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Perspective

On the road to zero growth
GMO’s Jeremy Grantham on why the US economy will see stagnating growth in the years to come

Jeremy Grantham

Attitudes to change are sticky. We cling to the idea of the good old days with enthusiasm. When offered unpleasant ideas (or even unpleasant facts), we jump around looking for more palatable alternatives. Critically, the technology boom and bust and the following housing boom and housing and financial busts helped camouflage the recent unpleasant economic development lying below the surface: the steady drop in long-term US growth. Someday, when the debt is repaid and housing is normal and Europe has settled down, most business people seem to expect a recovery back to America’s old 3.4% a year growth trend, or at least something close. They should not hold their breath. A declining growth trend is inevitable and permanent and is caused by some pretty basic forces. The question here is not, “Has the growth rate dropped?” (Yes, it has) or “Will it continue to drop?” (Yes, it will). The question is: “At what rate will it drop?” 

The old GDP battleship

The trend for US GDP growth up until about 1980 was remarkable: 3.4% a year for a full hundred years. There is nothing like this duration of strong growth anywhere else, although of course there are much higher growth rates for short bursts. But after 1980, the trend began to slip. It was not the result of a specific economic setback, but just a new, slower growth rate. After 2000, what had been a sustained surge of women entering the workforce came to an end, further reducing the growth rate. The effect of this slowdown was felt in the very slow recovery from the 2002 recession, when the slowest GDP growth and job creation yet recorded was experienced. This was despite the creation of a housing bubble, a difficult thing to achieve in a famously diversified US housing market. 

The bubble led directly to the building of at least 2 million extra houses, employing an extra 3-4 million workers. There was also unprecedented borrowing against increased housing values. Yet, still the recovery was slow. The current recovery from 2009 has been even more disappointingly slow. Times have changed. 

GDP can be conveniently divided into population effects and every thing else, loosely described as “productivity.” Here, we’ll start by looking at population effects. 

Demographics and growth

Demographics can get boring in a hurry so here are the bare bones. There has been a rapid decline in the growth of working age population in recent times (See: Coming of age). Part of the future squeeze comes from the ageing of the population. Also, it seems to be part of our global culture today to work less as we get richer. And why not? It is so durable a trend that in the US even after 1970, despite there being no further gains in real wages per hour, hours worked continued to creep down at 3 hours a year. Other developed countries, which did quite a bit better in average wages, not surprisingly fell quite a bit faster, too, at over 7 hours a year. Lucky them. From 1950 this effect has reduced potential growth in the US by 0.17% a year and, in the balance, of the OECD by over twice that at 0.4%.

Coming of age

There has been a decline in the growth of working age population in the US

The one very substantial positive in the US to the total hours worked picture: the dramatic increase in the participation of women. This added about 0.25% a year to work input up until 2000, when the trend ended. The demographic inputs peaked around 1970 at nearly 2% a year growth (there are many ways to do these calculations, each yielding slightly different results). They fell to about 1% average growth for the past 30 years, and demographic effects are now down to about 0.2% a year increase in man-hours, where they are likely to remain until 2050, with possibly a very slight downward bias. 

Unusually for things economic, these estimates are much more likely than the typical estimates to be quite accurate, for much is derived from the existing population profile and social trends, which, like birth rates, change very slowly. The only variable that is likely to jump around unpredictably is the US immigration policy.

The important point to note here is that these inputs are never going to get close to the glory days of the US GDP growth battleship. They have caused GDP growth to drop by over 1.5% from its dizzying peak in the 1960s, and nearly 1% from the average of the past 30 years. The population growth may just hold at current very modest growth rates, but it is very highly unlikely to bounce back. Similarly, the much more rapid global population growth is very likely to reach zero by 2050 plus or minus 10 years, which puts a substantial dampener on global GDP growth. I do not believe that this decline, backed as it is by unusually
dependable data, is fully appreciated yet by the business and investment community.  

Job Creation and Falling Man-hours — Possible Good News

So the big long-term problem for GDP growth is likely to be a steadily reducing stream of man-hours available to the economy. Yet, the big short-term problem is our apparently chronic failure to produce enough jobs. Well, obviously sometime in the intermediate term these forces will meet in what appears to be a very fortunate development, each taking some sting out of the other negative. 

Perhaps Japan has been giving us a sneak preview. We have all been gloating at their population crisis — working age population falling rapidly — while barely commenting on the fact that they have half our unemployment rate. Yes, they have other problems. But just imagine how much worse their past 10 or 20 years of unemployment would have been if the Japanese population growth rate had been 1% or 1.5% more per year. Very painful indeed. 

