Economic growth is something that people generally don’t think too much about. However, economic growth ultimately determines our standard of living, which on that basis is quite important.
There are many pieces of economic data that are published. Unless someone has a strong knowledge of economics or finance it is quite difficult to decipher the relevance of much of this data.
The most comprehensive source of data is Gross Domestic Product (GDP), which is released quarterly. Unlike other pieces of economic data, such as housing or manufacturing, which look at a portion of the economy, GDP covers the output for the entire country.
The GDP number that is reported is inflation adjusted. This is important, because if the quantity of output is unchanged, and only prices are rising then there hasn’t been any improvement. For example if the dollar amount of GDP increases 4%, and prices have gone up 2%, then the real GDP number is an increase of 2%.
Similar to other pieces of economic data, the GDP number can jump around some on a quarter-to-quarter basis. The GDP for a year might average 2%, but the individual quarters might vary from 0 to 4%. Sometimes these swings are just caused by a shift in inventories, which can be reversed in a subsequent quarter.
Therefore, when looking at GDP data, it is good to look at the reports over a period of time. That way someone can have a better evaluation of how well the economy is doing.
One area of concern for the economy is tha,t since around the year 2000 economic growth has averaged about 2% annually. This is a noticeable slowdown from the 3% pace during prior decades.
Some might think that this growth slowdown was due to the severe recession we had in the 2007 to 2009 period. However, the recovery we have had since then has also been much slower than what previous ones have averaged.
Generally what determines GDP over time is the growth and productivity of the labor force. If GDP growth averages 2%, you can have no labor force growth and 2% productivity improvement, or possibly the reverse with a 2% increase in the workforce and no change in productivity.
In recent years, while the growth of the labor force has been fairly steady, productivity growth has been weak. This helps to explain why wage growth has been quite low.
While the growth of the labor force has been fairly steady, in the future that growth will slow considerably. That is because of retirements that will be taking place among baby boomers, which account for a significant portion of the population. To maintain GDP growth in the future productivity will need to increase.
Looking at other mature developed countries, such as Japan and much of Europe they have been having economic growth even slower than the United States. This is due in part to a working age population starting to decline, which will continue to accelerate over time.
From an investment perspective economic growth is what ultimately drives profits and stock prices. If current trends stay in place, it is highly unlikely that stock prices will continue to increase at the pace we have seen in recent decades. This is not to imply that the stock market will do poorly, but just that future increases will be less than what has been previously experienced.
The stock market has done well recently on an expectation of faster economic growth with the new administration. That is certainly possible for a period of time, but for sustained higher growth, productivity will need to improve.