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Q&A On Waning Economic Growth

Harlan Levy: How much do you expect global turmoil to infect the U.S. economy and stop it from its slow pace?

Lakshman Achuthan: At this time, global turmoil is not likely to take much of a toll on the economy – and certainly not tip it into recession – because the U.S. economy is not in a recessionary window of vulnerability. As we wrote recently, “endogenous cyclical forces periodically open up windows of vulnerability for the economy, and … once it is cyclically vulnerable, almost any exogenous shock can easily tip it into recession.” That is not the situation today, but we remain on the watch for such a window of vulnerability to open up.

H.L.: How disruptive and how threatening to the U.S. economy and global economies is the Trump Administration’s policies and actions and the resultant uncertainty?

L.A.: Neither the U.S. nor any other major economy is currently in a recessionary window of vulnerability. Thus, policy uncertainty is likely to have a relatively limited impact on the U.S. and other major economies at this time. This can change once an economy enters a recessionary window of vulnerability.

H.L.: What’s ECRI’s prediction for the U.S. and global economies?

L.A.: Last year, we alerted our members to a cyclical upturn in U.S. growth, as well as a developing upturn in global economic growth. We made the public global growth upturn call early this year, while also alerting ECRI members to the “Brightest Global Growth Outlook Since 2010” far ahead of the consensus.

But U.S. economic growth is now “about as good as it gets.” In fact, the downturn in Weekly Leading Index (WLI) growth, which has fallen to a 73-week low, is warning of waning economic growth prospects. Still, neither the U.S. nor any other major economies are at risk of sliding into recession for the time being.

H.L.: Are we in a bubble, with a recession coming soon?

L.A.: There may very well be bubbles in some asset classes, but that does not mean that a recession is coming very soon.

H.L.: What sectors of the U.S. economy have good potential, and which ones don’t?

L.A.: The cyclically sensitive sectors have benefited from the ongoing cyclical upturn in U.S. economic growth. However, with the cyclical growth outlook fading, according to the WLI, their potential may no longer be as great.

H.L.: What’s your view of the Federal Reserve’s current situation?

L.A.: The Fed is caught between the Phillips-curve-driven convictions of its leadership – reflecting the assumptions of most mainstream economists – and the reality that the Phillips curve is badly broken. But this is not a recent development.

As we wrote around the end of the last century, “[t]he ‘Phillips curve’ relationship between unemployment and inflation has long been a dubious proposition. The [U.S.] Future Inflation Gauge [USFIG] remains a better guide to the direction of inflation.”

Indeed, in the years since the Great Recession, regardless of the unemployment rate, inflation has fallen during inflation cycle (IC) downturns and risen during IC upturns, which the USFIG has accurately predicted. Following the latest cyclical downturn in the USFIG, a fresh IC downturn has already begun, which is why inflation is falling and will continue to decline in the coming months, regardless of the decline in the unemployment rate below “full employment.”

Meanwhile, a Phillips-curve-driven Fed, confused by the simultaneous downturns in unemployment and inflation, is clinging to its faith that inflation will soon revive. Eventually, the inflation cycle will turn back up. But it is the USFIG – not the Phillips curve – that will provide early warning of that directional shift.

H.L.: Is the stock market not a reflection of the riskiness in the world?

L.A.: It isn’t – not in a world where global central banks continue to flood the markets with liquidity.

H.L.: How do you analyze the U.S.’s structural problem? What’s a realistic solution, and is it possible to implement?

L.A.: We first identified the structural decline in U.S. trend growth over nine years ago, before the Lehman Brothers collapse. And as we’ve been saying for years, it is “due to declines in growth in output per hour (i.e., productivity), growth in hours worked, or both. Taken together, they add up to real GDP growth. It’s just simple math.”

At the root of the post-recession drop in productivity growth is a sharp fall in capital intensity. And as we wrote in a paper published last year – referring to unconventional policy stimulus around the world – “Years of depleting future demand, while fostering and sustaining overcapacity and overproduction, have resulted in a world now plagued by lowflation and deflation. Thus, in effect, these policy initiatives have likely inhibited production, undermined profits, and discouraged investment. By perpetuating such stimulus, the world’s two largest economies have created a situation where the Fed is compelled to try to stave off the next recession at virtually all costs, with an eye on the potential negative-wealth effect of the associated stock price correction. Their compulsion may be related to the fact that the two largest post – World War II bear markets have occurred around the two twenty-first-century recessions.”

As long as international policymakers are committed to the use of extraordinary levels of stimulus to prop up economic growth, a sustained revival in productivity growth is unlikely. Meanwhile, the demographics are essentially etched in stone – other than immigration, which accounts for about two-thirds of the potential U.S. labor force growth of about half a percent a year. If legal immigration is reduced, or undocumented residents are removed, even those dismal demographics will be significantly worsened, significantly reducing potential GDP growth.

H.L.: Do you see much job growth ahead?

L.A.: For the time being, job growth will stay strong enough to push the jobless rate further below the Fed’s estimate of “full employment,” further confusing policymakers as inflation remains in a cyclical downturn.

H.L.: Are wages still essentially dead in the water, or do they have any strong growth potential?

L.A.: The reason for soft wage growth at this point in the cycle is widely misunderstood. As we explained back in the spring, “this is a symptom of strengthening economic growth, not weakness or disinflation. In other words, in a tight labor market it’s logical to see nominal wage growth rising when economic growth decelerates, and falling when it accelerates.”

H.L.: Are you at all hopeful, or are you pessimistic about the direction that the U.S. and the world are going?

L.A.: The U.S. and the developing world aren’t going in the same direction, so these are two different trajectories. In fact, the decline in U.S. dominance since the mid-20th century – and especially in the 21st century – has been driven partly by the downshift in U.S. trend growth due to worsening demographics and productivity growth, but also by the resurgence of China and India.

To put this in perspective, it’s instructive to take a long view of history. Few realize that China and India together dominated the world economy for more than 90% of the last two millennia in terms of real purchasing power. In year 1, India’s share was nearly a third of global GDP and China’s was over a quarter – both bigger than the Roman Empire. Asia as a whole produced almost three-quarters of global output. A thousand years later those percentages had only declined a little. China and India’s economic dominance didn’t start waning until a couple centuries ago, when there were huge shifts with the rise of the West, which dominated the global economy by the mid-20th century. But that historical “moment” was the exception in the long history of world GDP.

For Asia, excluding the Middle East, the comeback started slowly and then accelerated, with its GDP share surging to 43% today, a 160-year high. Meanwhile, the combined share of the U.S. and Western Europe has fallen to just one-third, a 166-year low. The U.S. share is now half of its mid-20th century peak.

The two key factors driving the rise of the West relative to the rest through the mid-20th century were the Industrial Revolution and colonialism, which is now history. And in recent decades we’ve seen a great deal of technological catch-up in China and India, which isn’t over. So the relative decline of the West and the rise of the rest hasn’t run its course. But that isn’t bad news for the world as a whole.


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