Five years on from the “Great Recession”, the US economy is finally emerging from the shadow of the financial crisis.
After several years of stop-start growth, the US economy has been cruising along at a respectable pace during much of the past year. Confi dence among US consumers continues to build as the job market strengthens and household debt deleveraging is now well advanced. US businesses have begun to scale up their investment programmes to upgrade equipment and expand capacity. And years of budget tightening have left the public finances in much better shape, with the budget deficit falling to its pre-crisis level in FY2014. Unlike in the UK, where the next parliament will be dominated by further battles over public spending cuts, fiscal policy should have a fairly neutral impact on the US economy over the coming years.
Nevertheless, growth is unlikely to break any records in the year ahead and, while the 2008-9 financial crisis itself is no longer exerting a material drag on activity, it is certainly not a distant memory. The US economy is still operating with a sizeable negative output gap (with GDP around 3-4 per cent below its potential, according to most estimates), unemployment remains elevated and neither consumers nor businesses appear as ready to embrace risk as they were before crisis struck. But if our expectations are borne out, US real GDP should nonetheless expand by around 3 per cent next year, which would make it the star performer among developed economies.
RECOVERY BACK ON COURSE
After faltering in early 2014, when the US faced a barrage of winter storms, the economic recovery is seemingly back on track. Following a contraction of 2.1 per cent (annualised) in Q1 2014, real GDP bounced back sharply, expanding by 4.6 per cent in Q2, before settling back to a more sustainable 3.5 per cent in Q3. Swings in inventory building have exaggerated the volatility of the economy over the last year, but the underlying trend has been one of a steady and well balanced recovery, reflecting improvements across all demand components, including consumer and government spending, residential and non-residential fixed investment, and net exports.
The broad-based strength of GDP is mirrored in a range of consumer, business and labour market indicators. Despite some ups and downs, indices of business and consumer confidence trended higher through 2014, in many cases reattaining their pre-crisis levels. Nowhere has this momentum been more evident than in the labour market. In the first three quarters of 2014, the US economy created almost two million new jobs, suggesting this will the best year of job creation since 1999. As a result, the unemployment rate has fallen below 6 per cent for the first time since 2008. However, while the persistent fall is encouraging, unemployment is still well above the pre-crisis low of 4.4 per cent, meaning that millions of Americans are still looking for work. Perhaps this explains why in a recent survey of public opinion, around half of those polled said they believed the US was still in a recession. But if the recovery has some way to go yet, the outlook is at least promising.
US CONSUMERS ARE STIRRING
Given that there are few more powerful economic forces in the world than the US consumer, the recovery of personal consumption expenditure over recent quarters is encouraging. During the first three quarters of 2014, consumer spending was 2.3 per cent higher than during the same period in 2013, having strengthened steadily since late 2011. The pick-up has been driven by strong spending on goods (3.1 per cent over the same period), notably durable goods (such as cars). However, it is worth noting that the growth of consumer spending is still a little below the trend over the last two decades (around 2.9 per cent).
Indeed, the US economy certainly does not appear to be on the brink of another consumption boom, but there are good reasons for thinking that growth should accelerate further – and that the recovery should be more widely felt.
Firstly, US consumers are in a much better shape financially: in the years since the financial crisis struck, households have been busy paying down their debts. The ratio of household debt-to-income fell below 100 per cent of disposable income in 2014, for the first time since 2002. Combined with low interest rates this has pushed down the burden of servicing debt to the lowest level since 1980. By devoting less income to paying interest and reducing debts, consumers will be able to spend more of their income on goods and services. Indeed, in a sign that a prolonged period of deleveraging is coming to a close, US consumers are now becoming more willing to take on credit again.
Secondly, the ongoing recovery in the labour market should also provide a more solid underpinning to household consumption in 2015. Although strong employment growth has helped support the growth of total disposable income, the growth of individuals’ earnings has been anaemic over the last few years. Average weekly wages, for example, grew by 2.3 per cent year on year in the first three quarters of 2014, compared with a 1.8 per cent rise in consumer prices. As in the UK, one of the main questions over the near-term outlook for household demand is how long-term growth can be sustained at its recent pace while wage growth barely outpaces inflation. Analysis by the Fed provides some reassurance. Richard Fisher, the president of the Dallas Federal Reserve, has argued that wages should accelerate when unemployment falls below a “tipping point” of 6.1 per cent. So while strong employment growth may well slow over the coming year as slack in the labour market is gradually reduced, the flip-side is that wage growth should also increase slightly.
