Investors Face Slow Economic Growth Caused by Structural Factors

The investment environment in the U.S. for the next couple of years is going to be OK but not great.

Economic growth in the past quarter showed a 1.5% rate of change, year over year.

This is up from a 1.3% rate of growth in the second quarter of 2016, a 1.6% rate of growth in the first quarter and a 1.9% rate of growth in the last quarter of last year.

This trajectory parallels the growth path of industrial production.

Officials at the Federal Reserve have predicted that the rate of growth for the economy in 2016 will be 1.8% and that it will increase slightly to 2% in 2017 and 2018.

Not much bounce at all.

If there is not much bounce in the aggregate economy, there will not be much incentive for business capital investment, and there will not be much room for growth in corporate profits.

The push is on for more governmental stimulus, especially more spending from the federal government. The two major candidates are both in favor of more infrastructure spending on the part of Washington.

The basic problem, however, is not just a lack of aggregate demand on the part of government. There are some real structural problems in the economy, problems that must be looked into if we hope to experience faster economic growth.

What are the structural problems?

For one, capital utilization in the U.S. is only modestly above 75%. This doesn't seem to be a cyclical thing, especially since we are in the eighth year of the current economic recovery.

In the latter part of the 1970s, capital utilization in industry peaked around 87%.

The other thing is that the labor force participation rate is now around 63%. 

It seems that there is something structurally amiss in the economy when there are so many people and so much capital not being used, and seemingly, not even being considered a part of the capital structure.

If there is so much unused capital in the country, what incentive is there for businesses to invest in new equipment or in training the workforce?

If there is so much unused capital in the country, where are corporate profits coming from?

If there is so much unused capital in the country, it is no wonder that the growth of labor productivity is so low.

And, if the labor force participation rate is so low and if labor productivity growth is nonexistent, is it any surprise that economic growth is so mediocre?

This is a structural problem, a supply-side problem and not a demand problem.

But, where are the corporate profits coming from?

There is increasing research indicating that a larger part of corporate profits in many companies appear to be coming from the use of financial engineering.

The returns are not there from the production side, and so attention is given to how a corporation might produce good results from financial activity, trading, asset acquisition, mergers & acquisitions, and so on. In addition, to get a positive bump in the stock price, issuing debt at historically low interest rates can be used for stock buybacks and dividend increases.

Given the current economic environment and the current arguments of the politicians, it appears that this will be the world investors will be facing over the next year or so.

The important thing to see is that future economic policies aimed at pushing up aggregate demand are not going to resolve this situation.

The underlying problem is the found on the supply-side. This is a problem that has been created by 50 years or so of economic policy. Short-term fixes are not going to resolve the situation.

This is the foundation to the environment that investors will have to live with over the next few years.

This article is commentary by an independent contributor. 

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