Stagnation and the OECD's Solution

Summary

  • We are in an Age of Stagnation.
  • The OECD proposed solutions not unlike President-elect Trump’s to revive growth.
  • Short-term growth may increase at the expense of the deficit and higher debt
  • The resolution of these problems is going to take years.

Introduction

Last week, Financial Sense published an article that I wrote called “Stagnation and the Secular Bear Market” describing my adventure to understand why the US (and the world) have been experiencing slow economic growth and how long it will continue. This update is based on “Using the Fiscal Levers to Escape the Low-Growth Trap” from the Organization of Economic Co-operation and Development's (OECD) Economic Outlook which I received just this morning. It recommends global solutions to the problems that I described in my article.

In summary, a continuation of the current low growth environment undermines fiscal sustainability. Structural reforms in entitlements—particularly healthcare, pensions, taxes and spending—should continue to be made. These reforms with low-interest rates have increased the ability of countries to increase fiscal spending. The OECD recommends a more expansionary fiscal policy than what the US is currently planning. Austria, Hungary, Iceland, Norway and Spain are planning fiscal stimulus of one percent or more for 2016. “The likely shift towards more expansionary fiscal policy in the United States in coming years will provide support to economic growth, although the mix between tax cuts and spending may unduly favor tax cuts.

Fiscal Spending

The OECD states that their member countries have the capacity to finance a half percentage of GDP in productivity-enhancing fiscal initiatives for 3 to 4 years. This rate applied to the US is about $90 billion per year or approximately what President-elect Trump has most recently set as a goal. They estimate that output gains in the first year would be about 0.5 percent with potential long-run gains of 1.5 to 2.0 percent. The gains “in long-term output are conditional on the assumption that the stimulus is financed after three to four years through an increase in non-distortionary taxes or a cut in other spending, with neither of these factors affecting potential output.” If this can be achieved, it would put us at President-elect Trump’s boastful 3.5% GDP growth. The Congressional Budget Office’s estimate of real potential GDP is 2% or less through 2026.

Tax and Spending Reform

The OECD stresses that taxes and spending should be restructured towards a mix that enhances long-term growth and private investment. For most countries, to counter high health care costs, taxes will have to be increased or spending cut by several percentage points of GDP by 2060.

They recommend for OECD countries, shifting part of taxes from personal and corporate income taxes to recurrent taxes on immovable property and/or consumption. They find that there has been a shift to non-productive taxes such as personal income taxes, social security contributions, and corporate income taxes since the financial crisis in most countries including the United States.

Productivity-Enhancing Fiscal Initiatives

Productivity-enhancing fiscal initiatives will most likely be more effective “if public investment manages to catalyze private investment.” It is not certain that the increase in output will result in a lower debt to GDP ratio, but they believe that the results will be more favorable than initiatives that focus on public consumption. Output gains from increased spending on research and development are potentially large.

Regulation Reform

They state that evidence suggests that most OECD countries can improve regulations such as access to market in order to achieve goals. In particular, reducing barriers to private investment has benefits.

Income Inequality

The OECD Outlook finds that increasing the quality and quantity of education and increased spending on family benefits reduces income inequality.

Bank Balance Sheets

My October article in Financial Sense was “Balance Sheet Recessions and the QE Trap” based on the book by Richard Koo. Along this theme, the OECD says that about a third of OECD members, particularly China, India, Russia and Italy, need to further clean up their balance sheets.

The Trump Presidency

The base case is that the Trump Presidency is facing stagnation headwinds outlined in my last article caused by factors of global imbalances, low productivity, demographics, high debt, income inequality, high taxes, excessive financialization, unsustainably high entitlements, and the need for regulatory reform. The Trump Economic Plan described by Wilbur Ross and Peter Navarro is mostly consistent with the OECD Outlook described in this article. Mr. Ross is expected to be selected as President-elect Trump’s Commerce Secretary.

CNN reported in “The Bashing of Trump’s $1 Trillion Infrastructure Plan Has Begun” that “Bernie Sanders and New York Times columnist Paul Krugman charged that the plan would be little more than a tax giveaway for companies.” The OECD points out synergies when public investment “catalyzes” private investment.

The Trump infrastructure investment plan is being scaled down from $1 trillion over 10 years, and is consistent with the $90 billion per year approximation from the OECD report. Yes, we are at full employment and growth might be slower and inflationary, but the labor participation rate is low, people are working longer, and real median incomes are low so there is some room to grow.

In “US-China Trade Troubles Grow," the WSJ cites how the yuan is at a five-year low while US manufacturing has dropped from 16 to 12 percent of GDP. The Obama administration has put duties on some imports such as cold-rolled steel. The structural differences that contribute to the problem are state-owned businesses, overcapacity and lack of a social net that results in high savings.

Conclusion

My views of President-elect Trump's incomplete economic plan is more favorable since reading about the issues in more detail. I hope that the final plan worked out with Congress and the Senate does achieve the desired goal of stimulating the economy. Monetary policy proved to be less effective than originally envisioned. In a few years, we may reflect back that fiscal policy and reform was not as effective as hoped. In addition to the stagnation headwinds, the business cycle has slowed and market valuations are very high. I remain defensive.

Disclaimer: I am not an economist, investment advisor nor investment professional. This material is for informational purposes only and should not be construed as investment, legal or tax advice. Investors should do their own research or seek the advice of investment professionals.

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