Four Headwinds to Economic Growth, Says Dallas Fed Chief

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Robert S. Kaplan, president and CEO of the Dallas Federal Reserve Bank, outlined four factors impeding the US and global economies during his “Fireside Chat” with PIMCO’s Marc P. Seidner, CFA, at the 2017 CFA Institute Fixed-Income Management Conference.

What they all amount to, according to Kaplan, are “Sluggish expectations for future growth.”

1. Demographics

“The first big driver I look at is aging population slowing workforce growth. The demographic changes are substantial,” Kaplan said. “And it’s one of the reasons why we’ve got sluggish GDP growth.”

Kaplan noted that the US labor participation rate was around 66% in 2007, right before the onset of the Great Recession. Today it stands at roughly 63%. So despite recent growth, the labor force has yet to rebound to pre-crisis level.

“I wish I could tell you that was going to get better,” Kaplan said.

Based on the Dallas Fed’s estimates, that 63% is likely to dip below 61% over the next 10 years, and will act as a drag on GDP growth for years to come.

Kaplan doesn’t think there are any easy solutions to the dilemma. While the US unemployment rate stands at 4.2%, a figure suggesting close to full employment, the so-called U-6 — which calculates the unemployed plus discouraged workers plus part-timers who want to work full time — stands at 8.3%.

Though this might imply some slack in the labor force, Kaplan believes that reaching this “discouraged” cohort will be difficult.

“It’s not an easy group to get into the workforce,” he said. But he thinks that promoting middle skills training and other initiatives might be aspects of the solution.

2. Technology-Enabled Disruption

The second driver Kaplan highlights is technology-enabled disruption, a phenomenon that he says is often confused with globalization.

There are three components of technology-enabled disruption, according to Kaplan.

The first is people replacing old technology, say buying new software, a better television, etc. “That’s not new,” he said.

The second component is consumers using technology to shop for goods and services for greater convenience. That means self-checkout at stores, for example, or making reservations online rather than over the phone or in person.

“The third element is disruptive competitors that are technology-enabled,” Kaplan said. “Amazon versus retail. Uber versus taxis. It goes on and on.”

These trends end up limiting the pricing power of businesses which, in turn, has what Kaplan calls a “muting effect on inflation.”

But the more compelling implication goes back to those discouraged workers. With businesses intent on keeping prices low, they have less incentive to hire more staff. This makes it even more difficult for displaced workers to find meaningful employment.

3. Globalization

Kaplan believes globalization receives more blame than it deserves when it comes to current economic conditions.

“We know that globalization . . . is good for economic growth,” he said. “On a local level, it’s been very disruptive to certain industries, cities, and so on, and that was particularly true 10, 15 years ago.”

Today, however, local disruption is more a product of technological forces than globalization, according to Kaplan, even though it’s being attributed to the latter.

“We’ve got that, I think, confused,” he said.

4. “High Levels of Debt to GDP, Particularly at the Government Level”

Households and financial sectors have deleveraged since the Great Recession. Though business debt is up, Kaplan thinks it’s manageable and he isn’t especially worried about systemic risk.

What he is concerned about is government debt.

Currently, the amount of US government debt held by the public adds up to 75% of GDP, according to Kaplan, and the present value of unfunded entitlements like Social Security is $49 trillion.

“Government is more highly leveraged than it was before the Great Recession,” he said. “The only reason we’re not screaming about it every day is because interest rates are so low.”

The demographic conditions will make this trend increasingly problematic.

“The ratio of dependents to workers is getting more adverse,” Kaplan said. “As we age, we’re getting more leveraged.”

A major takeaway from all this is that the economy is not likely to boom anytime soon.

“I don’t see GDP growth running away from us,” Kaplan said. “In fact, if we don’t take wise actions from a policy point of view, I actually think potential GDP is likely to trend lower over the next number of years from where it is now.”

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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