The most widely used measure for the economy is GDP, and we therefore use it in our economic discussions for the same purpose. However, it’s important to appreciate its flaws, especially those listed below:
- GDP measures revenue, but the focus should be on a host of variables, including income, return on capital, and employment.
- GDP can be bought. The government prints money and gives it to someone who ostensibly needs it. That individual spends it and GDP rises. Therefore, the more money the government prints, the faster the economy grows (nominally, anyway).
- Not everything that reduces GDP is bad for the economy. For example, cancer treatments and services cost $264 billion a year in the United States.8 Those costs represent someone else’s sales (e.g., hospitals, HMOs, drug companies) and contribute to GDP. If we found a cure for cancer, GDP would then be negatively impacted. Yet how could one argue that curing cancer would be bad for the economy?
We are not suggesting there’s a superior measure to GDP, just that economic discussions should take into account the limitations of the metrics at hand. Though anemic, 2011 showed a continuation of the economicrecovery, but GDP sits just 0.2% higher (adjusted for inflation) than the 2007 peak.9 We continue to havedifficulty figuring out how current U.S. economic weakness will be transformed into a place of significantly lower unemployment and strong economic growth. We do believe that we will once again have faith in our economy—some day, anyway, and most likely after further discomfort. Great change only comes from great challenge. What has occurred thus far doesn’t seem to have pushed enough people close enough to the edge to trigger that change. We thus expect continued economic struggles. At best, we see muddling through slow/negligible real growth.
The problem we see is that U.S. policy depends far too much on popular sentiment to run effectively. The majority tends to prefer the best for today at the expense of tomorrow, i.e. short-term gain for long-term pain. Someone needs to be the adult here and say, “enough already,” à la Paul Volcker’s hard line in the early 1980s. The majority of our government officials worry that pushing for tough, but appropriate, resolutions might cost them their jobs, as well as the influence, income, and bright lights that come with them.
Maybe they recognize the need to hang onto the jobs they have, especially amid today’s grim employment market. Indeed, an estimated 8.6 million people lost their jobs in the most recent recession, and this tepid recovery has created just 2.8 million jobs since—leaving us 5.8 million jobs short of 2007’s pre-recession peak.10 We feel, though, that there’s too much focus on the quantity of jobs, and not enough attention paid to their quality. Since not all jobs are created equal, looking at jobs numbers creates an oversimplified view. If a General Motors worker lost his job working on the assembly line, then finds work delivering pizza, the change is neutral as far as the unemployment data are concerned. However, he might earn just the federal minimum wage. At $7.25/hour, that’s a far cry from the more than $70/hour (including benefits) he could have been earning at GM.11 We have had similar, if not as dramatic, negative shifts throughout the nation—a trend that places additional pressure on our economy. The UAW worker is an extreme example, but as Paul Osterman, an economist at M.I.T.’s Sloan School of Management, noted in the book Good Jobs America:
Making Work Better for Everyone:
8 In 2010, the American Cancer Society estimated the overall annual cost of cancer was $263.8 billion.
9 David J. Lynch, “The Hollow Recovery,” Bloomberg Markets, January 2012, p 32.
10 U.S. Bureau of Labor Statistics. Job losses calculated from pre-recession peak in November 2007 through the trough in December 2009. The
number of jobs regained is net of losses from January 2010 through December 2011.
11 The Heritage Foundation. http://www.heritage.org/research/reports/2008/12/uaw-workers-actually-cost-the-big-three-automakers-70-an-hour.
Careful studies of worker displacement show that when people are laid off from previously stable employment, they take a wage hit—if they are lucky enough to find work—of over 20%, and this gap persists for decades after the job loss. Americans feel that these risks have grown: Successive national surveys show a long-term upward trend in perceived risk of job loss, a trend that remains even after removing the effects of the business cycle and changes in the demographic composition of the workforce.12
Given the insufficient creation of high-paying jobs, what little economic growth there has been has come more from productivity than from the top line (i.e., revenues). That’s pushed up corporate profit margins to an all-time high (since 1980), as reflected in the following BCA Research chart. With margins now at least 50% above average for that period, it’s reasonable to opine that the future holds more margin downside than upside—and that would add further pressure to the economy.
If it wasn’t for Europe’s difficulties, the markets would be a lot better. But that’s like saying, “If I could bat .400 against major league pitchers, I could play for the Dodgers.” A fractured Eurozone continues to stifle growth, not just in the underlying domestic economies, but in those of their trading partners as well. We don’t see how the Euro survives as a currency without merging monetary and fiscal fiefdoms, a step that would require nations to willingly surrender some of their sovereignty to wealthier neighbors. Such a step would, for the first time, give outsiders the power to influence domestic spending in the weaker nations. We suspect circumstances would have to worsen considerably for that to happen. German sensibility dictates operating with more long-range thinking than other EU countries. For example, Germany placed limits on wage growth, causing labor costs to grow more slowly, thereby enhancing productivity. This has contributed to their stronger GDP growth and better economic circumstances today. The short-range thinking of
others—Italy for example—has produced weaker economies. Such different mindsets will certainly keep Italians from freely ceding control to the Germans, but necessity may nevertheless become the mother of invention. We’d wager that Germany’s more prudent economic policies will create higher real net worth for German citizens in the future, particularly if Italian per capita net worth gets recalculated in Lira.
The notion that we might be able to save our way to prosperity is misguided. The combination of cautious saving, cutting spending indiscriminately, and raising taxes has never driven growth, and it won’t now. In fact, it could do quite the opposite. However, the proposals coming out of Washington and various States suggest that policy makers don’t see the danger of this triple threat. We want to see more investments in technology, education, and infrastructure, and less spending on improvident earmarks like snowmaking in Minnesota or adding another racetrack in North Carolina. We want to see the average age for Social Security benefits raised and uneconomic government pension benefits reduced. And, we want to see our legislators tread carefully when considering tax increases. Corporations can move offshore, as a number of companies in our portfolio have (e.g., Ensco International, Covidien, with Aon expected to move in 2012). States with higher taxes tend to lose corporations and high-income individuals to lower-cost states (e.g., California to Nevada), and create a disincentive for potential new entrants to the state. We’d