
A New Game Plan for New U.S. Leadership in 2016: Things Need to Change
It is time for a new plan for United States economic policy.
The global environment is changing with the free-flow of capital throughout the world and with the rise of China as a major competitive force. These latter developments will require that the Federal Reserve focus more on the strength of the U.S. dollar in world markets. It will be seen that the support of a strong dollar will also provide the economic conditions for the building of a stronger work force.
The background: This week, the October figures for industrial production were released. Year-over-year, industrial production rose by 0.3%.
Starting with the fourth quarter of 2014 when the year-over-year rate of increase was 4.5%, the growth of industrial production has fallen to 3.5% in the first quarter and 1.4% and 0.9%, respectively, in the second and third quarters.
The growth of real GDP has followed a similar pattern. In the first quarter of 2015, GDP growth was 2.9% and fell to 2.7% in the second quarter and 2% in the third. Over the 25 quarters of the current recovery, the compound annual rate of growth of the US economy has been 2.3%. The latest projections of Federal Reserve officials is for median expected growth of 2.1% for 2015; 2.3% for 2016; 2.2% for 2017; and 2.0% for 2018.
Any way you look at this picture, economic growth is not going to be too robust.
Furthermore, there is little growth, if any, in labor productivity and the labor force participation rate is at its lowest level since the late 1970s, when more women were entering the labor force.
Capital utilization is as its lowest peak level since the early 1970s. Every peak in the business cycle achieves a peak in capacity utilization, but since coming in just below 90% in the 1973-to-1974 period, capacity utilization has fallen and during the current recovery now stands just under 78%.
Essentially, America's productive resources are not being used that well. What's going on?
The trouble begins with the effort of Washington, D.C., both Republicans and Democrats, to follow an economic policy that is founded upon simple Keynesian prescriptions. The basic thrust of these policy prescriptions is to pump up the aggregate demand of the economy when the economy is working at a level below where the politicians would like it to be.
Initially, the programs were to be implemented to offset a cyclical decline in the economy. However, as politicians tried to win more votes, efforts were made to apply fiscal stimulus on a continuous basis.
The use of the Phillips curve, representing the trade off in the economy between inflation and unemployment, was the empirical support for this approach. (We see that the Phillips curve, introduced to the world in 1958, is alive and well within the Federal Reserve as evidenced by the recent speech of Stanley Fischer, vice chairman of the Board of Governors of the Federal Reserve System.)
The immediate problems with these efforts are two-fold.
First, the fiscal effort to stimulate the economy and reduce unemployment carries a longer-run problem. Keynesian aggregate-demand stimulation is aimed at putting the unemployed back to work in the jobs they held before being laid off. Whereas this may be beneficial during the downturn of a business cycle, if applied continuously over a longer period of time, it tends to create a situation in which workers feel it is their right to keep doing what they have always been doing. Keeping up with innovation and change is not a part of their responsibility.
Over time, workers that do not keep up with changing technology and business structures can fall behind and become superfluous within the workforce. The growth of labor productivity suffers and the labor force participation rate falls, as we have seen it fall.
The same thing can happen with capital utilization. If economic policy is aimed at keeping the same labor force with the same skills employed in the same jobs with the same physical capital, businesses don't see a real need to invest in new and better plant and equipment. As a consequence, these businesses keep physical capital on the books longer than needed, hence, since the capital is not being used as intensively, the capacity utilization rate falls.
Second, in 1968, the economist Milton Friedman argued that the unemployment-inflation trade-off represented by the Phillips curve was only a short-term phenomena and over the longer-term efforts to keep unemployment at levels that were below the economy's "natural rate" would result in a change in inflationary expectations and cause a change in investor behavior.
By the early 1970s it became obvious that the inflationary expectations of investors was changing and investment activity was moving from productive enterprises to the purchase of assets and trading. This movement has just been well documented in the new book by Financial Times writer John Kay, Other People's Money.
The economist Irving Fisher wrote in the 1920s and 1930s about a similar change in the U.S. economy: The economy allocated more of the money and credit being created toward the financial circuit of the economy, and away from the industrial circuit.
That is, within such an environment, government efforts, both fiscal and monetary, to stimulate the economy would lose effectiveness because money would flow into trading and the purchase of assets and away from bank loans that resulted in real capital investment and the growth of productivity.
This behavior has been seen in the recent recovery, as corporations have borrowed money at very low interest rates to buy back their stock, pay dividends, and to acquire other companies. None of these activities creates new capital investment to spur on faster economic growth.
The United States needs to have its leaders consider economic policies built around efforts to reverse the dislocations described above. Unfortunately, these efforts are of a longer-term payoff than most politicians like, because they focus so much on getting re-elected. But, the myopic approach got us where we are now and will not turn the situation around.
First, the United States needs to reduce the creation of money and credit that create a situation in which investors believe that they can earn a greater return in trading and investing in financial assets than from investing in physical capital.
Second, the United States needs to build programs in life-time education and training that continue to update and upgrade the knowledge and skills of population. One has only to look at the unemployment statistics and the labor force numbers to observe how important education is and how important the community culture that supports education is for success on this front.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.








