The Outlook for the U.S. Economy and the Policies of the New President

The Outlook for the U.S. Economy and the Policies of the New President Jason Furman Senior Fellow, PIIE SNS/SHOF Finance Panel Stockholm June 12, 2017 Peterson Institute for International Economics 1750 Massachusetts Ave., NW Washington, DC 20036

Outline 1. The short-run outlook 2. The prospects for long-run growth 3. The challenges of inequality and labor force participation 4. President Trump s policy agenda

Measures of Labor Underutilization Have Recovered 16 Alternative Measures of Labor Underutilization Percent 18 May -17 14 12 10 U-6 (Underemployment) Rate 8 6 4 2 Unemployment Rate Discouraged and Other Marginally Attached Involuntary Part-Time 0 2000 2003 2006 2009 2012 2015 Note: Dashed lines indicate averages from December 2001 to December 2007. Shading denotes recession. Source: Bureau of Labor Statistics, Current Population Survey; author s calculations.

The Quits Rate is Above Its Pre-Recession Average, While Openings Are Tied for A Record High 4.0 Quits and Job Openings Rates Percent of Total Nonfarm Employment 4.5 Apr-17 3.5 3.0 Job Openings Rate 2.5 2.0 1.5 Quits Rate Pre-Recession Average 1.0 2001 2003 2005 2007 2009 2011 2013 2015 2017 Note: Dashed lines indicate averages from December 2001 to December 2007. Shading denotes recession. Source: Bureau of Labor Statistics, Job Openings and Labor Turnover Survey; author s calculations.

Inflation Has Generally Been Below the Federal Reserve s 2-Percent Target Personal Consumption Expenditures Price Inflation Twelve-Month Percent Change 5 Apr-17 4 3 2 PCE Federal Reserve Target 1 0 Core PCE -1-2 2000 2002 2004 2006 2008 2010 2012 2014 2016 Note: Shading denotes recession. Source: Bureau of Economic Analysis, National Income and Product Accounts; Federal Reserve; author s calculations.

Compensation Growth Has Been More Mixed Goldman Sachs Wage Tracker (Nominal) Four Quarter Percent Change 6 2017:Q1 5 4 3 2 1 0 2000 2002 2004 2006 2008 2010 2012 2014 2016 Note: Shading denotes recession. Source: Goldman Sachs; author's calculations.

But Real Compensation About What Would Be Expected in a Low Productivity World 5 4 3 2 1 0-1 -2 Productivity Growth and Goldman Sachs Wage Tracker (Real) Four Quarter Percent Change 7 Nonfarm 6 Business Productivity Average: 2001 Cycle Average 2001 Cycle Wage Tracker Average: 2007 Cycle Average: 2007 Cycle 2017:Q1-3 2000 2002 2004 2006 2008 2010 2012 2014 2016 Note: Shading denotes recession. Compensation adjusted for inflation using the CPI-U price index. Source: Goldman Sachs; Bureau of Labor Statistics; author's calculations.

Gaps Have Closed In the United States Percent of Potential GDP 1 Output Gap 2017 0-1 -2 United States -3-4 2010 2011 2012 2013 2014 2015 2016 2017 Source: International Monetary Fund, World Economic Outlook.

Going Forward Growth Will Primarily Come from Potential Percent 3.5 3.0 Real GDP Growth: Actual vs. Potential Cyclical Potential 2.5 2.0 1.5 1.0 0.5 0.0-0.5-1.0 2013 2014 2015 2016 Note: Potential GDP growth is the intercept of an Okun s law regression using four-quarter changes in real GDP and the employment-population ratio from 2007:Q1 to 2016:Q4. All growth rates are Q4/Q4 for the year shown. Source: Bureau of Economic Analysis, National Income and Product Accounts; Bureau of Labor Statistics, Current Population Survey; author s calculations.

Measures of Optimism Have Remained Strong Even While Financial Markets Appear to No Longer Be Expecting Stimulus Index 140 120 100 80 60 40 20 Consumer and Business Confidence Consumer Confidence Small Business Optimism Business Roundtable CEO Economic Outlook U.S. Election May-17 Housing Market Index Percent Index, Jan 1997 = 100 3.0 130 2.5 2.0 1.5 1.0 0.5 Government Bond Yields and Exchange Rates 10-year Treasury Yield (Left Axis) Trade- Weighted U.S. Dollar (Right Axis) U.S. Election Jun-17 125 120 115 0 Jan 2016 Apr 2016 Jul 2016 Oct 2016 Jan 2017 Apr 2017 0.0 Jan 2016 Apr 2016 Jul 2016 Oct 2016 Jan 2017 Apr 2017 110 Source: Conference Board; National Federation of Independent Business; National Association of Home Builders; Business Roundtable; Board of Governors of the Federal Reserve System; author s calculations.

