Wall Street's Best Minds
FRIDAY, DECEMBER 13, 2013
The Hole in the Middle of the U.S. Economy
By RUSS KOESTERICH
BlackRock's chief investment strategist explains why this economic recovery is so lackluster.
Despite the encouraging jobs report in November and the upward revisions to third-quarter's gross domestic product, the economic recovery continues to feel uninspiring. Indeed, by most measures, the recovery that began in 2009 has been a disappointment. And one area in particular stands out as a letdown: household spending.
Consumer spending has long been the lifeblood of the U.S. economy. It is fair to say that other countries like to shop, but the United States has long done consumption better than anyone. For most of the post-WWII period, spending rose faster in boom times and dipped in recessions, but the overall trend was always higher.
Initially, rising consumption following WWII was fueled by rising incomes, but even during periods of stagnant income growth consumers usually found a way to spend. And during the late 1990s and the first seven years of the 2000s, consumers were able to juice their consumption through borrowing.
But since the recession ended, spending has never rebounded as expected. U.S. real personal consumption has grown annually at around 2% since the end of the recession, well below the long-term average of nearly 3.5%. We have even seen more evidence of this with the holiday shopping season, when it was widely noted that sales on Black Friday were actually down this year.
The persistent weakness in consumption is somewhat puzzling. After all, consumer debt is slowly normalizing, household wealth recently hit a peak and the housing market is roaring back to life.
In fact, behind the weak spending is a troubling, longer-term trend: stagnant income growth. Personal income, adjusted for inflation, grew at an annualized rate of less than 1% during the first eight months of 2013. Not only is this below the 50-year average of 3.25%, it also compares poorly with the already anemic levels of the post-recession environment.
But income growth has been moving in the wrong direction for some time. For most households, real income peaked somewhere between 1998 and 2000. Once you adjust for inflation, the vast majority of U.S. households have been contending with stagnant or declining incomes for well over a decade.
While consumers can, and often do, spend more than they make, ultimately, income drives consumption. In short, without faster income growth, it will be difficult for household spending, and hence the broader economy, to match its long-term growth rate.
Unfortunately, there are a number of longer-term trends that are, not all of them cyclical, impeding income growth. Four in particular are worth discussing:
Declining productivity. U.S. productivity growth is slower than it used to be. While there was a temporary surge in productivity in the mid-1990s, U.S. productivity growth has reverted to the levels of the 1970s and 1980s. Why this decline – which predates the recession -- has occurred is not quite clear, but productivity gains are the ultimate driver of sustainable wage growth.
Global competition. Since the late 1990s, U.S. workers have faced a flood of competition from countries that had previously been cut off from the global economy. Recent developments, such as rising Chinese wages, may slow this trend, but it is unlikely to reverse and it will continue to exert downward pressure on U.S. incomes.
Technology. Improving technology has a beneficial impact on productivity and living standards, but it is also eliminating the demand for labor across many industries (think of factories that are increasingly staffed with robots).
Rising transfer payments. The long-term increase in government transfer payments – in other words, direct payments to individuals through social security, unemployment, disability and other benefits -- has coincided with the deceleration in income growth. Transfer payments automatically rise during a recession when income growth is weakest, but as transfer payments have risen, overall workforce participation has dropped. There are several factors contributing to this drop—changing demographics, more time spent in university and a poor labor market— but increasing generosity from Washington may also be driving down labor force participation. Fewer working Americans means that aggregate income will rise at a slower rate.
What does all this mean for the economy and investors? To begin, stagnant income growth is likely to be a headwind for consumption and overall U.S. economic growth for some time. In addition, modestly weaker income growth and spending suggests that consumer spending is likely to continue to shrink relative to other sectors of the economy, such as energy or manufacturing.
Finally, apart from the level of income growth, how it gets distributed is important. To the extent that more income accrues to the top, this trend will actually exacerbate the slowdown in spending, because the marginal propensity to consume actually decreases with income levels. And should the majority of the income continue to go to the top 1% or 10%, this could have, and arguably already is having, significant political and social ramifications – including the likelihood of policy makers pursuing well-intended but unwise economic policies. Ultimately, this could be the biggest impact of the long-term trend of weak income growth.