Productivity

Productivity is the other half of the growth equation. According to a new paper by Professor Robert Gordon of Northwestern University, which gives us some historical perspective on the issue of productivity per capita, productivity gains were negligible for centuries (as was population growth, for the record). Growth slowly picked up first in the British Agricultural Revolution and then in the Industrial Revolution, rising to a then dizzying 1% growth rate around 1900. With the surge of innovations — steam engines, electricity, telephones, autos, and the full use of the stored energy of coal, oil, and gas — the rate soared to a peak of 2.5%  at mid-century. And then it started to decline, with the estimated trend reaching 1.8% in the year 2000. (Gordon predicts a further fall in the trend of productivity growth to 1.3% by 2025.)

Gordon offers a further thought experiment by speculating that possible future growth in productivity might continue to go down, all the way back to the original growth rate of about 0.2%. Gordon’s points are, I think, inarguably holding back our growth potential. But they were doing so during the past 30 years. If these factors are only predicted to be as bad as they had been in the past, then they have no effect at all on changing future growth, for they are already counted as some of the forces that have already caused productivity to drop substantially since the peak in the 1960s. In particular, relative educational standards, globalisation, and income disparity have all deteriorated so badly in the past that I am confident they will become less bad, perhaps much less bad.  

Reduced capital spending

Typically, I see less significance than others in debt and monetary factors and more in real factors. When someone says that China is building its trains and houses on debt, I think, “No, they are built by real people with real bricks, cement, and steel and whatever happens to the debt, these assets will still be there.” (They may fall down but that’s a separate story; you can build a bad high rise with or without debt). So I take the quality and quantity of capital and people very seriously: they are the keys to growth and a healthy economy.

A badly trained, badly educated workforce is a problem we will get to. But reduced, abnormally low capital investment, particularly in the US, is the current topic. My friend and economic consultant Andrew Smithers in London has a theory deserving much more attention in my opinion, and that is his concept of the “Bonus Culture”. 

When I was a young analyst, companies like International Paper and International Harvester would drive us all crazy, for just as the supply-demand situation was getting tight and fat profits seemed around the corner, they and their competitors would all build new plants and everyone would drown in excess capacity. The CEOs of these companies were all obsessed with market share and would throw capital spending at everything. It might not have been the correct way to maximise an individual company’s profit but it was great for jobs and growth. 

Now, in the bonus culture, new capacity is regarded with great suspicion. It tends to lower profitability in the near term and, occasionally these days, exposes the investing company to a raider. It is far safer to hold tight to the money and, when the stock needs a little push, buy some of your own stock back. This is going on today as I write, and on a big scale (approximately $500 billion this year). Do this enough, though, and we will begin to see disappointing top-line revenues and a slower growing general economy, such as we may be seeing right now.

Take a look at the chart, Capital punishment, which shows the long-term history of capital spending for the US (the savings and investment rate has a 25% correlation with long-run GDP growth). Mostly the data reflects a lower capital spending rate responding to slower growth. The circled area, though, suggests an abnormally depressed level of capital spending, which seems highly likely to be a depressant on future growth: obviously, you embed new technologies and new potential productivity more slowly if you have less new equipment. This currently reduced investment level appears to be about 4% below anything that can be explained by the decline in the growth trend. If this decline is proactive, if you will, and not a reflection of earlier declines in the growth rate, then, based on longer term correlations, it is likely to depress future growth by, conservatively, 0.2% a year. 

Capital punishment

Depressed level of capital spending is likely to deter future growth

Conclusion

With a little luck, US GDP growth should remain modestly positive, even out to 2030 and 2050, in the range of 1% at the high down to a few basis points at worst. Increasingly, the growth will be qualitative. Qualitatively, growth is likely to be limited to services as manufactured goods will bear the brunt of the rising input costs. It would certainly help a lot if considerable changes were made in how GDP is measured. It needs to be much closer to what we all think it is: a reasonable measure of the utility of useful goods and services.

The other developed countries will be very similar to the US in most respects but are likely to end up through 2050 with growth about 0.5% lower in population effects and, therefore, in total growth. That is to say, with growth at about zero, or even a little below.

Similar forces will serve to drive down global growth from 4.5% at its recent peak in 2006 and 2007 to around 3% by 2030 and between 2.0% and 2.5% by 2050, all on the assumption that nothing unexpectedly serious goes wrong on the resource, climate, and “all other bumps in the road” categories. All of the remaining growth will be in those developing economies that function effectively in the face of the resource and environmental squeeze. Sadly, there is likely to be an increasing number of failed or failing states.

The key issue will be how much unnecessary pain we inflict on ourselves by defending the status quo, mainly by denying the unpleasant parts of the puzzle and moving very slowly to address real problems. This, unfortunately, is our current mode. We need to move aggressively with capital — while we still have it — and brain power to completely re-tool energy, farming and resource efficiency. 

We need to do all of this to buy time for our global population to gracefully decline. It most certainly can be done.

Abridged version of GMO newsletter, November 2012

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