The Demographic Headwind to Future Growth Prime-Age (25-54) Population Growth, 1955-2026 Percent Change, Annual Rate (Ten-Year Trailing Average) 2.5 2.0 1.5 1.0 0.5 0.0-0.5 1955 1965 1975 1985 1995 2005 2015 2025 Source: Social Security Administration; author s calculations.

The Worldwide Productivity Slowdown is Not Helping, Either 2.5 2.0 1.5 1.0 0.5 0.0 Labor Productivity Growth, G-7 Countries Percent, Annual Rate 3.0 1996-2006 2006-2016 -0.5 United States Japan Canada Germany France United Kingdom Italy Source: Conference Board, Total Economy Database; author s calculations.

The Base Case for Potential Growth No. of Years: 54 10 CBO: Selected Components of Potential Real GDP Growth, 1953-2026 Growth Rate, Percentage Component Points at Annual Rate History Forecast 1953 to 2007 2016 to 2026 Population 1.4 0.8 Potential labor force participation rate 0.2-0.4 Potential real output per hour (productivity) 2.1 1.7 Other -0.5-0.3 Potential real GDP 3.3 1.8 Source: Congressional Budget Office; author s calculations.

Alternative Scenarios For U.S. Potential Growth Median: 1.8% 5 th Percentile: 0.7% 95 th Percentile: 3.0% Source: Bureau of Labor Statistics; Congressional Budget Office; author s calculations.

Top 1% Share Has Risen Further and Faster in the United States Share of Income Earned by Top 1 Percent, 1975-2015 Percent 28 24 20 Canada Germany Japan United Kingdom France Italy Sweden United States 2015 16 12 8 4 0 1975 1980 1985 1990 1995 2000 2005 2010 2015 Source: World Wealth and Income Database; author's calculations.

Taxes and Transfers Have Played a Bigger Role In Reducing Top 1% Inequality in the United States Source: Congressional Budget Office (2016); CEA calculations.

Inequality Compounded by Continued Decline in Labor Force Participation for Prime Age Workers 98 Prime-Age Male Labor Force Participation Rate Percent 100 May -17 Prime-Age Female Labor Force Participation Rate Percent 100 90 May -17 96 1948-2007 Trend 80 94 92 90 70 60 50 1948-2007 Trend 2000-2007 Trend 88 40 86 1950 1960 1970 1980 1990 2000 2010 30 1950 1960 1970 1980 1990 2000 2010 Source: Bureau of Labor Statistics, Current Population Survey; author s calculations.

Italy United States Estonia Turkey Denmark Korea Finland Norway France United Kingdom Australia Belgium Portugal Canada Japan Ireland Israel Spain Sweden Netherlands Greece New Zealand Luxembourg Germany Estonia Denmark Finland Sweden United States Turkey Norway Canada United Kingdom Australia New Zealand France Japan Korea Italy Israel Portugal Germany Belgium Netherlands Greece Ireland Luxembourg Spain The Decline Has Been Larger than Almost Any Other OECD Country Change in Labor Force Participation Rates Across the OECD, 1990-2015 Percentage Point Change 4 2 0-2 -4-6 Prime-Age Male Percentage Point Change 40 30 20 10 0 Prime-Age Female -8-10 Source: Organisation for Economic Co-operation and Development; author s calculations

Israel Italy United States Norway Finland Ireland Belgium Australia Turkey Poland Latvia Denmark Canada Korea Austria Portugal United Kingdom Chile Hungary Netherlands New Zealand Estonia France Germany Spain Slovenia Greece Sweden Slovak Republic Iceland Luxembourg Mexico Czech Republic Japan Switzerland Turkey Korea Italy Ireland United States Japan Australia Greece Israel New Zealand United Kingdom Belgium Latvia Luxembourg Canada Spain Netherlands Germany Estonia France Denmark Finland Norway Poland Slovak Republic Portugal Slovenia Austria Hungary Chile Sweden Mexico Iceland Czech Republic Switzerland Putting the United States Toward the Bottom of the OECD in Prime Age Labor Force Participation Percent 100 80 60 40 20 Labor Force Participation Rates Across the OECD, 2015 Prime-Age Male Percent 100 80 60 40 20 Prime-Age Female 0 0 Source: Organisation for Economic Co-operation and Development.

