Cover Story: The Great DivideJanuary 14, 2016 No Comments
“Flat is the new up.” That’s the pithy, and sobering, assessment of Goldman Sachs in predicting what’s in store for the U.S. economy and for investors in 2016. The investment bank in mid-November cut its forecast for 2016 U.S. economic growth to 2.4 percent, down from a previous estimate of 2.8 percent. (1)
But not everyone is fretting.
Wells Fargo’s chief economists are projecting a similar estimate for projected growth, though they are seeing this as a “slow but steady” demonstration of the U.S. economy’s continued growth. Mark Vitner, Wells Fargo’s managing director and senior economist, points out that the positive economic indicators really are outweighing the negatives: dominated by strong employment statistics that spin off into other benefits such as increased consumer spending and new home construction. The economists at UBS, too, remain unfazed. In fact, Maury Harris, UBS’ managing director and chief economist for the Americas, and his team expect real GDP to increase by 2.8 percent in 2016 and 2.5 percent in 2017. If realized, this recovery, which began in June 2009, would have lasted an incredible 102 months. Said Harris, “Achievement of our forecast means that the current economic recovery will become one of the longest on record.” (2)
The Great Divide
Actually, this is a theme that cuts across several measures of economic development, as reflected in Wells Fargo’s 2016 Annual Economic Outlook. We’ll review the update provided by John Silvia, chief economist; Mark Vitner, managing director and chief economist; and Jay Bryson, global economist. Through their eyes, we will look at the Great Divide being observed in emerging markets, in the changing structure of GDP, even across domestic geographies. (3)
The great divide in economic prospects is playing out across the world.
The Great Divide: Divergence among global economies
Economic deceleration in developing economies means that global GDP growth likely will remain modest in the near term.
First off, Jay Bryson takes us through his global outlook. In the Chart A, notice how, in the 1980s and 1990s, both advanced and developing regions were growing in tandem. The Great Divide—real divergence—has taken place in the last decade, with the emergence of the BRICS (Brazil, Russia, India, China, and South Africa).
As of 2015, the five BRICS countries represent over 3 billion people, or 42 percent of the world’s population. All five members are in the top 25 of the world by population, and four are in the top 10. The five nations have a combined nominal GDP of U.S. $16.039 trillion, equivalent to approximately 20 percent of the gross world product. (4)
The real slowdown in the global economy has hit the developing countries particularly hard. And that trend is expected to continue, certainly through 2016. Prior to the global financial crisis, we were seeing 8 percent growth rates overall in these countries. They won’t get back to that rate anytime soon. Global GDP is expected to be about 3 percent for 2016, which is below the historical average of 3.5 percent.
China: slower growth is anticipated, but not complete collapse.
Bryson and team are forecasting that real GDP in China will continue to slow, but that the Chinese economy will not implode. “We definitely have seen a slowdown in China,” said Bryson. “I feel comfortable saying that China never again will see growth at 10 percent on a sustained basis.” Today, China is growing at 7 percent year over year. By the end of 2016, it is anticipated they will be below 6 percent.
Certainly the Chinese economy could slow further, but its government has the policy flexibility to address any threatened collapse. “At the end of the day, the most important thing for Chinese policy makers is social stability,” said Bryson. “They can’t afford a debt crisis, and won’t hesitate to recapitalize if necessary.”
And the often-asked question: when will the Chinese economy become as influential as—or more than—the U.S. economy? According to Vitner, “Not anytime soon. In terms of value added, China is at least a decade if not more away. In terms of its capital markets, remember that the most transparent, most liquid, and deepest financial markets in the world are the U.S., and that’s not going to change anytime soon. So when will China catch up to be equally or more influential in financial markets? Decades away.”
Advanced economies have limited exposure to developing economies.
Chart B demonstrates this. Look at the sources of value added in advanced economies. In 2011, domestic spending in the advanced economies accounted for about 81 percent of value added in the global marketplace. Think of the U.S., and take healthcare as an example. Of all the value added in healthcare, the wages and salaries and profits, this means that over 80 percent of that is determined by spending within the U.S. That’s very powerful.
According to Bryson, looking at the U.S. specifically for those numbers, almost 90 percent of our value added is determined by domestic sources. Of the 10 percent that comes from abroad, 7 percent is from other advanced economies and only 3 percent is from the developing economies. This breakdown greatly limits our exposure to developing economies’ volatility.
The Great Divide: U.S. GDP Shift Beneath the Surface
Real GDP growth has been disappointing throughout most of this recovery. Though the numbers look like “more of the same,” there is a marked shift beneath the surface.
In terms of a U.S. economic outlook, though expected GDP is steady, what’s interesting is the volatility. It is this source of volatility that is creating the divide within the domestic marketplace.
According to Vitner, what we see going on is a shift—a divide. The economy doesn’t simply grow; it’s constantly evolving. We are feeling the pains of such an evolution. The early part of this recovery was in many ways a production-led recovery. Energy, mining, agriculture, and export-driven manufacturing led the way. It was fueled by the rapid growth we were seeing in China and other developing economies.
But the momentum is shifting. And its impact is being reflected in the increasing uncertainty in the marketplace. Its source is the sharp slowdown in the very sectors listed above, each of which is heavily influenced by global supply and economic strength.
