price-to-earnings (P/E) ratio since December of 2009 when
earnings were depressed due to the Great Recession. This is in part due to investors looking to find replacements for the income which was previously provided by bonds.
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EQUITIES
Many companies are also issuing cheap debt for
the purpose of distributing capital to shareholders in the form of dividends and share buybacks
as opposed to increasing capital expenditures.
These forms of shareholder distributions made
up 123% of earnings and 54% of free cash flow
as of the end of the second quarter. 2016 is on
pace for the fewest initial public offerings (IPOs)
since 2009 according to Renaissance Capital. A
glut of cheap financing is in part responsible for
the dearth of new public companies. The average
age of a company going public has increased
from four years in 1999 to 11 years in 2014.
With the upcoming election, inevitable curiosities arise as to how each candidate’s relative success will affect the markets. The equity markets have correctly “predicted” all but three elections since 1924 and every
election since 1980. If the S&P 500 was positive in the three months leading up to the election, the incumbent party won, while if the index was negative, the incumbent party lost in 19 of the 22 elections over this
time period. The cause and effect of this situation is up for
debate and variable. A weak stock market often reflects
weak economic conditions and could lead to the incumbent
party losing. On the other side, strong political positioning
of the incumbent party often reflects more predictable policy
ramifications, less uncertainty and a stronger stock market.
Paying attention to the respective policies of each candidate
is prudent, although they are not necessarily cause to alter
investment strategy dogmatically. While President Bush offered generally fiscally stimulative policies through tax cuts
and public spending, the performance of the market under
his presidency was ultimately poor as he entered office
shortly after the top of the technology bubble and left office
in the midst of the Great Recession. On a more micro basis,
President Obama’s support and subsidies for clean energy
could not help the performance of the industry. An investment in the iShares Global Clean Energy ETF (exchangetraded fund) on the day he was elected into office would
have lost over 40% of its value through the third quarter of
2016 in spite of a broad bull market. Certain assets have
been experiencing price movements based on perceived
2016 election probabilities. Over the course the first debate,
the Mexican peso appreciated almost 2% versus the U.S. dollar. Any disruption in trade between Mexico
and the U.S. would be destructive for Mexico’s economy as nearly 80% of the country’s exports go to the
United States, and Donald Trump has been especially critical of the North American Free Trade Agreement
(NAFTA) on the campaign trail. Over the long term, currency movements like this can affect the equity
markets through changes in competitive positioning and trade.
On September 9, the S&P 500 ended a streak of 43 trading days without increasing or decreasing beyond
1.0%, as concerns were renewed over a potential earlier-than-expected Federal Reserve (Fed) rate hike. This
coupled with market angst over Deutsche Bank’s solvency following an announced $14 billion fine from the
U.S. Department of Justice led to a relatively volatile end to the quiet quarter. The S&P 500 would subsequently have four additional days where the index would trade up or down greater than 1.0%.
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FIXED INCOME
The fixed income markets started the third
quarter on a strong note, following the surprise late-June vote by the United Kingdom
to leave the European Union. This unleashed
political and economic uncertainty, causing a
broad flight to safety reaction in the global
securities markets. After starting the quarter
at 1.47%, the U.S. 10-year Treasury benchmark bond’s yield to maturity (YTM) decreased to 1.36% as of July 8, a record low.
Cracks began to appear in the global bond
markets, and the 10-year Treasury benchmark
bond’s yield to maturity increased to 1.73%
in mid-September before ending the quarter
at 1.60%.
The selling of U.S. Treasuries led to a -0.3% return in the BofA-ML U.S. Treasury Master Index for the
quarter. In contrast to Treasuries, investments in corporate and high-yield bonds chalked up gains for the
third straight quarter. The BofA-ML U.S. Corporate Master Index returned 1.4% due to tightening credit
spreads (the gap in yield between corporate bonds and Treasury bonds). High-yield bonds had the best performance with the BofA-ML U.S. High
Yield Master Index (“junk” bonds),
returning 5.5% during the quarter and
15.3% on a year-to-date (YTD) basis.
