This may be the economy’s new normal — unfortunately.
The Congressional Budget Office and a growing number of private analysts say the potential annual growth rate in the U.S. has downshifted to about 2 percent from 3 percent on average since the turn of the century because of an aging population, reduced immigration, growing income inequality and other factors.
The CBO, Capitol Hill’s nonpartisan budget agency, has cited the disappointing performance of the economy since 2000 as a reason for lowering its own output estimate 7.3 percent by 2017.
The economic growth rate has averaged an uninspiring 2 percent in the five years since the Great Recession, but that was not the main reason for the downgrade. Instead, it was a lower growth rate for the U.S. during the expansion from 2002 to 2007, which ended with a spectacular housing market collapse and financial crisis.
“The trend is not our friend,” said Vincent Reinhart, chief economist at Morgan Stanley.
He predicts that the U.S. growth rate will continue to average around 2 percent for years to come and that the unemployment rate will fall no lower than 6 percent on average as a result of the aging workforce, reduced business innovation and other fundamental changes in the economy.
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Another hallmark of the recovery from the recession has been a decline in the share of adults who choose to work. The percentage of working-age Americans active in the labor market has sunk to the lowest levels since the 1970s.
Although that phenomenon has puzzled economists and provoked a sharp debate about whether Americans have lost their legendary work ethic, all sides agree that a large part of the decline is the result of a long-expected wave of baby boomer retirements — a trend that will accelerate in coming years and weigh down economic growth.
The drop in labor force growth figured prominently into the CBO’s thinking about the economy. Agency analysts estimate that demographics, immigration and other factors will suppress growth in the labor force from an average of 1.5 percent a year from 1950 to 2013 to no more than 0.5 percent in the next decade. As a result, analysts say, the economy will grow no more than 2.1 percent on average — close to its performance today.
While the CBO emphasizes a connection between the sluggish recovery and slow growth in the labor force, the International Monetary Fund has blamed the diminished performance in part on growing income disparity. The wealthy have captured more than 90 percent of U.S. income gains since the recession, but they are more inclined than lower-income households to save the money rather than spend it in a way that sparks stronger growth.
A faltering middle class
The middle class historically has been the engine of growth, with consumers overall accounting for about 70 percent of economic activity, but many middle-income Americans are now saddled with stagnant incomes, high debt loads and reduced access to credit since the housing market collapse.
Consumers have had to depend on growth in wages to fuel spending, but average wages have barely kept up with inflation since 2008.
Other economists assign some blame to Washington, with a toxic mix of partisan gridlock, increased regulation, high business tax rates and President Obama’s health care law that forces businesses to spend more on insurance coverage and less on wages or other investments that might perk up the average growth rate.
Whatever the factors, the trend is a big disappointment to political leaders and economists who have waited in vain for signs of growth rising back to a historic norm of about 3 percent. Many economists predicted the economy would reach that point this year because it appears to be shedding the last vestiges of the housing recession that led to serious mortgage and debt troubles, and because a historic wave of budget austerity at all levels of government is waning.
But an unusually long, cold and snowy winter has served to hold growth to the 2 percent range.
Optimists predict that the much-anticipated growth surge will appear this spring.
“There’s no permanent slow growth in this country,” said investment strategist and author Gary Shilling, who attributes the economy’s anemic growth rates to lingering strains from the financial crisis.
Recoveries from big banking and debt crises like those that shook the global economy in 2008 typically are prolonged and slow because households, banks and businesses are forced to slash spending for years to shed debt and return to solvency.
“We’ve got deleveraging,” Mr. Shilling told “Financial Sense Newshour.” “If history is any guide, we’ve got another four years to run, roughly. But when that’s over, I see no reason we’re not going to resume normal growth and probably even faster on a catch-up basis.”
New Federal Reserve Chair Janet Yellen also believes the economy’s mediocre growth is largely an aftereffect of the financial crisis and not a deeper structural change in the economy. At a news conference Wednesday, she cited “lingering conditions from the crisis” that are holding back growth, including millions of “underwater” houses that owners can’t sell or refinance, and the scarcity of home equity loans, mortgages and other credit for such homeowners as well as for people with average credit ratings.
Ms. Yellen’s insistence that the economy will return to normal after a long period of slower growth is significant.
Much is at stake for the Fed if the economy is on a permanently lower growth trajectory. If the economy can grow no faster than 2 percent on average, it may be unwise or futile for the Fed to try to stimulate growth as it has for years with near-zero interest rates and other extraordinary measures.
Morgan Stanley’s Mr. Reinhart said the Fed will have to adjust its policies to reflect the new realities. He co-authored a widely respected study that predicted the long, sluggish recovery from the Great Recession based on the diminished economic performances in other countries hit by severe financial crises since World War II.
“We have a long track record in warning that a severe financial crisis takes an enormous toll,” he said. “The expansion of potential output ground to a halt after the financial crisis.”
Mr. Reinhart’s projections are not based only on the banking crisis. He said the biggest factors will be the decline in labor force growth and the decline in population growth to about 0.7 percent a year resulting from low birthrates and reduced immigration.
Also in the mix are declining productivity increases caused by reduced business investment in technology.
Lackluster business investment has caused U.S. worker annual productivity growth rates to tail off from more than 3 percent a decade ago to 0.5 percent last year. That trend, if it persists, has the potential to cut the economic growth rate significantly. A rule of thumb among economists ties the rate of economic growth to the growth rate in productivity plus the increase in the labor force. Thus, labor force growth of 0.5 percent, for example, combined with yearly productivity gains of 1.5 percent would yield a growth rate of about 2 percent on average.
The decline in the labor force may be hard to reverse, given the lure of retirement for the aging boomers, but the drop-off in business investment spending should be easier to remedy because American corporations have record amounts of cash on hand.
Although businesses could invest more, economists say, a vicious cycle of lackluster economic growth and stop-and-go consumer spending patterns gives them little incentive. Many corporations instead are investing in emerging countries such as China, where they see potential for stronger growth.
A big exception to anemic business investment is one that Mr. Reinhart cites as a reason for optimism. That is the robust growth from oil companies since the discovery in the past decade of new ways to extract large quantities of oil and natural gas from shale bedrock in the American heartland.
“We are reluctant to discount the dynamism of the U.S. economy” entirely, Mr. Reinhart said, noting that the oil and gas sector has accounted for nearly a quarter of all investment in structures recently, demonstrating how American businesses can unleash world-changing innovation when they are motivated to do so.
The shale revolution, moreover, is prompting other industries such as chemicals and plastics to invest in new plants in drilling areas to take advantage of the relatively low-cost energy, he said.