JOHN MASON - Can the US Expansion be sustained ?


Can the US Expansion be sustained ?

The United States economy grew at a 3.0 percent rate of growth, year-over-year, in the third quarter of 2018.

This number is above the figure for the second quarter, which was 2.9 percent and up substantially from the 2.3 percent figure of one year ago. In the third quarter of 2016, the rate of growth was only 1.5 percent.

Although the 3.0 percent rate of growth is a good one, it is not as great as has been achieved in other economic recoveries but is consistent with the modest nature of the current expansion.

But, the current expansion contains good news and bad news. The good news is that the United States is in its tenth year of expansion and next year at this time could be come the longest economic expansion in US history.

The bad news is that the compound rate of growth of the economy over the past 37 quarters is only 2.3 percent…the slowest recovery on record.

The current expansion has been driven by consumer expenditures, just as former Fed Chairman Ben Bernanke planned it. The recent pickup in the rate of growth is no exception, as the consumer is still driving it.

In the third quarter the consumer did get help from the defense sector due to a pickup in orders for military aircraft.

The question that seems to be on everyone’s mind is whether or not the third quarter performance can be sustained. A lot of experts don’t believe that it can.

Many economists believe that the economy will tail off as it goes into 2019. They argue that the current acceleration has been especially created by the tax reform bill that was passed in December 2017 and the subsequent budget that was produced by Congress in February 2018. Once the short-term impacts of these efforts are over, the economists say, the economy will again drop back to lower levels.

The Federal Reserve, for example, put out projections at its September FOMC meeting with the following path: 2018—3.1 percent; 2019—2.5 percent; 2020—2.0 percent; 2021—1.8 percent; and for the longer term 1.8 percent. Although no recession is projected in the numbers, the expectation for the future is that it will be more like what has happened throughout the current recovery.

This brings up another question. Maybe the economy has changed.

I have written a lot this year about how the nature of the corporation is changing as we move from an industrial world to a world dominated by information technology. This transformation has changed the structure of the modern business, something I have named the “new” Modern Corporation, for want of a better term.

The “new” Modern Corporation is based upon intangibles, like intellectual property, and not physical investment. The “new” Modern Corporation thrives upon building platforms, networks, that have tremendous scale advantages over the industrial conglomerate.

Furthermore, the “new” Modern Corporation excels in financial engineering, one reason being that many parts of the “new” Modern Corporation operate in a zero marginal cost environment and so have lots of cash to deal with. The businesses must do well in financial management or their returns will not be as high as they could.

But, financial engineering has become a mainstay in the whole economy due to the credit inflation and financial innovation that took place in the last forty years of the last century. Furthermore, this growth in financial engineering has meant that financial jobs take up more than 40 percent of US jobs, which has a major impact on employment and the growth and measurement of labor productivity.

Combine this with the number of jobs that now exist in information technology and you have to admit that today’s job market is nothing like the job market that existed in 2000…or 1980.

Furthermore, in an environment driven by credit inflation, governmental stimulus tends to go into the “financial circuit” of the economy and not into the “industrial circuit.” Consequently, we are more likely to get asset bubbles that consumer price inflation. By the end of the 1980s, my research indicates that most government stimulus went into the financial circuit and by the time of the Great Recession, almost all of government stimulus was handled by financial engineering.

It has been reported that most of the December 2017 tax cut went into stock buybacks and dividend increases.

Investment also takes place in a different way in the “new” Modern Corporation. The economist William Baumol presented information in his book “The Free-Market Innovation Machine” showing the time lag between the introduction of an innovation and competitive entry against that innovation. A chart is found on page 76.

In the period 1887-1906, the lag was almost 33 years. In the period 1927-1946, the lag was almost 14 years. In the period 1967-1986, the last one presented, the lag was 3.4 years. Can you imagine what it must be today? Maybe 2 years?

The point of this is that the rate at which innovation takes place impacts how the firm invests in physical capital but also in the investment of intangibles. Business investment is different today than it was back in the 1967-1986 period.

Here again, the “new” Modern Corporation led the movement into what is called “time pacing.”

“Time pacing” occurs when corporations invest according to the calendar, rather than according to when the economic conditions are “right.” If you have to have a new round of products and services to the market in two years, you have to plan your innovations and your investments to meet this schedule. Hence, the “new” Modern Corporations invest according to time, the invest more in intangibles, and the have the cash to take on this activity regardless of financial markets.

So, more firms are working with intangible assets, more firms require people with a college education or more (hence the unemployment rate of these individuals is so low relative to all other categories), investments (tangible and intangible) are more regular and less subject to the policy swings of government, and labor productivity is something different than it ever was.

These reasons may be major contributors to the “slower” economic growth of this period of expansion and it may help to explain the growth of areas like information technology, finance, and health. It way also explain why some of our statistics do not capture all that is going on in the economy. It may also help to explain why our measurements of labor productivity, wage increases, and labor force participation have not been behaving as they once did.

These reasons may explain why economic growth may taper off over the next few years.

The bottom line is that we need to understand a lot more of what is going on than is captured by the statistics that we are basing our analysis upon.


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