High-yield bonds have proven to be
popular with investors, largely based
on the fact that it is one of the few asset classes left that still offers elevated
investment income. A weak dollar was
not able to help the BofA-ML Developed Markets Sovereign Bond Index
overcome low yields, as the index returned only 0.2% for the quarter when
denominated in U.S. dollars. This
brought the index’s return to 11.5% for
the year.
During the quarter, the yield curve flattened slightly in response to concerns that the Fed will raise interest
rates in December. As a result, short-term bonds represented by the BofA-ML U.S. Corp – Gov (1-3 Years)
Index were essentially flat while the BofA-ML U.S. Corp – Gov (10+ Years) Index increased 0.9%. Intermediate-term bonds did not fare as well as their longer-term counterparts as the BofA-ML U.S. Corp – Gov
(3-5 Years) Index returned only 0.1% for the quarter.
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FIXED INCOME
2016: T HIRD Q UARTER
On September 21, the Fed
concluded their two-day
meeting with a decision not
to increase the Fed funds
target interest rate. The Fed
had sent signals in prior
months that a rate increase
was just around the corner
and three of the twelve voting members of the Federal
Open Market Committee
wanted to immediately raise
rates. However, the Fed decided it was better to err on
the side of caution, noting
that the labor market still
had the potential to add workers into the labor force and that inflation continues to run below the Fed’s target rate. The Fed pointed out that its decision to stand pat on rates “does not reflect a lack of confidence in
the economy.” However, for the third time this year, the Fed downgraded its forecast for economic growth
in 2016. It is now forecasting growth of 1.8% versus the 2.0% it had forecasted back in June. Many economists and investors have been questioning the credibility of the Fed given the conflicting signals it has been
sending.
In recent years, low yields in Japan and Europe have made relatively higher-yielding U.S. Treasuries attractive. Foreign investors
were able to generate extra income by hedging against the foreign
exchange (currency) risk involved with purchasing U.S. Treasuries. This strategy worked well for several years and put upward
pressure on the price of U.S. Treasuries. More recently, the cost of
hedging against foreign exchange swings has become very expensive, wiping out the extra income which could be earned by foreign investors. Unwinding trades made sense to many foreign investors which put downward pressure on Treasuries. According to
media reports, Japanese investors became net sellers of U.S.
Treasuries during the month of September.
Year-to-date global debt issuance through September 22 has
topped $5 trillion, according to Dealogic. This puts 2016 debt issuance on track to exceed the record $6.6 trillion in debt issued in
2006. Record-low global interest rates have led companies and
countries to issue record amounts of debt, as central banks around
the world buy up debt in an effort to stimulate economic growth.
Without record debt issuance, interest rates would be lower and
central banks such as the European Central Bank (ECB) and the
Bank of Japan (BOJ) would likely run out of debt to buy for their
quantitative easing programs. The ECB is currently buying $88
billion in fixed income every month while the BOJ has targeted
$733 billion in purchases for 2016.
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ECONOMICS
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Corporations posted YOY declines in business investment in both the first and second quarters of 2016, the
first two times since the beginning
of the current economic expansion.
Despite their strong balance sheets
and record-low cost of capital due to
low interest rates, companies have
been hesitant to invest given the
multitude of regulatory, political,
and global uncertainties. This lack
of investment represents another
economic growth headwind. Much
of the fallout has been seen in the
Energy Sector as oil prices have remained depressed. The price of
Brent crude oil declined 15.7% in
July before coming back to close the
quarter up 0.4%. Oil prices finished
the quarter still nearly 60% off of
their 2014 highs, causing continued reluctance among energy companies to undertake new projects in areas
such as exploration and development. Corporate margin compression and a continued decline in earnings
across the S&P 500 have also contributed to stifled investment.
