07/ 25/ 2007
by Bill Dunkelberg
The U.S. economy continues to underperform its long-run potential. The surprise to many is that the unemployment rate hasn't risen. Most likely this is because the economy is close to full employment. This means we employ a near-record percentage of the adult population. All sectors of the economy except housing seem to be at or near peak capacity, consumer spending has outpaced income for more than a year, and we import $2 trillion worth of stuff that we don't or can't make here. Growth is slower when we are at capacity. Perhaps the best indicator is that one in four NFIB members has at least one unfilled job opening, 50 percent try to hire each month, and 80 percent of those trying to fill a position report few or no qualified applicants. If you can't find workers or can hire only marginal workers, you can't make as much output--which slows GDP growth.
Though consumer spending was strong, GDP crept along during the first quarter of the year--crawling at an annual growth rate of 0.6 percent, which is hardly moving at all. The weakness came from housing starts, which is no surprise since there are too many houses for sale and fewer new ones being built. Another weakness in the first quarter was government spending, which is a surprise. Few think defense spending and overall government spending declined in the first quarter, but the government accounts say it did. This trend will likely be reversed when second-quarter reports come in. Whether consumers will continue to spend more than they make remains a risk to GDP growth. If consumers start saving, GDP growth will slow down.
A Trend of Slow Growth
The NFIB Small-Business Optimism Index signaled a major downshift in economic activity in March 2006, falling nearly four points--a big decline. The government reported that economic growth was exceptionally strong that quarter, with GDP growth of 5.5 percent, way above trend growth. But small-business owners anticipated the slowdown, and the second quarter came in at 2.5 percent growth, below trend. And we only got slower from there. The Index has stayed below its historic average of 100 all year--not a recession signal, just a signal of slow growth. Capital spending has been sluggish, too, and plans to make capital outlays in the coming months have also been historically weak. This fact is important for the growth in labor productivity because, without new tools and software, workers can't increase their output per hour.
Uncomfortably High Inflation Rates
Inflation remains a problem. The Consumer Price Index inflation rate is unacceptably high, reaching annualized rates of more than 8 percent. This is primarily due to energy costs, food costs (the mandated ethanol debacle is a heavy player here) and the usual health-care cost increases. In making policy, the Fed focuses on the CPI basket of goods and services with food and energy excluded, or the “Core CPI.” The core inflation rates are running a little over 2 percent, so the Fed feels comfortable. NFIB members, however, don't corroborate the low-inflation finding. The net percent of owners who report higher average selling prices has been running over 15 percent. (Net is determined by the percentage of owners raising prices minus the percentage cutting prices.) This percentage is far too high to get the real inflation rate down to comfortable levels.
So, for the rest of the year, NFIB members anticipate that the economy will pick up some speed, price pressures will not go away, job growth will be steady (but low due to the shortage in good workers), labor compensation will rise, interest rates will rise a bit, and we'll finish the sixth year of the expansion in positive territory. Hey, every year can't be above trend.
