Pictet Group
US moves to shore up its economic leadership
Over the long run, growth is a function of capital and labour. Combined, they provide ‘total factor productivity’ (TFP). The TFP is used to measure productivity gains — which in practical terms means doing more with the same resources. The US is, thanks to top-notch universities, its entrepreneur-friendly institutions and its venture-capital ecosystem, still at the forefront of global innovation and we expect the US to remain so in the coming years. The 2021 United Nations Technology and Innovation Report is just one of many that places the US in the top spot in this regard, followed by Switzerland, the UK, Sweden and Singapore. We think innovation and a well-embedded entrepreneurial ecosystem should translate into healthy productivity growth in the US going forward.
There have been ups and downs in US productivity since the covid pandemic (see chart). The rush to adapt systems led to outsized gains in productivity in 2020, but these gains now look like normalising. The five-year average growth in US productivity is still a very respectable 1.8%. The outlook is hazy when itcomes to the labour input to TPF. Some international surveys suggest that the quality of education has stopped improving in the US, while demographics are also becoming more challenging. Population growth in the US has declined sharply since the 1990s, coming in at around 0.5% per annum, versus 1.3% in the early 1990s. Relatively high immigration has long given the US economy an extra edge over other countries. But immigration levels have fallen, due both to border closures during the pandemic and the stricter policies adopted by the administration of Donald Trump. The continuation of restrictive immigration policies could cloud the growth outlook as a lack of workers in critical sectors has often held back the US economy in the past.
Fiscal policy and an increasingly pro-active ‘industrial policy’ (a concept usually associated more with Europe) will also shape the outlook for the US in the coming 10 years. The administration of Joe Biden has become more involved in guiding the business sector though major tax incentives and some outright protectionist measures. The so-called ‘Inflation Reduction Act’(IRA), designed to spur the US’s energy transition, arguably combines the two. The IRA, voted into law in 2022, marks a crucial regime shift, with more active government involvement in the economy, especially when it comes to developing the industries of the future. The IRA is largely focused on green energies and electric vehicles as well as the surrounding ecosystem (such as batteries).
The IRA is also Biden’s response to new geopolitical realities, including China’s transformation into a global technological powerhouse. The US fears that China’s ascent could translate into geopolitical advantage or even lead to armed conflict. But the IRA could be a double-edged sword since it risks antagonising traditional allies, notably in Europe, who view it as a solo move by the Americans to promote their own domestic interests, even it that potentially means poaching innovative companies from outside the US. Further ramping-up oftension with China, the world’s second-largest economy could also hurt the US, which, at the end of the day, benefits from a strong and open global economy.
We expect inflation to be higher on average in the coming years than in the pre-covid years. In the 2022 edition of Horizon, we argued that the cost of the energy transition and of reorganising global supply chains would end up being passed on to US consumers. However, over the next two years at least, inflation could temporary abate due to the very proactive monetary tightening by the Federal Reserve (in fact the most aggressive tightening since the early 1980s). As some economists like Christina Romer have highlighted, it can take 12–18 months for monetary policy to fully impact the labour market and inflation. We think it is therefore key to differentiate between cyclical and structural strands in inflation. We think structural factors point to higher US inflation in the long run, with the headline consumer price index coming in at an annual average of 2.7% over the next 10 years.
We think we will remain in a fundamentally ‘soft money’ monetary regime.
The question then is what will be the long-run direction of US monetary policy if inflation is above previous long-term averages. We continue to think that the sharp rate tightening seen in 2022 will be the exception in a regime that we think fundamentally remains one characterised by ‘soft money’. A soft money regime is one in which creditgrowth (bank and nonbank) is promoted at the expense of savings, and usually involves interest rates staying below inflation. In other words, inflation-adjusted interest rates tend to be negative. We think this will remain the norm over the coming years and we do not expect the Federal Reserve to keep rates above long-term inflation.
Put differently, we do not think the current high interest rates (a Fed funds rate of 4.75–5.0% at end-March 2023) will be sustained. Our forecast is for the Fed funds rate to converge towards 2.5% over the next 10 years, compared to an average annual inflation rate of 2.7%. We think businesses could live with 2.7% inflation, although it will be important to distinguish between businesses able to pass on higher costs from those that aren’t. However, we recognise that the Fed could be less tolerant should inflation stay anchored above 4%.
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