The Institute of Supply Management (ISM) Manufacturing Index, a survey of manufacturing firms that
measures employment, orders, inventories, and deliveries, came in at 51.5 for the month of September versus expectations of 50.5 and last month’s reading of 49.4. An index reading above 50.0 indicates economic
expansion, and a reading below 50.0 indicates a general decline in economic conditions. August marked the
first reading below 50.0 since February, causing concern of a contraction in manufacturing before September’s stronger numbers. New orders, up six points from the previous month, were a healthy component in
September, while factory employment, which has breached the 50-mark only once in 2016 (June), continued
to weigh on the index.
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ECONOMICS
In 2015, Americans received their largest raise since the Census Bureau began keeping records in 1968. Median real (inflation-adjusted) household income rose to $56,516 last year, up 5.2% from 2014. Wage increases impacted lower-income earners most; the
lowest-earning decile saw the most significant
salary increase at roughly 8%, followed by those
in the 20th percentile. Middle-class earners also
saw significant wage increases. Top quintile earners still experienced wage growth, but at a lower
rate, resulting in an overall decrease in the wage
gap last year. American workers have continued
to see wage increases this year, although the pace
of salary growth slowed to 0.25% in August, its
lowest level since February. The jobs market continued to strengthen in the third quarter; initial
jobless claims trended downward in August and
September, and continuing claims, already at their
lowest level in over a decade, dropped from
2,149K in the first week of September to 2,058K by the third week. The U.S. consumer continues to remain
upbeat as a result; the consumer-confidence index increased from a seasonally-adjusted annual rate (SAAR)
of 101.8 in August to 104.1 in September, its highest level in nine years.
Despite the sustained high level of consumer confidence, consumer spending flattened during the third quarter. The recent downturn in spending has come as wage increases have been offset by consumers choosing
to save more. The personal savings rate rose to 5.6% and 5.7% in July and August respectively, although it
still remains lower than its 6.1% level at the beginning of 2016 and significantly below its 8.4% long-term
average. After stout secondquarter consumer spending
growth, inflation-adjusted Personal Consumption Expenditures (PCE) stagnated in August
to a seasonally-adjusted monthover-month (SA M/M) growth
rate of 0.05%, its slowest since
March, indicating that consumer
spending likely did not provide
the same boost to economic
growth in the third quarter as it
has in prior quarters. Retail sales
fell 0.3% in August after posting
a modest 0.1% increase in July.
Reflected in the retail sales data,
consumers are increasingly foregoing brick-and-mortar locations and instead opting to shop online more
frequently. E-commerce continues to grow significantly as a percentage of total retail sales, reaching 8.1%
in July of 2016, up from 6.6% a year before. Auto sales also bear a significant responsibility for the spending decline; total light vehicle sales dropped 0.5% in September from a year ago to a SAAR of 17.7 million.
Home building is also predicted to be a headwind to GDP growth, as SA M/M construction spending declined in both July (-0.30%) and August (-0.74%) to its lowest growth level in eight months. New home
sales reached a post-recession peak of 659K (SAAR) in July, but fell off 50K in August. While new home
sales have continued on a general uptrend since the end of the most recent recession, the U.S. homeownership rate is currently at its lowest level since 1965.
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WHAT AILS THE U.S. ECONOMY?
(Continued from page 1)
Subpar Economic Growth
C O M M E N TA RY
The U.S. economy has experienced 11 recessions in the post-WWII era and 11 subsequent economic
recoveries and expansions. June 2016 was the seventh anniversary of the latest recovery – July 2009 to
June 2016. The real annualized growth rate of GDP for the seven years has been 2.1%, the lowest of all
11 recoveries since 1949. The first nine recoveries experienced average annual growth of 4.8%. The
2001-2007 recovery had growth of 2.8%, the second-lowest since 1949, so GDP growth has definitely
slowed since 2000. U.S. households have paid a price for this slow economic growth; real median
household income was 2.4% lower in 2015 than it was in 1999 and 1.6% lower than in 2007, according
to the Census Bureau. This is one reason the majority of households say they have not fully recovered
from the Great Recession.
