The US Economic Outlook - Peterson Institute for International

THE US ECONOMIC OUTLOOK:
• Strong investment is needed to sustain strong growth in 2004-05.
• Weak job growth is associated with productivity;
trade and health costs are secondary.
• To sustain long-term growth,
the tax cuts should be allowed to expire.
Martin Neil Baily
with assistance from Jacob F. Kirkegaard
Institute for International Economics
April 1, 2004
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• Real GDP growth will be between 4 and 4½ percent in
2004 and 4 percent in 2005 (Q4 to Q4).
• Under this scenario, consumption will be a main driver of
growth, increasing between 3½ and 4 percent in both years.
• Inventories will rebuild.
• Trade will likely be a modest drag on US growth for the
first half of 2004 but should start to contribute to growth after
that, as the lower dollar helps export growth – with the
expected time lag.
• Government spending growth will moderate in the second
half of 2004 and in 2005.
• There are significant risks around this forecast.
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Short-term Risks:
– Investment is now growing, but sustainability is a question. If
investment growth slows, GDP growth will be closer to 3½ percent in
2004.
– High oil prices are a drag on consumer spending.
Longer-term Risks:
– The twin deficits (budget and trade) present a challenge for the US and
the rest of the world.
Upside Potential:
– If jobs and investment kick in, and productivity growth continues,
there could be growth of over 5 percent.
Geopolitical risks remain high
The Growth Contribution from Housing Is Tapering
Off, Equipment and Software Are Growing, but
Structures Investment Remains Weak
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In Current Dollar Terms, Nonresidential
Investment Is Rising – Very Slowly
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Payroll Employment Has Been Much
Weaker Than in Previous Cycles
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Value at time of November 1992 election (20 months after
the end of the recession) = 100.6
6
Weak Employment Growth Results from Modest
GDP Growth and Blockbuster Productivity Gains
1)
Excludes 1980 Recession
Source: BEA, Bureau of Labor Statistics
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The Increased Trade Deficit 2000-03 Caused
at Most 14 Percent of the Payroll Job Decline
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In the 1990s the trade deficit did not cause net job loss because
domestic demand was more than strong enough. With weak demand
since 2000, trade has contributed modestly to employment weakness.
• The increase in the manufactured goods trade deficit implies a
decline of 350,000 manufacturing jobs (annual data).
• This represents 13 percent of the 2.74 million decline in the
manufacturing sector from 2000-03.
• The slow increase in the services trade surplus implies a decline of
14,000 service sector jobs (assuming, conservatively, sectoral
productivity growth at historical rates).
• Total job loss 2000-03 from trade, 364,000.
• This represents about 14 percent of the 2.64 million decline in
nonfarm employment 2000-03.
• As evidenced by US postwar experience, the expansion of
international trade does not cause job loss.
Source: Bureau of Labor Statistics, Author’s calculations
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Is Weak Job Growth the Result of Rising Health
Care Costs?
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• These are growing rapidly, but total compensation per hour is not accelerating.
• Since benefits are a fixed cost, they encourage companies to increase hours rather than
the number of employees as demand picks up.
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Dealing With the Structural Imbalances to
Sustain Growth
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• Chronically low private savings together with large federal (and
local) deficits mean that the US is not financing its domestic
investment.
• So far the consequences have not been that severe, because the rest
of the world has been willing to lend to the US on very favorable
terms.
• But the deal has not been cost free for the US – a chronic trade
deficit, fewer jobs in manufacturing, and protectionist pressures.
• Balancing the federal budget will not guarantee trade balance (e.g.,
2000). But rebalancing the world economy will be hard (impossible)
unless fiscal discipline is restored in the US.
• The rest of the world must play a part, allowing exchange rates to
adjust and stimulating domestic demand.
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US Federal Budget Scenarios, 2004-14
$400
-extend expiring tax cuts
-plus reform alternative minimum tax
$200
-plus discretionary spending growth at
nominal rate of GDP
$0
2000
2001
2002
2003
2004
2005
2006
-$200
2007
2008
2009
2010
2011
2012
2013
CBO Base Case Jan 2004
-$400
2004 Cost of Iraq $87bn
-$600
• No extension of expiring tax cuts
• No reform of AMT
-$800
• Discretionary spending at Nominal GDP
• Productivity at 2.5%/year
-$1,000
Source: CBO January 2004, author’s calculations
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2014
It Will Be Very Hard to Keep Spending Growth at
the Same Rate as Nominal GDP
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18%
16%
14%
12%
March 2004, Social Security and Medicare Boards of Trustees
Report:
“The projected date of HI Trust Fund exhaustion has moved
forward significantly to 2019 from 2026 in last year’s report,
and projected HI tax income falls short of outlays beginning
this year, as compared to 2013 in last year’s report”
10%
6%
CB
4%
O
on
ic
16%
er year
p
%
1
t
a
8%
growth
t
s
o
c
s
io
: exces
r
o
i
r
a
a
n
e
n
c
diate s
e
sce
m
r
e
t
h
CBO In
hig
ss
e
c
: ex
8%
sed
a
b
t
cos
t or
his
th
ow
r
g
al
(2.5
e
t
ra
a r)
e
y
er
%p
5%
CBO low scenario: excess cost growth at zero
2%
20
0
20 3
04
20
0
20 5
0
20 6
07
20
08
20
09
20
1
20 0
11
20
12
20
1
20 3
14
20
15
20
16
20
1
20 7
1
20 8
19
20
2
20 0
21
20
22
20
23
20
2
20 4
2
20 5
26
20
2
20 7
28
20
2
20 9
30
20
3
20 1
3
20 2
33
20
3
20 4
35
20
3
20 6
37
20
3
20 8
3
20 9
40
20
4
20 1
42
20
4
20 3
44
20
4
20 5
4
20 6
47
20
48
20
49
20
50
0%
Source: CBO December 2003 Long-Term Budget Outlook
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Conclusions
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• As growth in residential housing, auto sales, and
government spending cool down, business investment must
fill the gap to sustain strong GDP growth.
• Rapid productivity growth, not matched by sufficient
demand growth, has resulted in continued hiring weakness.
Trade/offshoring and rising health costs have contributed, but
are much less important.
• If the tax cuts are allowed to expire, if spending growth is
kept to the growth of GDP and productivity growth is at 2½
percent, the deficit is gradually eliminated.
• To deal with Social Security and Medicare, additional tax
revenues will almost certainly be needed.
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