There are, however, two caveats to this. One is the possibility that growing confidence in the economic recovery could attract currently disengaged workers back into the labour force, raising the supply of available workers and thus reducing pressure on wages to rise. This would imply that at least some of the recently observed decline in the labour force participation is a temporary, cyclical phenomenon (by contrast, some Fed officials have argued that the bulk of the decline is “structural”, reflecting retirement by the babyboomer generation and the growing number of Americans claiming disability). A second caveat is that productivity growth has been fairly weak in recent years. Having surged in the aftermath of the recession, in response to labour shedding, output per hour has grown by less than 1 per cent per year since 2011, compared with an annual average of 2.8 per cent in the decade prior to the financial crisis. In the absence of stronger productivity growth, firms may be unable to afford to boost pay, and consumption growth could follow a weaker trajectory.
THE INVESTMENT OUTLOOK IS IMPROVING
There are many plausible candidates for explaining the slowdown in US productivity growth in recent years. One prominent theory sees the source of the problem in the industries that produce information technology or those that use IT intensively, which are experiencing a return to more “normal” productivity growth after nearly a decade of exceptional IT-fuelled gains. Other theories focus on the decline of new business start-ups and entrepreneurialism, which in turn has been variously attributed to skills shortages, difficulties in obtaining financing, and an increasing regulatory burden that has raised the cost of doing business. Weak business investment in recent years is also widely believed to have played a part: faced with sluggish growth and high levels of uncertainty, many US firms have used profits to buy-back shares rather than invest in productivity-enhancing innovations.
Fortunately, there are signs that this situation is changing. Business investment in structures, equipment and intellectual property rose by 6.1 per cent in the first three quarters of 2014, with upward revisions to previous quarters reinforcing the impression of a cyclical upswing since 2013. Encouragingly, the Fed’s regional reports indicate that capital spending plans remained firm during the second half of 2014, a picture that is also borne out by leading investment indicators, such as strengthening capital goods orders. There certainly appears to be scope for a further expansion of business investment in the near term; the OECD estimate that in 2013 the level of investment as a share of GDP (in nominal terms) remained below both pre-crisis norms and where it needs to be to prevent the capital stock from falling over the long-run, given expected rates of depreciation and economic growth projections (OECD Economic Outlook, Volume 2014, Issue 1).
Similarly, trends in new household formation suggest that there is considerable scope for residential investment to provide a solid underpinning to economic growth over the medium term. The main worry here is that the actual level of housing starts remains well below potential demand. A shortage of supply has pushed up prices in many US cities which, while helping the equity position of existing homeowners, has stretched affordability for first-time buyers. At the same time, the Fed credit conditions survey highlights that a general relaxation of lending standards has yet to spread to mortgages: although cash purchases have supported house sales to an extent, mortgage applications remain depressed. If financing constraints remain too tight, the housing market could provide less support to the economy than expected over the coming year, through lower construction and consumer spending.
ANOTHER FALSE DAWN?
Overall, the outlook for the US seems more positive than it has for several years. An improving labour market and a pick-up in wage growth are expected to support consumer spending and housing construction. Surveys suggest US businesses are becoming more willing to invest. Monetary policy should also continue to support economic expansion for some time yet: remarks by Fed officials suggest the central bank’s main goal is to achieve full employment, and that inflation and wage growth will be allowed to run ahead of target at least for a short while to ensure that the recovery beds down.
Naturally, making any predictions of economic developments for the year ahead will leave many hostages to fortune – particularly on the international front. Financial market volatility increased in the final few months of 2014, as the global economic outlook became gloomier, with the threat of a renewed slowdown and deflation in the euro zone a particular concern. Markets are likely to remain choppy as the date draws ever closer when the Fed raises its main interest rates for the first time since mid-2006, particularly if the performance of the world’s major economies diverges further. Further market volatility has the potential to transmit a serious confidence shock to the real economy, while weaker global demand for US exports would inevitably lead to a slightly larger drag on growth from net trade.
Alongside such concerns, the list of “known unknowns” that could affect the US outlook includes the possibility that the recent weakness of productivity growth will prove to be more persistent than expected, implying that real wage growth could also remain lacklustre. The recovery of the US housing market could also prove weaker than expected. Geopolitical threats to the recovery remain numerous, from the turmoil in the Middle East and the Ukraine to the threat of Ebola. And this is not to speak of the “unknown unknowns” – this time last year who could have predicted the polar vortex? If meteorologists saw it coming, economists certainly did not. But assuming all goes well, the US economy seems well placed to enjoy a durable upswing in the coming years.
The CBI (The Confederation of British Industry) provides a voice for businesspeople and their businesses on a national and international level. We speak for more than 240,000 companies of every size, including many in the FTSE 100 and FTSE 350, midcaps, SMEs, micro businesses, private and family owned businesses, start-ups and trade associations in every sector. Our mission is to promote the conditions in which businesses of all sizes and sectors in the UK can compete and prosper for the benefit of all. To achieve this, we campaign in the UK, the EU and internationally for a competitive policy landscape.