Things are not getting any better; annual economic growth for the three quarters ending in June 2016
averaged 1.0%. There are possibly structural changes in the U.S. economy that may explain the subpar
economic growth for the last 15 years. After 2000, the economy has experienced two recessions, a technology bubble collapse, a housing boom and bust, the biggest financial crisis in 75 years, and 15 years of
weak growth. These were turbulent times and have prompted a re-evaluation of what the potential is for
U.S. economic growth. The consensus is that the “new normal” for real economic growth is lower than
experienced since 1949 and closer to 2.0%-2.5% versus the 3.0%-3.5% growth from 1949-2001. A 1.0%
difference in economic growth does not seem like a big deal, but over a lifetime of one’s working age of
15 to 65, it is like compound interest. Assuming income is highly correlated with economic growth,
which it is, an average worker’s income would be 63% higher at retirement at 3.0% economic growth
than at 2.0%.
The Financial Crisis
One explanation for the slow economic growth since the Great Recession is offered by Reinhart and
Rogoff who published a book in 2009 titled This Time is Different: Eight Centuries of Financial Folly.
They provide empirical evidence that recoveries from recessions caused by a financial crisis take longer
than the normal cyclical recession. Financial crises are typically caused by excessive debt accumulation
(leverage) or currency debasement (hyperinflation), resulting in banking and currency crises, external
debt default, inflation crises, and economic depressions. The problem in the U.S. was too much debt in
the household sector (primarily mortgage debt) and the financial sector (particularly the large commercial and investment banks). Housing prices nationally declined by 35% from 2006-2012, forcing homeowners to pay down mortgage debt which they did from 2009 to mid-2015. Housing losses, plus the
more than 50% decline in the stock market as measured by the S&P 500, caused household wealth to
decline by $15 trillion. Because of leverage, losses in household wealth are more traumatic than stock
market losses, but both certainly deflated consumer confidence.
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C O M M E N TA RY
The banking sector was also over-leveraged; when Lehman Brothers went bankrupt in September 2008,
the firm had $33 of debt for every $1 of equity. It did not take much of a decline in asset values to wipe
out its capital. The Dodd-Frank law required banks to more than double their capital as well as exit
many risky businesses. The Fed’s reaction was to keep its benchmark interest rate near zero long after
the recession ended in 2009. In 2012, then-Fed Chairman Ben Bernanke cited lingering weakness in the
housing market, higher credit standards for obtaining loans, and government budget cuts as temporary
headwinds in holding back the economy.
These headwinds have now abated. For the first time since 2009, all sectors of the economy are chugging along at normal rates except business investment. Household debt as a percentage of disposable
income has returned to normal levels, and household net worth is at an all-time high of $89.45 trillion,
far surpassing the 2007 peak of $67.69 trillion. Net wealth is at record levels relative to aggregate net
income and GDP yet households have been reluctant to spend. Home building has rebounded but not to
pre-crisis levels. Federal and state government spending is increasing after several years of austerity.
Banks are lending again and home prices are back to 2006 levels. The S&P 500 is more than 180%
above its March 9, 2009 low on a price-only basis. Still, the economy continues to experience subpar
economic growth after seven years of economic recovery. The longer this slow economic growth lasts,
the more likely it is to be secular and not cyclical.
Secular Stagnation
The Fed has continuously lowered its annual economic growth forecasts since 2011 to the present 2.0%
rate through 2018 and the foreseeable future. Given that economic growth has been subpar since 2001,
some believe that the financial crisis is not solely responsible for the trepid growth since 2009. Lawrence
Summers, former Secretary of the Treasury and Harvard economist, and others argue that deeper forces
are holding back economic growth in the U.S. and other developed countries. They hypothesize that the
economy is in an era of “secular stagnation,” a term coined in the 1930’s Great Depression, whereby
demand falls short of productive capacity. A country in the grip of secular stagnation cannot find enough
good investments to utilize available savings. This results in an economy with less credit growth, lower
economic growth, lower wage growth, lower interest rates, and lower inflation. Contributing factors to
secular stagnation may be demographics, inequality, excess savings, government spending, industrial
overcapacity, consumer confidence, regulatory overkill, and a host of others.
