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On the Road to Zero Growth
GMO
By Jeremy Grantham
November 20, 2012


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Summary

  • The U.S. GDP growth rate that we have become accustomed to for over a hundred years – in excess of 3% a year – is not just hiding behind temporary setbacks. It is gone forever. Yet most business people (and the Fed) assume that economic growth will recover to its old rates.
  • Going forward, GDP growth (conventionally measured) for the U.S. is likely to be about only 1.4% a year, and adjusted growth about 0.9%.
  • Productivity in manufacturing has been high and is expected to stay high, but manufacturing is now only 9% of the U.S. economy, down from 24% in 1900 and 15% in 1990. It is on its way to only 5% by 2040 or so. There is a limit as to how much this small segment can add to total productivity.
  • Growth in service productivity in contrast is low and declining. Total productivity is calculated to be just 1.3% through 2030, if we use current accounting methods.
  • However, current accounting cannot accurately handle rising resource costs. Spending $150-$200 a barrel in offshore Brazil in the future to deliver the same barrel of oil that cost the Saudis $10 will result perversely in a huge increase in (Brazilian) GDP. In reality, rising resource costs should be counted as a squeeze on the balance of the economy, as they lower our total utility.
  • Measuring the non-resource balance of the economy produces the correct effect. The share of resource costs rose by an astonishing 4% of total GDP between 2002 and today. It thus reduced the growth of the nonresource part of GDP by fully 0.4% a year.
  • Resource costs have been rising, conservatively, at 7% a year since 2000. If this is maintained in a world growing at under 4% and a developed world at under 1.5% it is easy to see how the squeeze will intensify.
  • The price rise might even accelerate as cheap resources diminish. If resources increase their costs at 9% a year, the U.S. will reach a point where all of the growth generated by the economy is used up in simply obtaining enough resources to run the system. It would take just 11 years before the economic system would be in reverse! If, on the other hand, our resource productivity increases, or demand slows, cost increases may decelerate to 5% a year, giving us 31 years to get our act together. Of course, with extraordinary, innovative breakthroughs we might do even better, but we certainly shouldn’t count on that. (Bear in mind that we don’t even know precisely why the prices started to rise so sharply in 2000.) Excessive optimism and doing little could be extremely dangerous.
  • For a few years fracking will add helpfully to growth: my guess is that the benefit will peak at about 0.5% within five years, but be modest over longer periods. The key concept here for understanding growth is to know when the maximum upward push will occur. (See Appendix A.)
  • Increasing climate damage, reflected mainly in food prices and flood damage, is going to increase. With any luck this will not be severe before 2030 (we allow for a 0.1% setback) but it is very likely to accelerate between 2030 and 2050. A great deal will depend on our responses.
  • The bottom line for U.S. real growth, according to our forecast, is 0.9% a year through 2030, decreasing to 0.4% from 2030 to 2050 (see table on Page 16). This is all done presuming no unexpected disasters, but also no heroics, just normal “muddling through.”
  • GDP measures must be improved so that they begin to measure output of real usefulness or utility. The current mish-mash of costs and of “goods” and “bads” produces poor and even damaging incentives.
  • Accurate measurements of growth must eventually include the full costs of running down our natural assets. True income (said Hicks) is meant to allow for sustained productive capacity, which our current measures clearly do not. If they had done so the developed countries might well have been in reverse for the last 20 years.
  • Investors should be wary of a Fed whose policy is premised on the idea that 3% growth for the U.S. is normal. Remember, it is led by a guy who couldn’t see a 1-in-1200-year housing bubble! Keeping rates down until productivity surges above its last 30-year average or until American fertility rates leap upwards could be a very long wait!
  • Some of the investment implications of this low growth outlook and the Bernanke optimism will be addressed next time (with luck!).

 

Introduction: Wishful Thinking


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 tech 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 and important drop in long-term U.S. 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 U.S. 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, the slowest GDP growth and job creation yet recorded. This was despite the creation of a housing bubble, a difficult thing to achieve in a famously diversified U.S. housing market. The bubble led directly to the building of at least two million extra houses, employing an extra three to four 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 everything else, loosely described as “productivity.” Here, we’ll start by looking at population effects.


Effect of Demographics on Past and Future Growth


Demographics can get boring in a hurry so here are the bare bones. Exhibit 1 shows the recent rapid decline in the growth of working age population. Part of the future squeeze comes from the aging of the population. Exhibit 2 shows one of the simpler effects – hours worked per worker. It really 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 U.S. even after 1970, despite there being no further gains at all 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 at over 7 hours a year. Lucky them. (From 1950 this effect has reduced potential growth in the U.S. by 0.17% a year and in the balance of the O.E.C.D. [not shown] by over twice that at 0.4%).


Exhibit 3 shows the one very substantial positive in the U.S. to the total hours worked picture: the dramatic increase in the participation rate 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 last 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 profi le and social trends, which, like birth rates, change very slowly. The only variable that is quite likely to jump around unpredictably is the U.S. immigration policy.

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(c) GMO

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