Unless you’ve turned off your access to television or the World Wide Web, you’ve certainly heard pundits and politicians making the following six provocative assertions about the U.S. economy:
1. Economic growth has slowed to unacceptable levels;
2. Income inequality continues to rise at an alarming rate;
3. Debt levels are unmanageable;
4. The link between productivity and worker pay is broken;
5. Worker wages have gone nowhere for decades; and
6. Upward mobility is a thing of the past.
In reality, each of these assertions is demonstrably false!
However, there are related trends which, if left unaddressed, could diminish some of America’s core competitive advantages in the years ahead.
Given the growing gap between perception and reality, let’s examine these beliefs and why they are so prevalent.
Let’s start with the assertion that, “Economic growth has slowed to unacceptable levels.”
In this case the perception is partially correct.
Since the beginning of the Great Financial Crisis, the growth trend-line for real U.S GDP has slowed from a long-term rate of 3.1% a year to just 2.1% a year.
And while this is historically lackluster, it has enabled the U.S. economy to grow 82% over the past 15 years, while Europe has grown just 6%!
America’s downshift in growth was caused by three factors which are easy to understand.
Output is defined by “hours worked” times “productivity per hour.”
Growth arises when either or both of those numbers grows.
“Hours worked” is constrained by the number of hours worked by each worker and the number of workers.
Productivity-per-hour typically grows when businesses add more capital equipment, higher levels of skill, or superior technologies.
The first factor impacting U.S. economic growth is slowing population growth coupled with lower labor force participation rates.
This slowdown in population growth is caused by immigration barriers combined with low birth rates.
However, it’s exacerbated by a social safety net which fails to demand workforce participation.
If we examine real GDP per capita, we see that going all the way back to the Civil War, real per capita growth has varied only modestly from an average of 2% a year, compounded.
That confirms that demography places real limits on what is possible.
A second and more serious problem is glacial productivity growth.
Capital investments and increased skills typically raise output per hour worked.
However, the rate slowed markedly after 1973, except during the Dot-Com boom.
Why? Because economic progress is determined largely by technological progress.
As we’ve explained in prior issues, the enormous surge in productivity we saw between World War II and 1973 represented the “golden age” of the Mass Production Era.
That extraordinary surge in productivity was enabled by post-war market opportunities coupled with commercialization of the capital investments and discoveries made during the war.
Interstate highways, airlines, broadcast TV, discount retailers, and large-scale assembly lines combined to support a vibrant ecosystem.
As highlighted in trend #2 this month, digital technology is now in a similar golden age which is forecasted to run through the mid-2030s.
Many of these changes will happen naturally, but others will need to be encouraged.
Important pro-growth policy adjustments are addressed in trend #3.
The third reason for this down-shift in economic growth is that the kinds of goods and services dominating the U.S. economy over the past 15 years are difficult to quantify.
That’s because most of their value is qualitative and subjective. For example, smart phones have added immeasurably to our quality of life by replacing landline phones,
GPS devices, televisions, phonographs, calculators, personal computers, books, newspapers, magazines and myriad other devices.
They’ve also enabled whole new sources of value like social media and e-commerce platforms.
However, these new products don’t add to GDP in the same way as the products they replaced.
That’s because post-millennial innovation has transformed what were formerly physical products or paid services into ad-supported digital services which appear to be “free.”
And these often don’t show up in GDP.
However, it appears that America is on the verge of a transition away from growth in “qualitative intangibles” and back to more “quantifiable value.”
That’s because the new drugs, materials, machines, processes and services enabled by AI will drive new production and related revenues which actually show up in GDP.
Now, let’s examine the claim that U.S. “income inequality continues to rise at an alarming rate.”
The Congressional Budget Office calculates the Gini coefficient to estimate the income gap between higher-income and lower-income households.
(A chart capturing this relationship appears in the printable Trends issue.)
However, there are two different measures that are commonly used in this calculation, and they give different answers regarding trends in inequality.
One is so-called “market income” based on pre-tax numbers and the other is “income after taxes and transfers.”
For measuring inequality, income after taxes and transfers is the only metric that makes sense.
Unlike market income, income after taxes and transfers is a comprehensive measure of living standards which considers the impact of taxes and social safety net transfers on people’s real economic well-being.