If the U.S. is in an era of “secular stagnation,” so are the other developed countries of the world. The
International Monetary Fund (IMF) recently warned leaders of the Group of 20 largest economies that
the global economy is at risk of stalling without urgent action to revive dismal global trade and business
investment. They have downgraded the global growth rate to 3.1%, its lowest level since the 2009 recession. The best example of secular stagnation that all countries are trying to avoid is Japan; they have had
numerous recessions, stagnant economic growth, and deflation for the last 25 years. Those economists
who think the U.S. is experiencing secular stagnation believe fiscal policy and fiscal stimulus are the
solutions, which translates into more government spending and larger fiscal deficits. In 2016, the federal
deficit is expected to increase 35% to $590 billion from $438 billion in 2015, the largest deficit since
2013.
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The one area receiving the most attention for increased government spending is infrastructure. Bank of
America Merrill Lynch estimates that the U.S. should spend $3.3 trillion on infrastructure in the next
decade; $1.8 trillion is planned, leaving a gap of $1.5 trillion mostly in the transportation sector. Federal,
state, and local government infrastructure spending in 2015 fell to 2.5% of GDP, its lowest level in the
post-WWII era. Most of the money was spent to replace or repair worn-out 1950’s-1970’s infrastructure.
Spending on new infrastructure in the U.S. was only 0.5% of GDP, one of the lowest among developed
countries. The American Society of Civil Engineers gives U.S. infrastructure a D+ rating, not far from
failing, and estimates that it will hinder economic growth by billions of dollars in the next decade.
C O M M E N TA RY
Lower Productivity
A book by American economist Robert Gordon, The Rise and Fall of A merican Growth, presents another argument as to why economic growth will be subpar going forward. He makes a case that the century
from 1870 to 1970 was unique and exceptional for increasing worker productivity per hour worked. To
quote Gordon, “The century of revolution in the U.S. after the Civil War was economic, not political,
freeing households from an unremitting daily grind of painful manual labor, household drudgery, darkness, isolation, and early death. Only 100 years later, life had changed beyond recognition.” This exceptional century happened because of technological innovations. Except for the steam engine, little had
changed in several centuries including productivity and standards of living. Innovations after 1870
changed the course of human life and lifestyles. These included electricity, the telephone, the internal
combustion engine, refrigeration, running water and sewers, air travel, radio and television, home appliances, vaccines and penicillin, the assembly line, nuclear power, and numerous others. These innovations set the stage for the greatest advancements in productivity and standards of living from 1920 to
1970. Gordon analyzes total factor productivity which includes capital and labor. Output per hour
worked increased as well as the number of people working; the hours worked per person actually declined. Productivity growth was particularly strong in the post-WWII era from 1947 to 1970 when it averaged over 2% annually. Productivity growth has never reached these levels again; it has averaged well
under 1% since 1970.
Gordon analyzes economic growth from the supply side and makes a strong case that the stagnation in
recent decades is because of productivity issues due to the slow pace of technological innovations.
Productivity is important because in the long term it drives growth in real disposable income as well as
standard of living. The annual growth in U.S. real disposable income averaged 2.7% from 1947-1970,
2.2% from 1970-2000, and only 1.3% from 2000-2015, less than half of the 1947-1970 average. Interestingly, the bottom fifth of the income distribution did better in terms of growth in real disposable income than the middle fifth and even the top 1% from 1947-1970. The upper half of the income distribution has done much better than the lower half since 1970, especially the top 10% and 1%, increasing income inequality. Thus, while the productivity slowdown has impacted income growth, it has especially
impacted the average worker.
