No quick fix for US potential GDP growth
- Output and labour gap to close faster than Fed thinks
31 March 2016
Signe Roed-Frederiksen
Senior Analyst
+45 45 12 82 29
[email protected]
Danske Bank Markets
Kristian Olsen
Assistant Analyst
[email protected]
Danske Bank Markets
Investment Research
www.danskebank.com/CI
Important disclosures and certifications are contained from page 35 of this report
Low productivity and labour force growth set to keep
potential GDP down
• The classic determinants of potential GDP growth are (a) labour productivity
growth and (b) growth in hours worked.
• We expect demographic developments to keep the trend in hours worked
subdued for many years. Short term, a cyclical rebound in the labour force is
possible.
• Labour productivity growth has been extremely low over the past five years. Our
analysis suggests the slow trend is likely to continue.
• Conflicting implications for the Fed and markets depending on the time horizon
considered: a faster near-term ascent of the fed funds rate but to a lower level.
• Near term, slow productivity growth should allow for significant further
progress in the labour market, including a further reduction in labour market
slack and accelerating wages.
• Longer term, a continuation of recent slow productivity growth would depress
potential GDP growth and is likely to mean a lower terminal fed funds rate.
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US potential GDP has been hit by both slowing labour force
growth and surprisingly weak labour productivity growth
Source: BEA, BLS, Danske Bank Markets
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No quick fix for labour productivity growth
– significant slowdown began before the ‘great recession’
US labour productivity growth
• The slide in US labour productivity
US labour productivity growth
growth started well ahead of ‘the
great recession’.
• There is little evidence that the
repercussions of the recession itself
are behind the slowdown.
• This suggests to us that the current
productivity slowdown is not a
cyclical or temporary phenomenon.
Particularly weak over
past four years
Source: BLS, Danske Bank Markets
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Productivity slowdown is broad based across sectors
– a general challenge for longer term growth
Productivity by industry
Avg. % ch. y/y AR
1997-2004
3.7
2005-2014
0.3
Manufacturing
7.3
2.2
-5.1
Wholesale Trade
5.3
0.5
-4.8
Utilities
2.3
-0.5
-2.7
Retail Trade
2.9
0.6
-2.2
Arts, Entertainment, Recreation, Accommodation & Food Services
1.4
-0.6
-2.1
Professional & Business Services
1.9
0.2
-1.6
Information
5.7
4.4
-1.3
Transportation & Warehousing
1.2
0.0
-1.3
-0.3
-1.6
-1.2
2.5
1.5
-1.0
-0.9
-1.3
-0.3
Educational Services, Health Care & Social Assistance
0.2
0.0
-0.2
Mining
0.7
1.3
0.5
Total Private
Construction
Finance, Insurance, Real Estate, Rental & Leasing
Other Services
Change
-3.3
Source: BEA, Census, BLS, Danske Bank Markets
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Three distinct periods for labour productivity over the past 30 years
– the 1990’s IT boom in productivity was an outlier
%-point, annual growth rates
3.5
3.0
TFP
Capital intensity
Labor quality
2.5
2.0
1.5
1.0
0.5
0.0
1987-1995
1995-2004
2004-2014*
* 2014 numbers are preliminary, private business sector
Source: BLS, Danske Bank Markets
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Contributions to labour productivity growth
– less support from capital intensity and TFP behind recent slowdown
%-point,
5
4
3
2
1
0
-1
TFP
Capital intensity
Labor quality
-2
1988
1992
1996
2000
2004
2008
2012
Source: BLS, Danske Bank Markets
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POTENTIAL GDP OUTLOOK:
Low for long
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Potential GDP from a growth accounting framework
• Growth accounting sums up the way inputs in the economy are
transformed to output. We use four inputs.
I. Capital deepening: the amount of capital available to workers, both physical capital such
as machines and intangible capital such as software and R&D.
II. Labour quality: the quality of the labour input.
III. Total factor productivity: a residual, the part of GDP growth that cannot be explained by
labour quality, capital deepening or hours worked – the most important swing factor for
future potential GDP growth.
IV. Hours worked: labour supply in terms of raw hours worked.
• We add this to a standard Cobb-Douglas production function to reach
our estimate for potential GDP growth.
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GDP and labour productivity
With a standard Cobb-Douglas production function, output is defined as follows.
𝑌𝑡 = 𝐴𝑡 𝐾𝑡 𝛼 𝐿𝑡 1−𝛼
Dividing by hours worked and log differentiating gives us a measure of labour
productivity growth.
𝑌𝑡 − 𝐻𝑡 = 𝛼 𝐾𝑡 − 𝐻𝑡 + 1 − 𝛼 𝐿𝑡 − 𝐻𝑡 + 𝑇𝐹𝑃𝑡
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Potential GDP growth and labour productivity growth
Potential GDP growth can be defined as follows.
