By KC Mathews
We all know of Aesop’s fable, “The Tortoise and the Hare” — a story of two unequal opponents who agree to a race. The outcome appears to be obvious, but in a surprising twist, the ever-so-diligent tortoise perseveres and wins the race. The moral of the story is slow and steady wins the race.
UMB’s economic theme for 2016 is The Tortoise or the Hare. We think the U.S. economy, which has grown over the past few years at a tortoise-like pace, will continue to produce mediocre growth in 2016. Given the stimulus that abounds, one might think the economy should grow at a faster pace, more “hare-like”; however, we think slow and steady will win out once again. We anticipate the U.S. economy will once again grow in the 2 percent to 2.5 percent range in 2016. Relative to other economies, tortoise-like growth will be a winner.
Historically the U.S. economy has been more hare-like. So what has changed? When did our economy go from consistently growing more than 3 percent annually, to a tortoise-like economy, with growth less than 2.5 percent? For example, from 1955 to 2005, the U.S. average real GDP was 3.4 percent. Fast-forward to the period from 2005 to 2015 and real GDP averaged a paltry 1.5 percent, leaving economists wondering what happened.
To answer this question we investigated two economic variables that drive potential GDP: labor force growth and productivity gains. In economics, potential output refers to the highest level of real GDP (output) that can be sustained over the long term. Year-to-year actual GDP may vary from potential GDP; this is called the output gap. Forecasting potential GDP should be relatively easy, as the formula is simply labor force growth plus productivity gains.
Labor force growth has changed over the years and is influenced by several factors. In the 1960s and ‘70s labor force growth changed due to population growth, the baby-boomer generation reached working age and more women were working outside the home and entering the labor force. However, the significant labor force growth rate increase of the ‘70s will not be repeated anytime soon. One reason is that most baby boomers have more siblings than children and labor force growth is partly a function of population growth.
The second variable is productivity, or the efficiency of production. According to the Bureau of Labor Statistics, productivity change in the non-farm business sector from 2007-2014 was only 1.3 percent. There is an ongoing debate among economists over the drivers of productivity gains. One theory argues that capital accumulation drives growth. Another suggests that a combination of accelerating technical progress in high-tech industries and the resulting investment in information technology drives productivity.
One common theme between both theories is that investment is critical to any growth theory. Therefore monitoring measures of human capital and research and development expenditures is necessary. We believe we will continue to see exciting new technologies developed in the future, but caution that even though new technology is introduced, the lack of adoption to these new technologies can be limiting to productivity. Therefore, we don’t see productivity gains spiking higher in the near future.
So as the fable goes, the tortoise never gives up — it is patient and persistent and wins the race. I think this is a great parallel to the U.S. economy in 2016 and perhaps even over a longer timeframe. Our economy has been slow growing since the Great Recession in 2009 and has continued on that path to real GDP of 1.5 percent in 2013, 2.4 percent in 2014, and near 2.5 percent last year.
I expect our economy to continue to grow at a slow and steady pace in 2016 with real GDP in the range of 2.2 percent to 2.5 percent. This is in part due to several tailwinds and a few headwinds…which we will discuss in Part 2 of this forecast series.
KC Mathews is executive vice president, chief investment officer of UMB Bank, Kansas City.