Based on income after taxes and transfers, inequality increased 7 percent in the 30 years from 1990 to 2019.
However, the entire rise occurred from 1990 to 2007. On the other hand, inequality decreased by 5 percent since 2007 when political and media attention to inequality peaked in response to the Great Financial Crisis and the Occupy Wall Street protests.
In short, U.S. income inequality has actually been shrinking over the past 16 years.
Another popular assumption is that “current debt levels are unmanageable” and this will lead to catastrophic problems in the years ahead.
Do the facts support this assertion?
Let us first consider the state of U.S. household balance sheets.
Private sector net worth now stands at a record $154.3 trillion, al most double what it was just 10 years ago.
Even after adjusting for inflation, we find that the net worth of U.S. households has been increasing at an average rate of 3.6% per year since 1952.
That works out to a 12-fold increase in just 70 years.
Critics would say, “the population has also increased a lot over that same period.”
However, if we look at inflation-adjusted per capita data, we find that the living standards of the average American have increased by a factor of almost 6 in the past 73 years.
On the other hand, it’s outrageous that our Federal debt as a percentage of GDP is roughly 124%.
However, it’s worth noting that this figure previously soared to 119% at the end of World War II, just as the great post-war boom was about to begin.
From there, it fell to a low of about 32% in the mid-1970s and rose to just over 55% in 2001.
The current peak developed in the wake of stimulus related to the Great Financial Crisis and the Covid pandemic.
While 124% is high, that debt has only become risky since the Federal Reserve recently raised rates, driving up the government’s debt service costs.
And even then, only about 23% is owed to non-U.S. entities, so it simply provides a risk-free place for U.S. citizens, companies, and agencies to park their money.
More importantly, because this debt is denominated only in U.S. dollars, the Federal government does not face the default risk most other countries’ face with their sovereign debt.
Furthermore, America’s economic and geopolitical advantages, mean that its GDP is likely to grow faster than government debt in the decades ahead, bringing this ratio down.
On the other hand, the private sector does have a non-zero chance of insolvency or default at some point.
But the good news is that the private sector has de-leveraged by about 40% since 2007!
That means private sector debt as a percentage of GDP is now back down to where it was in the early 1970s.
Based on the foregoing, there is little, if any, reason to worry about U.S. debt levels.
Nevertheless, we need to avoid borrowing to fund counter-productive priorities.
Next, let’s consider whether “the link between productivity and worker pay is broken.”
The simple answer is “No! It isn’t.”
You might have seen some version of the chart in the printable issue titled, “Hourly Wages and Output per Hour.”
It shows a massive long-term divergence of five-to-one between productivity growth and wage growth.
However, this chart is highly misleading.
In a recent research paper titled “The Link Between Productivity and Wages Is Strong” Michael R. Strain of the American Enterprise Institute focuses on another chart which tells a radically different story about productivity and pay.
It shows that productivity growth and wage growth move together decade-after-decade.
Here we see some modest divergence since 2000, but nothing like the disconnect seen in the first chart.
The fact is the second chart more accurately reflects economic reality in its basic conceptual choices.
First, it defines output as net output rather than gross output.
Productivity calculated based on net output per hour of work makes sense since it removes capital depreciation.
As Strain observes, “Since depreciation is not a source of income, net output is the better measure to use when investigating the link between worker compensation and productivity.”
Second, it’s better to include non-wage compensation, including health benefits, rather than just wage compensation given that non-wage compensation has risen as a share of total worker compensation.
In contrast to the current narrative in some policy circles, this analysis makes clear that the link between productivity and wages remains strong.
As a result, there is little reason to argue that American workers, on average, are being short-changed relative to their contribution to the system.
Another popular canard is that Worker wages have gone nowhere for decades.
The most common version of this claim is that “since the 1970s, real wages haven’t gone up much at all.
In fact, some pundits argue that wages may have only risen 5% over the past five decades of American economic history.
And this leads to a highly misleading claim of widespread “stagnation.”
The truth is that, from the peak of the 1990 business cycle through 2019, real wages have actually gone up by 20% as measured relative to the consumer price index and by over 33% as measured relative to the price consumption expenditure (or PCE) index, according to Strain’s calculations.
Moreover, if we consider how much money peo ple have after taxes and transfers, the stagnation argument looks even more dubious.
