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Is An Annual GDP Growth Rate of 3% Realistic?
Posted on August 28th, 2017 by Dr. Sina Ebnesajjad in Chemical R&D
Breakdown of the US GDP Components for the 2nd Quarter 2017 –Total figure is the annual estimate for 2017 (Source: Federal Reserve Bank of St. Louis, created with Datawrapper, by Investopedia, Aug 2017).
If you believe the highly advertised 3% GDP growth rate by the current Administration, you must read on. Your instinctive reluctance is understandable. A lot of people have turned sour on economic speak because of Allan Greenspan’s famous comment: “I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I’ve said.” This post is going to be easy to understand because I am not an economist and write in a language I understand.
GDP is defined as the value of all finished goods and services produced in a country in a year. GDP is also measured on a quarterly basis. It consists of the sum of private and public consumption, government expenditures, investments, inventories, and paid construction costs, plus exports minus imports. The difference between exports and imports is called the balance of trade. The components of the United States GDP are illustrated in the header image.
Out of the annual GDP of 19.2 trillion dollars, 69% is personal consumption; 17% is government spending; 16% is domestic private investments; and balance of trade is -3% (trade deficit). To grow the GDP one or more of its components must grow. That means consumers and government must spend more money and more private investment is required; the trade deficit must be turned into a surplus. Can the net growth, realistically speaking, amount to 3% annually, as the Administration tells us? Let’s examine the fundamentals of GDP components and the technical indicators.
GDP Component 1: Personal Consumption
Over 71% of the consumer debt consists of mortgages and home equity loans. Only 30% of the 125 million US households do not have home mortgages; of whom most are in 55+ age range or in high-income brackets. Total mortgage balance of the US amount to over $9 trillion. Consequently, every household with a mortgage has a staggering average balance of $104,000. In addition to home mortgages, credit card balances ($750 billion), car loans ($1.2 trillion) and student loans ($1.3 trillion) retard the consumer ability to borrow more and drive the growth of the 69% share of the GDP. Servicing various loans; the current US wage stagnation; and healthcare and pharmaceutical inflation leave little discretionary income for the majority of the US population.
Excluding immigration, the US population growth has slowed down and the proportion of older adults is growing rapidly. Every day 10,000 people turn 65 years old. The number of Americans ages 65 and older is projected to more than double from the present 46 million to over 98 million by 2060, and the 65-and-older age group’s share of the total population will rise to nearly 24 percent from 15 percent. Both income and spending of people age 55, and over, decline. The older demographics do not spend heavily on homes and other consumer goods as indicated by data (Figure 1) published by the United States Bureau of Labor Statistics (BLS). The older population depends on Social Security payments, personal savings, pensions and Medicare/Medicaid as opposed to the younger employed adults who contribute directly to the US productivity.
Figure 1 Income and expenditure for 2013 based on the age of reference persons
(Source: United States Bureau of labor Statistics)
Fortunately, up to this point the inflow of immigrants has augmented the low birth rate of the aging US population. The arrival of new immigrants, and the births of their children and grandchildren together account for 55% of the U.S. population increase from 193 million in 1965 to 324 million today. A Pew Research Center projection indicates that the nation is expected to grow to 441 million in 2065 and that 88% of the increase is linked to future immigrants and their descendants. Even with immigration included the US population growth rate has continued to decline (Figure 2), as has been the case with other developed economies such as Germany and Japan. The United Nations estimates indicate a net US population growth of 0.4% in 2050 assuming immigration is not reduced precipitously. Germany has offset its population decline by admitting waves of migrants including nearly a million people from Syria and other war torn countries.
Figure 2 Historical US population growth rate (Source: United Nations Population Division and Populyst)
GDP Component 2: Government Expenditures
What about increase in Government expenditures? They include military spending such as bullets and bombs, with hardly any positive bearing on national well-being. The colossal national debt of almost $20 trillion is approaching unsustainable levels. Lawmakers have been forced to cut spending increases including healthcare expenditures and assistance programs. Relatively little of the Government share of the GDP is devoted to investment in the infrastructure and other beneficial national investments. Deficit spending, i.e. printing money, expands the monetary volume thus would normally be inflationary. The low wage growth, liberal US imports policy and the global demand for dollar, because of its perceived safety, are among the reasons inflation has remained in check. It is doubtful the US Government expenditures would grow substantially in the near future.
GDP Component 3: Balance of Trade (net exports)
Increasing the US exports and decreasing its imports would improve balance of trade. The export-import issues are, however, quite complex. A large wave of offshoring and outsourcing has moved the US manufacturing of goods (and some services) overseas to East and South Asian countries. Any abrupt curtailment of imports could lead to shortages, increase in price of goods and trigger inflation and retaliatory action on US exports by the countries selling to America. Increasing US exports is easier said than done because of the competition from other countries, tariffs, unfavorable regulations and other impediments erected by many countries.
GDP Component 4: Private Domestic Investment
Finally, the growth gross private domestic investment (GPDI) is the least stable of GDP components. GPDI includes three types of investments: 1. Non-residential investment; and capital expenditures such as tools, machinery and factories; 2. Expenditures on residential structures and residential equipment that is owned by landlords and rented to tenants; and 3. Change in inventories in a given period. The public is told about approximately two trillions dollars cash, held by US companies, that is awaiting tax reforms before repatriation and certain investment in the country.
Cash holding of corporations is a large sum but only one side of the coin. Corporate debt is also at historically high levels causing an imbalance between cash and corporate debt outstanding at $5.8 trillion. According to the Standard & Poor Global (May 2017):
- Cash and investments held by the 2000 S&P Global Ratings’ universe of rated U.S. nonfinancial corporate issuers rose by 10% to $1.9 trillion in 2016 mostly held overseas. The top 1% (25 companies) controls more than half of this cash pile while it has $700 billion debt.
- But rising debt, now at a collective $5.1 trillion for 99% of the companies, is a concern. Adjusted leverage for both investment-grade and speculative-grade bond issuers is near decade highs and, conversely, the cash-to-debt ratio nears decade lows.
- A tax reform that facilitates the repatriation of roughly $1.1 trillion in cash held offshore would likely spur a wave of share repurchases, leading to lower cash balances and potentially weaker credit metrics.
An important technical indicator is the historical evolution of US GDP growth rate. One approach to discovering any trends is by taking the average of growth rates over each ten-year interval. Table 1 shows the GDP growth rate averaged for each decade since the 1890s. There has been a slow decline in the GDP growth rate of the United States. It is simply more difficult to grow large GDP numbers at same rate as those in the earlier decades. The underlying reasons were described earlier. While it is not out of realm of possibility for the GDP numbers to rise again at 3% or higher rates, that outcome is not very probable. It is imprudent to make budgetary assumptions based on sustained 3% GDP growth rates.
Table 1 Historical Trends of US GDP growth
* Calculated for periods prior to the advent of GDP
All opinions shared in this post are the author’s own.
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Dr. Sina Ebnesajjad
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