Comment: A long, slow pull for the US economy

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The Independent Online
The mood about the American economy has suddenly shifted. At the time of the election in November there was still considerable doubt about the solidity of the recovery. It was sluggish, uneven and insecure - or so it seemed. Figures published shortly after the polls closed, however, showed that US economic growth had been cantering along at a fair clip during the third quarter, although the voters had failed to notice. This growth continued during the final three months so that the economy expanded at an annual rate of 3.5 per cent during the second half.

Underlying what is now an established cyclical recovery, something else may also have been happening, something of less immediate political or market impact, but ultimately far more important. Forget about the cyclical improvement, for that was bound to happen sooner or later. There is evidence that the underlying long-term economic performance of the US may be improving to a greater extent than previously thought. If that is right it is enormously important, for it suggests that the relative decline of the US economy may be slowing.

There are a number of different ways of measuring US economic might. It is still the world's largest economy in terms of gross domestic product and, with the possible exception of Switzerland, the world's richest in terms of GDP per head, provided the calculation is made with purchasing power parity exchange rates. Using market exchange rates a number of European countries and Japan are richer. (Britain, incidently, has roughly 70 per cent of US per capita GDP, almost exactly the same relationship it had with the US on the eve of the First World War).


But perhaps the relative position of the US in relation to the rest of the world is most interesting of all. In 1914 the US economy accounted for roughly one third of world output; at the height of American power in the early 1950s it was well over half; now it is back to one third. One can argue, as David Hale of Kemper Financial Services in Chicago does, that the US is merely going back to its natural position in the world: that the dominance of the 1950s was never sustainable and Americans should not chastise themselves for that. But of course if the relative position continues to slip, the share of world output in 15 or 20 years will no longer be more than 30 per cent, but perhaps nearer 20 per cent. That would lead to a serious reassessment of the US's role in the world.

For the past 20 or so years, while US manufacturing and service industry productivity have in absolute terms been the highest in the world, there have been several uncomfortable signs. One is that the lead in manufacturing seems to have narrowed, while some industries, including the vast car industry, have fallen behind the brand leader, Japan. Another is that service industry productivity has been only creeping upwards, if it has been rising at all. A third is that much of such additional wealth as has has been created has been absorbed in excessively expensive healthcare, high policing costs, high legal and insurance fees, expensive banks and so on. As a result, living standards for all but the top 20 per cent of income-earners have hardly risen for 20 years.

But now come some figures that suggest that something may have changed. Last year non-farm businesses increased their productivity by 2.7 per cent, the fastest increase for 20 years. While this is obviously encouraging, as Nomura Research Institute points out, these figures also carry a further message: faster productivity growth means fewer jobs for any particular level of output. Thus the US economy will have to grow by close to 4 per cent a year if it is to pull down the unemployment totals.

I'll come back to that in a moment. Why is productivity suddenly rising faster? No one really knows yet, but clearly there are several factors. Hours worked have been rising; capital spending has risen sharply in the last year; the enormous investment in personal computers may have increased productivity in service industries, and the pressure from Japanese investment in the US may have persuaded domestic manufacturers to improve their performance by adopting their management methods.


Some at least of these look sustainable. A commonsense view would surely be that the introduction of PCs in every office and many homes must boost productivity. One has only to look at the revolution taking place in companies like GM or IBM to see US corporate giants responding, belatedly and painfully, to outside pressures.

What is not yet at all clear is whether these improvements can be translated into higher living standards. They will not, if the benefits are mopped up by rising healthcare costs or yet more expensive litigation.

Further, if the new administration seeks to drive the economy to faster growth than it can naturally sustain (and there are genuine dangers in trying to boost the growth rate when the economy is already expanding quickly) then ductivity growth will suffer, as it did in the 1980s when the economy was responding to the increasing budget deficits.

As we now know in Britain, if you push an economy beyond the growth rate it can sustain, you create all sorts of distortions that ultimately hinder growth. Example: London's office building boom of the 1980s.

But there is a political problem for the Democrats in higher productivity if it means that the jobless total keeps on rising. There will be dollars 30bn of new measures in the Clinton package being prepared. In the short term the economy will grow faster as a result, but whether it can achieve the steady growth of more than 3.5 per cent that it needs to pull back unemployment is another matter.

The key thing in understanding how economies are moving is to distinguish the cyclical from the structural. The cyclical story in the US is now pretty clear, and will be reflected in upgrades for GDP growth in the coming months. But it would be very brave to claim that the structural position of the US economy is improving much. Something is happening, but it will be a long, slow pull before it is clear that the great American wealth-creating machine has radically improved its performance.