Consider five key facts the CBO noted in its recent look at incomes from 1979 through 2019:
First, over the 41 years, every income group saw its highest average “income after transfers and taxes” in 2019.
Second, income growth after transfers and taxes was fastest for top earners; however, it was pretty comparable across the entire distribution due to progressive taxes and safety net transfers.
Third, after transfers and taxes, the lowest quintile’s income grew 94 percent – or 1.7% annually.
Fourth, after transfers and taxes, the middle three quintiles’ income grew 59 percent – or 1.2 percent annually. And,
Fifth, after transfers and taxes, the highest quintile’s income grew 123 percent or 2.0 percent annually, reaching $252,100 in 2019 versus $113,100 in 1979.
An important factor was that the average federal tax rate for top earners decreased, resulting in slightly faster growth in income after taxes.
And that brings us to the nearly ubiquitous claim that upward mobility is a thing of the past.
The truth is that upward mobility is still happening. But it’s less obvious than it was 50-to-100 years ago.
To understand, ask yourself, “Are people doing better in their 40s than their parents were doing during their 40s?”
Overall, research shows that around 73 percent of Americans in their 40s have higher real incomes than their parents did.
And for kids raised in the bottom 20 percent, that number is 86 percent.
However, it has become less likely that someone will be able to move up from a lower quintile to a higher quintile.
That’s different than simply being better in absolute terms.
As explained in prior Trends issues, much of this difference is due to a divergence in lifestyle attributes between people born into the five income quintiles.
For example, research from the Brookings Institution shows that graduating from high school, getting and keeping a job, staying out of jail and not having a child until married can virtually ensure a life free from poverty.
Beyond those metrics, having two parents at home correlates strongly with upward mobility.
However, those are values not often mimicked by friends and family in the bottom two economic quintiles.
The influence of peers largely explains why those at the bottom disproportionately stay at the bottom, while the same is true for the top.
What’s the bottom line?
The foregoing analysis demonstrates that things are better than most Americans and economic pundits believe.
However, things could be better still. Investors, managers, and policy-makers must remain vigilant if we hope to make things even better for ourselves and future generations.
Given this trend, we offer the following forecasts for your consideration.
First, in the coming decade, real U.S. economic growth will return to the 3.1% trend it enjoyed prior to the Great Financial Crisis.
This will be made possible by the AI-driven productivity revolution described in trend #2, coupled with talent migration discussed in trend #4.
Second, the biggest threat to America’s coming resurgence involves the continued regulatory overreach discussed in trend #3.
Resources now devoted to compliance with obsolete and counter-productive regulations will be reallocated to productivity enhancing priorities.
This should quickly eliminate the cumulative regulatory drag on economic growth over the past 40 years raising GDP growth rates by at least 1% a year, in perpetuity.
Third, North America’s growth will benefit enormously from today’s global demographic crisis during the 2020s.
The new Cold War will increasingly limit the global flow of resources and technologies, creating a powerful down-draft for economies in the de-facto Sino-Russian alliance.
Meanwhile, the workforce in most European and Asian countries is rapidly aging and shrinking limiting their growth possibilities.
So, as re-shoring and friend-shoring accelerate, the “best and the brightest” will be drawn to where they see the most upside and that will typically be North America.
Since, assimilation is a key competitive advantage of the United States and Canada, they will be able to take advantage of the world’s increasingly mobile talent pool as explained in trend #4.
Fourth, absolute income inequality is likely to increase slightly as a premium is placed on talent and merit.
However, the shortage of skilled blue-collar talent means that percentage gains will be greatest in those job categories.
Fifth, as the AI-driven productivity boom takes off, the national debt will shrink as a percentage of GDP.
This surge in GDP will increase tax revenues reducing the deficit.
And as we saw in the 1990s, a tech driven boom may even create a budget surplus.
Combined with lower interest rates, these factors will make servicing the national debt easier than it is today. And,
Sixth, total worker compensation will continue to keep pace with productivity, even as profit margins in most industries expand.
Because of the increased contribution of technology to profits, shareholder returns will accelerate.
However, these gains will not come at the expense of workers.
Resource List
1. Faster, Please! September 4, 2023. JAMES PETHOKOUKIS. What is the outlook for long-term US economic growth?
