By Jeff Korzenik, Chief Investment Strategist, Fifth Third Private Bank
Published on September 1, 2019
Much of the data is telling us that the U.S. is more or less at full employment. Unemployment is low. Apart from one blip in February, jobs created each month are high. The labor force is tight. People who want to work are finding jobs – and there are even some industries who have jobs to fill but can't find the people to fill them.
So the question becomes, given these circumstances, how do we continue to expand the economy? In theory, an economy at full employment can continue to grow at its “long-term potential growth” rate, one currently estimated by the Congressional Budget Office as under 2%. But sub-2% potential maximum growth is a vulnerable level, one where events could easily tip the country into a recessionary spiral.
When the economy is at full employment, only two paths remain to lifting growth to safer levels. We have written extensively about the first, lifting labor force participation rates. The other path is through raising productivity.
In economic terms, productivity is calculated by dividing GDP by the total number of hours worked. So we continue to grow the economy by increasing productivity, improving the output given the number of hours works. That is currently driving—and should continue to drive—our ongoing expansion in this era of full employment.
What Drives Productivity
The traditional economic view is that productivity is driven by capital investments—from hand shovels to steam shovels. The equipment, the assets, and the technology a company invests in improves productivity.
Productivity is also driven by investing in people – training and educating current employees. This brings employees who might have otherwise been on the sidelines to the forefront by fully utilizing their potential and their expertise.
There are, of course, other factors in driving productivity—access to capital, investments abroad—and each of these factors will need to be considered and utilized in order to continue our current economic expansion in this current ecosystem of full employment.
Key Economic Productivity Factors Moving Forward
- Demographics: On average, a 45-year-old worker is going to provide more productivity than a 25-year-old worker. They bring with them more experience, better judgement, more training and overall more knowledge about their industry and the problems they're working to solve. All of this bodes well for the U.S. as the millennial generation becomes the largest group in the workforce. As they approach their early 30s, they are more grounded in their careers, they have picked a line of work, and they will likely stick with the trajectory they're on—accumulating those skills and insights to drive productivity.
- Investment in People: Unfortunately, for many years corporate America has cut back on training. But that is starting to change. Through a combination of public-private partnerships, collaboration with local colleges and universities, in-house training and adoption of new technologies, companies are investing more and more in their people. The old school of thought was "If we train people, they'll leave”—and it can be more difficult to measure the increased output that training brings. But done the right way with the right corporate culture, it can be a worthwhile investment to increased productivity.
- Capital Investment: Business confidence and capital investment are closely connected. Increased confidence leads to increased investment. Business confidence has been on the uptick—driven by federal elections and changes in tax policy. Capital investments for new technology or equipment, for instance, can have a huge impact in productivity—especially if the equipment being replaced is especially outdated. I've come across manufacturers using equipment originally designed in the 1930s. You can imagine the exponential improvement in productivity when those machines get replaced. And because companies are now paying a lower marginal tax rate and are able to write off that expense sooner with accelerated depreciation, it makes capital investment all the more attractive. Unfortunately, trade tensions have eroded business confidence and slowed investment.
- Access to and Cost of Capital: Of course, you won't see an increase in capital investment without the access to and cost of that capital improving. Low interest rates allow corporations to make the investments in equipment, technology and other factors to help improve productivity. Pair that with changes to laws impacting deemed repatriation of foreign earnings – the taxes and costs associated with bringing foreign profits back into the U.S.—it's now easier for companies to take the money they've earned globally and reinvest it back in the U.S. economy to improve productivity.
- Investments Coming Home: In the past, U.S. companies chose to focus some investments in emerging markets. But now, with the dynamics of the global economy changing, those same foreign markets come with greater burdens and lower returns. We're now beginning to see better investment and productivity in the U.S. The cost structure is becoming more competitive. This is especially true in the energy industry—where a domestic head start on technology and infrastructure.
Productivity Gains with Full Employment
As I've said before, we're likely on the tail-end of more than a decade of economic expansion. Since the financial crisis of 2008, one of the biggest factors in that expansion has been job creation. But even though we're currently at full (or near-full) employment, it doesn't necessarily mean the expansion has to end. Capital investments, investing in people, and shifts in demographics—along with other factors like action, or inaction, from the Federal Reserve—could help increase productivity and stretch this era of growth out a little longer.