As the global economy continues to be volatile, and dependence upon its growth a more risky business, sectors dependent upon it for growth, too, are slowing. Indeed, by the end of 2015, all four areas had slowed to the point of being considered “in recession.”
In their place is the shift to domestic-focused industry and activity, as measured by the employment situation and manifested in increased consumer spending.
Employment posted solid gains in 4Q 2015, alleviating fears of a slowdown. Unemployment continues to trend lower, helped along by lower labor force participation.
“It may seem a little contrary that we see employment growth holding up relatively well when four key areas have slowed as much as they have,” said Vitner, “but other sectors are gaining momentum. Sectors like healthcare, business and professional services, leisure and hospitality, they all are labor intensive. So job numbers should hold up relatively well despite the tremendous drag on the production side.”
“Ultimately, we want to drive home the point: from a labor market standpoint, which is most important in fueling demand, the economy is on relatively sure footing,” summarized Vitner. In fact, forward-looking indicators suggest that unemployment rate is likely to drop even further in 2016.
The Great Divide: Domestic consumer recovery is not being experienced equally
Wealth recovery disparity
Chart C shows the rebound in consumer spending. Spending in this cycle has been driven to a much greater extent by gains in household wealth, largely concentrated in gains in financial markets and home value prices. The Great Divide is reflected in its unequal dispersion through the economy.
Home prices have risen most dramatically in large urban markets with very strong job growth, especially areas with large tech sectors. And the rise in financial markets has benefited parts of the country with wealthier populations. Overall, when you look at household net worth as a share of after-tax income, it’s right back to previous highs we hit at the top of the housing boom. But, again, not everyone gets to play.
This statistic is particularly interesting. Chart D pictures the percent change in personal income by state, from Q2 2014 to Q2 2015. Nowhere is the Great Divide more clearly demonstrated domestically than through this lens. You can see it very clearly by looking at personal income by state: the darkest states, to the west, are where income is growing the fastest.
Many of the areas where incomes are growing the fastest are technology-driven economies. This reflects back to the shift referenced above: business and professional services growth, labor-intensive, is representative of this “shift beneath the surface.” This is true particularly on the west coast, in the major metro areas reflected there.
One divide worth noting: look at the Midwest. States driven more by agriculture, energy, and mining have seen dramatic slowdown in their income growth. That’s likely to play out increasingly in 2016. Areas tied to domestic growth will see stronger gains; those tied to global economy will slow. Minnesota is the one bright spot. That said, we have challenges ahead as well. Minnesota’s Management and Budget Office (MMB) November 2015 economic forecast calls for Minnesota’s expansion to continue over the next several years, but at a generally slower pace than the national average. Both employment and wage income growth are expected to remain modest in 2016 and 2017, with the average nominal wage slowly accelerating. The forecast expects small improvements in household formation, labor force growth, and labor productivity. (5)
What are the bright spots of the U.S. economy?
The negatives in terms of financial markets always seem to stand out more clearly than positives (perhaps leading some to hold a less positive view on the economic outlook). But to Vitner and his team, positives clearly outweigh the negatives in terms of the US economic outlook.
Vintner broke it out this way:
- The most positive of all is the improvement in employment stats. Not only has job growth been stronger over last couple of years, but also the quality of jobs has been much better.
- The next positive is that job growth in turn leads to other good things. One of which is household formation, which largely had been missing in action. They have picked back up to a pace that is at or above long run trend. And this, in turn, is driving the housing market.
- And when we look at housing market, another positive. There is very little inventory of new homes on the market right now, even though demand is relatively strong. Which means that any improvement in sales going forward is likely to lead to a fairly significant increase in new home construction.
- Believe it or not, one of the differences between 2016 and the past few years is sorely needed positive is fiscal policy, switching from being a drag on overall GPD growth to being a slight positive. We have a budget deal allowing for a small increase in defense spending and non-defense discretionary spending. We’ve got a transportation bill….it may not be what everyone was looking for, but we’ve got one. So we’re likely to see increased government outlays, a small positive for GDP growth in 2016.
A Word from Minnesota Management and Budget: Prospects Ahead
Minnesota’s labor market performance has been impressive since the recession ended over six years ago. The state has added more than 50,000 jobs since employment surpassed its pre-recession peak in mid-2013, and most indicators suggest the labor market continues to tighten considerably. The number of job vacancies in Minnesota has soared to the highest level since 2001, and the state’s jobless rate was down to 3.7 percent in October, matching the low that has prevailed since mid-2014. With the excess supply of workers rapidly diminishing, a tighter labor market is leading to some long-awaited wage acceleration. It increasingly appears that Minnesota is near its full employment potential.
Nonetheless, Minnesota’s economy faces challenges. Manufacturing, mining, and agricultural activity in the state has struggled in 2015, as Minnesota producers adjust to lower commodity prices, the strong dollar, and weak global growth. The pace of the state’s housing recovery has been slow in part due to persistently slow household formation, although there are recent signs of improvement. Moreover, Minnesota’s labor force growth remains weak, despite the fast-tightening job market. This is impeding the state’s ability to increase employment. MMB’s economic forecast depends on stronger labor market conditions beginning to translate into improvements in household formation, the supply of labor, and productivity, thereby putting further upward pressure on hourly wage growth. 6
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B Kyle is the vice president of strategic development at the Saint Paul Port Authority. She can be reached at email@example.com.
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