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Gordon thinks of the slow productivity growth in the decades since 1970 as the norm and the 1920-1970
era as a “historical blip,” probably not to be repeated. He does not argue that returning to more rapid
growth is impossible, but that we have exhausted the benefits of prior society-changing innovations.
He does not believe similar innovations of the same breadth and depth are probable in the near future,
but realizes the perils of forecasting the impact of technological changes. The big productivity gains
from the PC and Internet Revolution happened in the 1990’s. He also is not impressed by the impact that
recent innovations have had in entertainment, mobile communications, and information processing on
productivity; mobile communication and social media may in fact hinder economic growth.
C O M M E N TA RY
Global Trade
For centuries, economists theorized that free trade was good for an economy. For most of the post-WWII
era, global trade grew at twice the rate of the global economy and the benefits to global growth were
easily seen. Recently, the political rhetoric in the U.S. and elsewhere has been turning anti-trade and anti
-globalization. Brexit was an example of this sentiment. Many countries will be facing the question going forward of whether to be an economy open to free trade or closed. It is a major topic in the U.S.
presidential election. Polls show the majority of voters think free trade is good for the U.S. The U.S. has
free-trade agreements with 20 countries, with the North American Free Trade Agreement (NAFTA) being the largest and most politicized. The 20 U.S. trade agreements account for over 50% of U.S. exports,
which have grown much faster than exports to non-free trade countries. The Trans-Pacific Partnership,
with 11 countries including Japan but not China, is potentially the largest trade agreement and awaits
congressional approval. Proponents of free trade also state that free trade offers U.S. consumers many
more choices and, according to the Peterson Institute for International Economics, saves the average
U.S. household about $10,000 per year because of lower prices.
The U.S. trade deficit of $529 billion represents 2.9% of GDP. It is comprised of a goods deficit of $800
billion annually and a service surplus of $271 billion. The U.S. trade deficit is correlated with economic
growth; the higher the growth, the higher the trade deficit. In 2006, the trade deficit was $794 billion.
From 2006 to 2015, exports increased by roughly 40% versus a 15.3% increase for imports, reducing the
deficit by $265 billion. The Great Recession and slow economic growth since 2009 account for most of
the declining trade deficit. Structural imbalances, such as suppressed wages and consumers as well as
undervalued currencies in surplus countries, still exist which should result in a continuing chronic trade
imbalance in the U.S.
Manufacturing is the area where globalization appears to be the most contentious. Manufacturing provided about 45% of U.S. jobs after WWII; today it is closer to 10%. Total employment has grown since
then, so the total loss of manufacturing jobs is not as great in absolute terms as it looks on a relative basis. But loss of jobs and the declining U.S. share of global manufacturing in recent years are receiving
the most attention.
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C O M M E N TA RY
The U.S. share of global manufacturing has fallen from 20% in 2000 to 18% today and according to the
Bureau of Labor Statistics, the U.S. had 17.3 million manufacturing jobs in 2000 just before China was
admitted to the World Trade Organization (WTO). Even during the economic recovery from 2001-2007,
manufacturing jobs declined by 3.5 million and another 2.3 million manufacturing jobs were lost during
the Great Recession of 2008-2009; one-third of manufacturing jobs disappeared over the entire period.
Manufacturing jobs have gradually increased from 11.5 million in 2010 to 12.3 million today, but are
still 5 million below the level of 2000. While there appears to be a causality link between China joining
the WTO and the loss of manufacturing jobs, studies show that it accounts for only 20%-25% of manufacturing jobs lost. Most have been lost, in reality, due to technological innovations and automation.