𝑌𝑡 = 𝛼 𝐾𝑡 − 𝐻𝑡 + 1 − 𝛼 𝐿𝑡 − 𝐻𝑡 + 𝑇𝐹𝑃𝑡 +𝐻𝑡
(K-H): capital
deepening
- Capital services per
hour worked
- Investments
- Depreciation
(L-H): labour quality
TFP: total factor
productivity
H: potential hours
worked (simple sum)
- Labour input beyond
hours worked
- Education
- Shift in employment
between sectors
-
- Innovation
- Utilisation rate
(labour effort and
capital work week)
- Population age
- Population growth
- Labour force
participation
- Average work week
Source: Danske Bank Markets
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1. Capital deepening
𝑌𝑡 = 𝛼 𝐾𝑡 − 𝐻𝑡 + 1 − 𝛼 𝐿𝑡 − 𝐻𝑡 + 𝑇𝐹𝑃𝑡 +𝐻𝑡
(K-H): capital
deepening
- Capital services per
hour worked
- Investments
- Depreciation
(L-H): Labour quality
TFP: Total factor
productivity
H: Potential hours
worked (simple sum)
- Labour input beyond
hours worked
- Education
-Shift in employment
between sectors
- Innovation
-Utilisation rate
(labour effort and
capital workweek)
-Population age
-Population growth
-Labour force
participation
- Average workweek
Source: Danske Bank Markets
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Capital deepening has been a headwind for labour productivity
over the past four years…
• We can break capital services into
four components following the
specification from BLS.
IT investments and ‘all other’ have been the key
reasons for the ups and downs in capital intensity
3.5
%-point
3.0
All Other
a. Information capital (IT)*.
2.5
b. Research and development (R&D).
2.0
c. All other intellectual property products
(IPP)**.
d. All other capital services (all other)***.
IT
IPP
R&D
1.5
1.0
0.5
0.0
-0.5
-1.0
1988
1992
1996
2000
2004
2008
2012
Source: BLS, Danske Bank Markets
* Computers, communication and other information processing equipment
** Software and artistic originals
*** Structures, residential rental capital, inventories, land and all other equipment
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…as investment in capital has slowed significantly,
particularly in high tech
Overall non-residential investment growth has been very
slow over the past four years…
…and the slowdown has been particularly strong in hightech (IT) investments, which is the most important
contributor to productivity growth
Source: BEA, Danske Bank Markets
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The composition of investments matters
• Capital is not just capital – the capital service
flow of one USD of investment differs across
asset types and it is the service flow that affects
productivity.
• Think of a light bulb – the bulb is the capital
asset, while the light it delivers is the capital
service flow.
• An asset with low service life years generates a
larger flow of capital services per year than a
capital good with high service life years.
• In general, high-tech investments generate a
large capital service flow per USD invested,
compared with other capital goods.
• However, the recent substitution within IT
investments of computers (five-year service life)
with communications equipment (13-year
service life) lowers the capital service flow from
IT investments and thereby potential labour
productivity.
Type of asset
Service life years
Computers
5
Trucks
12
Communications equipment
13
Construction machinery
13
Boats
33
Railroad equipment
35
Structures
56
Source: BEA, Danske Bank Markets
40 %
Total IT ex. communications
30
Communications
20
10
0
-10
-20
-30
-40
-50
2001
2003
2005
2007
2009
2011
2013
2015
Source: BEA, Danske Bank Markets
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Capital deepening
– only limited support for productivity growth in coming years
• Slow non-residential investment
%-point, annual growth rates
growth, in particular in hightech/IT, suggests the gain in
productivity growth from capital
deepening will be very limited in
coming years.
• We take an optimistic approach
and expect the trend to improve
from the very weak performance of
the past four years.
• The risk to this forecast is on the
downside, as a pickup in ITintensive investments remains to
be seen.
