The strange shape of the US recovery    
One factor in the long, not strong, economic upswing is a stretchy labour force

 by: Stephen King
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Uber and Deliveroo are two clear targets of the Taylor review © PA
    
   
Within a handful of weeks the US economy will in all likelihood have delivered both the longest and the weakest economic upswing in the entire postwar period. Unemployment has dropped to levels typically consistent with accelerating wages, mounting inflationary pressures and rapidly rising interest rates.

Yet, even though the US Federal Reserve has nudged rates up a touch, there are few obvious “end-of-cycle” pressures. Growth remains weak, productivity gains continue to be lacklustre and wage pressures are incredibly muted.

The forecasting community does not quite know what to do with all this. Most forecasters expect US growth to accelerate, yet none expects unemployment to drop much further from its current 4.4 per cent rate. Implicitly, therefore, forecasters appear to be assuming that productivity growth will suddenly accelerate, even though there is no evidence whatsoever to support this.

That they are doing so reflects their belief that US economic growth must eventually return to “normal”, alongside their strong conviction that unemployment is already close to, or possibly below, its “natural” rate. It is a form of cognitive dissonance.

There are, however, other possibilities. One is simply that the unemployment rate falls a lot further without significant upward pressure on wages. This would be a continuation of the “long, not strong” upswing seen to date. Technology may be reshaping the relationship between employment, wages and investment. Most obviously, the “gig economy” allows companies to hire workers by the task or by the hour, not just the week, month or year.

This makes labour supply a lot more “stretchy” from the employer’s point of view. As a result, companies can expand their operations without having to make the risky long-term investments that would, in other circumstances, lead to faster productivity growth.

The stretchiness of labour supply, in turn, implies that even the least marginally productive worker may be hired on occasion. The so-called “natural” rate of unemployment is thus able to drop to much lower levels than seen in the recent past. In effect, the US becomes a high employment, low wage, low investment and low productivity economy.

Another possibility is simply that the US economic upswing will come to an end much sooner than the vast majority of economists expect. Having already seen 92 months of falling unemployment, history suggests it is not unreasonable to think that the next downswing may be just around the corner. No one is forecasting it, but then again very few successfully spotted either the 2000 or the 2008 downswings until they were visible in their rear-view mirrors.

So what might cause a downswing? There are three potential triggers.

First, based on the Shiller historic price/earnings ratio, the US stock market is more expensive than at any other point in history apart from 1929 and the run-up to the tech bubble in 2000. Should the gap between financial hope and economic reality have to close suddenly, the risk of economic dislocation could increase significantly.

Second, although it has not happened yet, it may just be that wage growth will suddenly accelerate (in spite of the gig economy) thanks to a tightening labour market, triggering a more aggressive response from the Fed than anyone currently thinks is plausible.

Third, we live in strange times. The EU and Japan may be on the verge of signing a trade deal but, thanks to Washington’s newly isolationist attitude, it is not impossible to imagine that business confidence is ultimately tripped up by the return of protectionism in some form.

Whichever possibility becomes reality — and they are not mutually exclusive — they are all more plausible than the current consensus that, in effect, chooses to ignore much of the accumulated evidence of recent years.

Forecasters have persistently overestimated both the growth rate of the US economy and its unemployment rate. They have done so because they have had a fixed view about productivity performance that, in the event, has proved to be hopelessly optimistic.

In a world in which growth is structurally a lot lower than it once was, it is time to believe the unbelievable. The hitherto believable, after all, no longer makes sense.


The writer is the author of ‘Grave New World’ (Yale) and HSBC’s senior economic adviser

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