While the U.S. may have gained overall from globalization, evidence shows that the gains have not been
shared equally. The pain tends to be concentrated in manufacturing sectors and also geographically. Early on in the 1970-2000 era, the anti-free trade sentiment was directed at Japan. Since China was admitted
to the WTO in 2001, it has received the brunt of sentiment followed by Mexico. What would be detrimental is another tariff act similar to the Smoot-Hawley Tariff Act of 1929. After the tariff was set,
world trade fell by roughly 60% as nations turned inward and embraced protectionist trade policies, a
primary cause of the Great Depression of the 1930’s. Even if the U.S. were to throw out existing trade
agreements, it may be difficult to regain global manufacturing share. Supply chains are now globalized
and there may not be sufficient job skills in the U.S. needed in manufacturing, which has become more
technologically advanced. Factories struggle to find qualified workers as the number of open manufacturing jobs has risen to its highest level in 15 years according to Labor Department data. Further, in recent times, the growth of global trade has been less than the growth of the global economy, something
that has not happened in decades, which makes it more difficult to address any trade imbalances.
Regulatory Burden
Since 2000, the federal bureaucracy has imposed 1,100 new rules and regulations on the economy, costing $743 billion, based on data provided by federal agencies. This amounts to a regulatory tax of approximately $2,300 on every American. Add in old rules and regulations and the federal government is imposing $1.9 trillion of costs annually on the U.S. economy at a cost per person of $5,750. This regulatory
tax is especially burdensome for small businesses; there has been a steady 30-year decline in business
formation (startups) while the rate of business deaths (exits) has held steady. State and local government
rules and regulations also do not help the small business environment.
Demographics
For the period 2006-2015, the number of workers grew 0.5% annually and real output per worker increased 0.9% for an annual GDP growth rate of 1.4%. Over the prior 50 years, real GDP growth averaged 3.3% as the number of workers grew 1.6% on average and real output per worker increased 1.7%.
Looking to the future, the Census Bureau forecasts the civilian population ages 15-65 will only increase
0.4% annually from 2015-2024. To get annual GDP growth of 2.0%, productivity will have to almost
double to 1.6%. It would help if some of the workers who have left the workforce could be enticed back;
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1 1 1 TH E D I T I O N
2016: T HIRD Q UARTER
the labor-force participation rate is 62.8% for all civilians over age 16. The share of prime-age workers
– those 25 to 54 years old – participating in the work force is 81.3%, lower than in 2007. Productivity
will have to do the heavy lifting if the U.S. is to achieve 2.0% economic growth.
Conclusion
C O M M E N TA RY
U.S. productivity has declined for three consecutive quarters, the longest period of decline since the
1970’s, and remains below pre-crisis levels. Unless productivity growth increases, the U.S. will struggle
to raise living standards. While the U.S. cannot do much about demographics, it can do several things to
increase business investment directed at enhancing productivity. The low-hanging fruit would be comprehensive federal tax reform, less policy uncertainty, reducing the regulatory burden, and more infrastructure spending. These reforms and other structural reforms are needed longer-term to improve innovation and productivity as well as the global competitiveness of the U.S.
Higher economic growth would be preferable, but one bright spot for the current economic recovery is
its duration. The current recovery began in mid-2009, which means at 86 months it is now the fourth
longest since 1850 and has already lasted more than two years longer than the average of the past 11
recoveries from economic recessions; 1991-2001 was the longest at 120 months, 1961-1969 at 106
months, and 1982-1990 at 92 months. The real annualized growth rate of this recovery at 2.1% is certainly sub-par compared to other post-WWII recoveries but seven years at 2.1% results in total growth
of 15.7%. One more year of economic growth at this rate and the current economic expansion will exceed the average total growth of prior recoveries. Hopefully, slow growth results in even greater longevity as economic expansions do not necessarily die of old age; the Netherlands had an economic expansion that lasted 25 years and three quarters and Australia’s current expansion is 25 years old. All things
considered, it may be that slower growth for longer actually proves more beneficial than higher growth
that is more volatile in nature.
“Globalization presumes sustained economic growth. Otherwise the process
loses its economic benefits and political support.”
~ Paul Samuelson
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