1.4
1.2
Capital intensity
1.0
0.8
0.6
0.4
0.2
0.0
1987-1995
1995-2004
2004-2014*
Danske trend
forecast
* 2014 numbers are preliminary, private business sector
Source: BLS, Danske Bank Markets
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2. Labour quality
𝑌𝑡 = 𝛼 𝐾𝑡 − 𝐻𝑡 + 1 − 𝛼 𝐿𝑡 − 𝐻𝑡 + 𝑇𝐹𝑃𝑡 +𝐻𝑡
(K-H): Capital
deepening
- Capital services per
hour worked
- Investments
- Depreciation
(L-H): labour quality
TFP: Total factor
productivity
H: Potential hours
worked (simple sum)
- Labour input beyond
hours worked
- Education
- Shift in employment
between sectors
- Innovation
-Utilisation rate
(labour effort and
capital workweek)
-Population age
-Population growth
-Labour force
participation
- Average workweek
Source: Danske Bank Markets
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Labour quality unlikely to be a big swing factor
The contribution to labour productivity by labour quality
has been small and relatively stable
%-point,
1.00
We expect a continuation of the recent trend
%-point, annual growth rates
Labor quality
0.5
0.4
Labor quality
0.80
Labor quality
0.4
0.3
0.60
0.3
0.40
0.2
0.2
0.20
0.1
0.00
0.1
Labor quality
0.0
-0.20
1988
1992
1996
2000
2004
* 2014 numbers are preliminary, private business sector
Source: BLS, Danske Bank Markets
2008
2012
1987-1995
1995-2004
2004-2014*
Danske trend
forecast
* 2014 numbers are preliminary, private business sector
Source: BLS, Danske Bank Markets
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3. Total factor productivity
𝑌𝑡 = 𝛼 𝐾𝑡 − 𝐻𝑡 + 1 − 𝛼 𝐿𝑡 − 𝐻𝑡 + 𝑇𝐹𝑃𝑡 +𝐻𝑡
(K-H): Capital
deepening
- Capital services per
hour worked
- Investments
- Depreciation
(L-H): Labour quality
TFP: total factor
productivity
H: Potential hours
worked (simple sum)
- Labour input beyond
hours worked
- Education
-Shift in employment
between sectors
- Innovation
- Utilisation rate
(labour effort and
capital work week)
-Population age
-Population growth
-Labour force
participation
- Average workweek
Source: Danske Bank Markets
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Total factor productivity
• TFP growth measures the growth in
TFP growth
output in excess of the increase in labour
and capital inputs.
4.00
• TFP is a residual contribution and can be
1.00
• The IT-producing and IT-intensive sectors
have been by far the largest contributors
to TFP growth historically.
• TFP tends to fluctuate with GDP in the
short run due to the 'utilisation rate' – high
demand means more intense use of
capital and labour.
3.00
2.00
0.00
-1.00
-2.00
-3.00
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
seen as a measure of innovation growth.
Utilisation adjusted TFP growth
Source: Fernald (2014), Federal Reserve Bank of San Francisco
Sector contribution to TFP growth
Bubble sectors
2.50
Non IT-intensive
IT-intensive
IT-producing
%-point, annual growth rates
2.00
1.50
1.00
0.50
0.00
-0.50
-1.00
1987-95
1995-00
2000-04
2004-07
2007-11
Source: Fernald (2014), Federal Reserve Bank of San Francisco
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Prospects of TFP growth
• Private R&D spending has grown
rapidly in recent years, though
concentrated in the manufacturing
sector in particular pharma and
electronics.
• This leaves some hope that
innovation will add to productivity
growth ahead.
• We look for TFP to stay around the
trend for the past 10 years.
Source: BEA
2.0 %-point, annual growth rates
TFP
1.8
1.6
TFP
1.4
1.2
1.0
0.8
0.6
0.4
0.2
0.0
1987-1995
1995-2004
2004-2014*
Danske trend
forecast
* 2014 numbers are preliminary, private business sector
Source: BEA, BLS, Danske Bank Markets
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Summing up
– labour productivity growth likely to increase only modestly
We expect private business sector labour productivity growth to increase from the subdued 0.6% over the past four
years to 1.4% over coming years
%-point, annual growth rates
3.5
TFP
3.0
Capital intensity
2.5
Labor quality
2.0
1.5
1.0
0.5
0.0
1987-1995
1995-2004
2004-2014*
Danske trend
forecast
* 2014 numbers are preliminary, private business sector
Source: BLS, Danske Bank Markets (both charts)
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4. Potential hours worked
𝑌𝑡 = 𝛼 𝐾𝑡 − 𝐻𝑡 + 1 − 𝛼 𝐿𝑡 − 𝐻𝑡 + 𝑇𝐹𝑃𝑡 +𝐻𝑡
(K-H): Capital
deepening
- Capital services per
hour worked
- Investments
- Depreciation
(L-H): Labour quality
TFP: Total factor
productivity
H: potential hours
worked (simple sum)
- Labour input beyond
hours worked
- Education
-Shift in employment
between sectors
- Innovation
-Utilisation rate
(labour effort and
capital workweek)
- Population age
- Population growth
- Labour force
participation
- Average work week
Source: Danske Bank Markets
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Potential hours worked
Not much to gain on the average work week
Growth has to come from an increase in the labour force
Source: BLS, Danske Bank Markets
Source: BLS, Danske Bank Markets
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Any rebound in labour force growth is likely to be temporary
Population growth is trending lower…
Source: BLS, Danske Bank Markets
…and so is the participation rate
Source: BLS, Danske Bank Markets
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A small cyclical rebound but aging population continues to put
downward pressure on the participation rate
The bulk of the decline in the US labour force participation
rate is caused by aging of the population
The participation rate falls significantly around
retirement age
90
80
%
70
60
50
40
30
20
10
0
16-24 25-34 35-44 45-54 55-64 65-69 70-74
Source: BLS, Council of Economic Advisers (CEA), Danske Bank Markets
75+
Source: BLS, Danske Bank Markets
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Short-term rebound in the labour force but aging effect dominates
• We forecast a modest cyclical rebound in
the labour participation rate as
discouraged workers return to the labour
force along with a tighter labour market.