Slower Productivity, Rising Inequality, and Declining Participation Have Combined to Slow Median Income Growth Real Median Family Income, 1948-2015 2015 Dollars (Log Scale) 100,000 1948-1973: 3.0%/yr 1973-2015: 0.4%/yr 50,000 25,000 1948 1958 1968 1978 1988 1998 2008 Source: Census Bureau; author's calculations.

The Policy Agenda 1. Fiscal Policy a) Tax Policy b) Infrastructure c) Other fiscal changes d) Fiscal trajectory 2. Regulation 3. Immigration 4. Trade 5. International Cooperation

Tax Policy Tax cuts or tax reform?

Tax Policy Current Law President s Principles House Republicans Corporate Rate 35% 15% 20% Expensing / No interest Deduction Border Adjustment Top Individual Rate 39.6% 35% 33% Broader Base Some More Cost ~$5.5 trillion Goal is $0 Share Top 1% ~33%+ 99%

Deficit-Increasing Tax Cuts Could Hurt Long-Run Growth Change in Real GDP Under Trump Campaign Tax Plan Percent Change from Baseline 2 2040 0-2 -4-6 -8 2015 2020 2025 2030 2035 2040 Note: Based on medium elasticities scenario. Source: Nunns et al. (2016); author's calculations.

Infrastructure Proposal: Short-run Increases Followed By Long-term Reductions President's FY 2018 Budget: Change in Infrastructure Spending Relative to Baseline by Fiscal Year Billions of Dollars 50 40 30 20 10 0-10 -20-30 2027 Source: Office of Management and Budget (2017).

Other Budget Policies 8 percent increase in defense spending in FY 2018 13 percent decrease in non-defense spending in FY 2018 11 percent cut in National Science Foundation 22 percent cut to the National Institutes of Health, including 19 percent cut for cancer research 23 percent cut in financial aid for college 34 percent cut to training and employment programs $2.5 trillion decrease to low- and moderate-income programs over ten years, 15 percent reduction Repeal/replace of the Affordable Care Act including health reductions to pay for high-income tax cuts

Overall Fiscal Outlook Under Current Law and the President s Policies Federal Deficit as a Percent of GDP, FY 2017 - FY 2027 Percent of GDP 6 FY 2027 5 4 CBO Baseline + President's FY 2018 Budget + President's Tax Plan CBO Baseline 3 2 1 CBO Baseline + President's FY 2018 Budget 0 2017 2019 2021 2023 2025 2027 Source: Congressional Budget Office; Office of Management and Budget; Tax Policy Center; Committee for a Responsible Federal Budget; author's calculations.

Regulation The Trump Administration has expressed interest in reducing regulation across a number of sectors: e.g. banking, health care, energy markets, labor markets Effects of deregulation on growth are likely to be small One estimate is that full repeal of Dodd-Frank would add 0.06 p.p. to annual growth rate (Holtz-Eakin 2015) effects of partial repeal are smaller Growth effects of deregulation also limited because of less control over State and local regulation In most likely case, deregulation could add at most 0.1 p.p. to growth rate

Immigration Restrictions on legal immigration and increased uncertainty for unauthorized immigrants would harm growth: RAISE Act (Sens. Cotton and Purdue) would cut legal immigration in half after a decade Implies reduction in annual growth rate of 0.2 p.p. over next decade

President Trump Has Not Followed Through on Campaign Promises for a 45% Tariff on China and a 35% Tariff on Mexico Percent 20 Effective Import Tariff Rate 15 With 45% Tariff on Imports from China and 35% Tariff on Imports from Mexico 10 5 0 1929 1939 1949 1959 1969 1979 1989 1999 2009 2019 Source: Census Bureau; Bureau of Economic Analysis; author s calculations.

But There Has Been a Significant Increase in Import Restrictions in the First 100 Days Share of U.S. Imports Covered by Barriers Imposed under Trade Laws, Including Projection for Trump s First "100 Days" Percent 14 12 10 8 China 2017 Trump Effect? Projected coverage of "100 days" actions 6 4 Total 2 Non-China 0 1995 2000 2005 2010 2015 2020 Source: World Bank TTB database; ComTrade (WITS); Chad Bown (2017).

Source: openclipart.org. Change in U.S. Multilateral Role

In Conclusion U.S. economy at/near full employment. Wage growth is lower than desired largely because of slow productivity growth. The outlook is for growth ~2%. This assumes unfavorable demography continues and productivity bounces back somewhat. Inequality and labor force participation compound low productivity growth, leading to slow income growth. President Trump s policy agenda could hurt growth further and promote greater inequality of incomes.