photo: Joshua Roberts/Reuters/Newscom
Structural Forces Weigh on Future U.S. Growth
July 12, 2016
- U.S. growth resilient, forecast at 2.2 percent this year, 2.5 percent in 2017
- Addressing long-term structural problems key to ensure continued solid growth
- U.S needs to lower public debt
While the U.S. economy is doing well, continued solid growth hinges on addressing long-term issues of falling labor force participation, weak productivity, rising income polarization, and high poverty rates, the IMF said in its annual review on the state of the U.S. economy.
According to the report, the U.S. economy has been resilient: 2.4 million new payroll jobs have been created over the past year; the unemployment rate has fallen to 4.9 percent, about half of its peak during the Great Recession; and inflation remains contained.
While the economy lost some momentum over the past year due to a strong dollar, a contraction in oil sector investment as oil prices tumbled, still weak external demand, and some episodes of global financial market distress, the IMF said that growth this year is projected to be 2.2 percent. Barring any major shocks, the U.S. economy is expected to bounce back to 2.5 percent by 2017.
The IMF said that near-term risks include uncertainties related to a strong dollar, which is taking a toll on exports, corporate investment and production, as well as weighing on overall inflation. Further dollar appreciation, particularly if driven by a divergence in the inflation outlooks between the United States and other systemically important economies (rather than by diverging growth prospects) would eat into growth and could create broader financial stability concerns, including in some emerging market economies. Other risks pertain to the path of oil prices and its effects on investment in the energy sector, which has sharply contracted.
Confluence of forces
Over a longer horizon, the United States faces a confluence of forces that will weigh on the prospects for continued gains in economic well being: lower labor force participation mainly due to a rising share of U.S. labor force that is shifting into retirement, scant gains in productivity, income and wealth distribution that are increasingly polarized, and high levels of poverty.
Reversing these trends will require efforts on multiple fronts to boost potential growth, which at below 2 percent is notably lower than before the Great Recession. Policies need to give incentives for work, raise productivity through investment in infrastructure and innovation, reverse income and wealth polarization trends, which have resulted in a shrinking middle class, and help low-income households to move into higher income brackets (see box).
Balancing structural needs with fiscal consolidation
The IMF report considers that near-term fiscal policies are generally adequate, but a credible medium-term deficit reduction plan is needed to prevent an unsustainable rise in the public debt. Such a plan would need to target a medium-term federal government primary surplus of about 1 percent of GDP, especially as demographic trends and rising interest rates will lead to larger deficits over the medium term.
Since many of the structural measures needed to boost potential growth will require additional fiscal resources, they should be funded from new revenues or a reallocation of spending priorities and fit within a fiscal path that ensures a steady decline in the public debt-to-GDP ratio.
Interest rate path
The U.S. Federal Reserve raised the policy interest rate in December for the first time in almost nine years. The IMF argues that future rate hikes should remain data dependent. Given some improvements in labor market data, there is now a clear case to proceed along a very gradual upward path for U.S. interest rates, conscious of global disinflationary trends and confirming along the way that wage and price inflation are indeed maintaining their steady upward momentum. Such an approach would be consistent with the Federal Reserve’s dual mandate of maximum employment and price stability.
Protecting the U.S. financial system
According to the report, the U.S. financial system is generally sound, and proved able to weather financial storms very well earlier this year. However, the United Sates will need to take concrete action to implement the range of improvements in the financial regulatory framework that were outlined in the 2015 Financial System Stability Assessment. Perhaps most pressing, though, is the need to oppose any wholesale or broad-based efforts to dilute some or all of the provisions of the Dodd-Frank Act (financial reform legislation passed in 2010 as a response to the 2008 financial crisis), which required greater bank supervision, with increased emphasis on banks’ capital planning, stress testing, and corporate governance.
Key U.S. priorities
The IMF recommends the following policy actions to alleviate long-running supply side issues:
• Increase state and federal infrastructure investment.
• Adopt comprehensive skills-based immigration reform.
• Expand the Earned Income Tax Credit combined with an increase in the federal minimum wage.
• Upgrade social programs for the nonworking poor.
• Deepen and improve family-friendly benefits including paid family leave and childcare assistance.
• Increase funding for training programs, vocational partnerships, and early childhood education. Raise the effectiveness of spending on science, technology, engineering and mathematics programs.
• Comprehensively reform the corporate income tax.
• Ratify the Trans Pacific Partnership, conclude a trade and investment treaty with Europe, and resist all forms of protectionism.