• Demographic trend remains a headwind.
An aging population should keep overall
growth in the labour force subdued.
• We estimate that US labour force growth
Source: BLS, Danske Bank Markets
will slow from 1.2% to 0.7% per year on
average over the next 10 years.
• With labour productivity growth set to
move only gradually higher, potential GDP
growth is likely to stay below the
estimated long-term trend of 1.8% for the
next two years at least.
Source: BLS, Danske Bank Markets
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Summing it all up
Source
Source: Fernald, CBO, IMF, FOMC, OECD, Danske Bank Markets
Private business
sector:
Projected potential GDP growth
Fernald (2014)
2.10%
CBO (2015)
2.20%
IMF (July 2015)
2.10%
FOMC (Dec 2015)
2.00%
OECD (2014)
2.40%
Gordon (2014)
1.60%
Danske Bank Markets
1.80%
Source: Fernald, CBO, IMF, FOMC, OECD, Danske Bank Markets
𝑌𝑡 = 𝛼 𝐾𝑡 − 𝐻𝑡 + 1 − 𝛼 𝐿𝑡 − 𝐻𝑡 + 𝑇𝐹𝑃𝑡 +𝐻𝑡
1.4%
= 2.1%
0.7%
Non-business sector potential output: CBO estimates 0.85%
Total potential GDP growth: 0.76*2.1%+0.24*0.85% = 1.8%
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FED IMPLICATIONS:
Gaps will close fast
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Output gap set to close next year
US output gap
US real potential GDP growth and Danske forecast
Source: CBO, IMF, OECD, Danske Bank Markets
Source: CBO, IMF, OECD, Danske Bank Markets
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Slow labour productivity growth set to support employment
Labour productivity to stay subdued as capital deepening
and TFP are held back by slow investments
Given our GDP forecast private payrolls should grow by on
average just below 200,000 per month in coming year
Source: CBO, BLS , BEA, Danske Bank Markets
Source: CBO, BLS , BEA, Danske Bank Markets
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Unemployment set to fall faster than Fed thinks
We expect the unemployment rate to fall further below
NAIRU this year
Our GDP forecast is not far from that of the FOMC
Source: Federal Reserve, Danske Bank Markets
Source: Federal Reserve, Danske Bank Markets
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Wage inflation set to pick up as unemployment reaches
NAIRU
As the labour market continues to tighten we expect to
see higher wage inflation
Our wage indicator suggests a continued upward trend
Source: BLS, Census Bureau, BEA, Danske Bank Markets
Source: BLS, Census Bureau, BEA, Danske Bank Markets
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Market pricing of Fed funds rate path too low
• Current market pricing is consistent with
less than two fed funds rate hikes by the
end of 2017.
• In our base case for GDP growth, the
output gap will be closed next year and the
labour market will become increasingly
tight.
Hikes each year
(bp)
Danske Bank
expectations
Rest of 2016
2017
2018
Market
pricing
25
75
100
17
17
22
Implied
hiking pace
from FOMC
dots
50
100
100
Source: Federal Reserve, Bloomberg, Danske Bank Markets
• Even though we expect the Fed to deliver
only one additional rate hike this year (in
September), we look for a faster pace of
rate hikes in 2017 as wage and price
pressures intensify.
• Thus, we thus believe the market will need
to adjust the fed funds rate path for 2017
higher and the Fed will be surprised by the
lack of slack in the economy.
1.30%
1.10%
0.90%
0.70%
0.50%
0.30%
Mar15
May15
Jul15
Aug15
SWAP 1Y 1Y USDOIS
Oct15
Dec15
Jan16
Mar16
Current live price
Source: Bloomberg, Danske Bank Markets
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Disclosures
This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S (‘Danske Bank’). The author of the research report is Signe RoedFrederiksen, Senior Analyst.
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