Signs are pointing to strong growth for the U.S. economy and that’s a big deal

Global growth will pick up faster than previously expected in the coming months as the Trump administration’s planned tax cuts and public spending fire up the U.S. economy, the OECD recently announced, revising its forecast upward from earlier this year.

In its most recent Economic Outlook, the Organization for Economic Cooperation and Development projected the U.S. economy would grow by 2.3 percent in 2017 and to 3 percent in 2018. Global growth is expected to accelerate from 2.9 percent this year to 3.3 percent in 2017 and reach 3.6 percent in 2018.

Markets have shown some early confidence that the economy will improve with the new administration. The Dow Jones Industrial Average is up almost 5 percent since election day and the S&P 500 is up more than 3 percent. Consumers seem to be sharing the confidence with early reports of strong retail sales for Black Friday and Cyber Monday.

During his campaign, Mr. Trump pledged to boost infrastructure spending by as much as $1 trillion, although the details of how that would be financed are sketchy. He has also promised to cut corporate and personal income taxes. In addition, changes to employment regulations and the Affordable Care Act are expected to spur hiring by businesses and bring more Americans into full time employment.

Costly and onerous overtime rules imposed by the Obama administration have been blocked by a federal judge and are likely to be overturned during the Trump administration. Changes to the ACA are expected to jettison mandates triggered by having more than 50 employees or by working more than 29 hours a week. Be prepared for more people working more hours.

Financial reforms are on the way with an expected overhaul of Dodd-Frank. House Finance Committee Chairman Jeb Hensarling and others in Congress have laid out the key principles they say will guide financial reforms: restoring rule of law to the regulatory process and allowing banks to regain control of their own lending and other business decisions so long as they are credibly taking risks with their own funds rather than relying on the protection of taxpayers. This may be the end of “Too Big to Fail.”

Rising interest rates will strengthen bank profits and provide a tailwind to encourage more lending while also slowing the growth in housing prices.

Does growth really matter? Yes, it’s a big deal

When economists talk about growth, they are trying to get a handle of how much better (or worse) off are we versus a year ago. Are we getting richer or poorer or just standing still? When we talk about growth, we talk about year-over-year percentage growth rates. But, what is a “good” growth rate?

Here’s some perspective, looking back in time.

Average incomes doubled from the bottom of the Great Depression in 1933 to the middle of the post-war boom of 1950—a space of just 17 years. Over that period, incomes grew an average of 4 percent a year. Incomes doubled in less than one generation.

It took another 27 years afterward (1950 to 1977) for incomes to double. The people watching the TV show Happy Days were twice as rich as the people portrayed in the show. That amounts to an average annual growth rate of 2.5 percent a year.

Then, after that, it took another 38 years (1977 to 2015) for incomes to double. Over that period of time, average incomes grew by 1.8 percent a year. It took almost two generations for incomes to double.

A difference of 1.5 percentage points in the growth is the difference between doubling incomes every generation or doubling every other generation.

Think of it this way. Since 2010, GDP growth has been about 2.2 percent a year. At that rate, it would take more than 30 years for incomes to double. If that growth can be boosted to 3 percent a year, incomes would double eight years faster. That’s a big deal. That’s one reason stock prices rise on even modest upward revisions to GDP forecasts.

Look on the flip side, regulations and taxes that stifle growth—even if by less than one percent—can have serious long run effects on our standard of living. When a politician says, “Well it’s just half a percentage point off the growth rate,” you should answer, “Well that’s another five to ten years we lose in income growth.” That’s a big deal.

So, let’s get out there and grow this economy. Your kids and grandkids will thank you for it.

Chinese wines are getting better and heading here soon, but what did the military have to do with it?

A few years ago, I did some consulting and testimony regarding a land use matter for a vineyard owner and winemaker. He bought 1,600 acres of wheat land in the Walla Walla Valley American Viticultural Area—home to some of the best red wines in world. He wanted to subdivide the wheat land into 40 acre vineyards that he would sell off. Because of Oregon’s one-of-a-kind land use laws, the process required a major hearing with expert testimony.

As we were touring his existing vineyards, the winemaker told me to keep an eye on China and Chinese wines, because someday they’d be big in the U.S. His thinking went like this:

  • Anywhere you can grow apples, you can grow grapes.
  • In the 1980s, China shrunk its military considerably to free up resources for economic development, nearly 1 million men were rotated out of the military. Because of the one child policy, there was a shortage of potential brides, so the Chinese government determined that these ex-military guys needed gainful employment.
  • Many of the former military men were given agricultural land and trained to run apple orchards.
  • As their agricultural skills improved, apple orchards were converted to vineyards.
  • Winemaking is a natural extension of vineyards, and the Chinese would quickly learn how to make good wines.

Now, it looks like that someday for Chinese wines is almost here.

The Wall Street Journal reports that China now accounts for nearly 11 percent of the land devoted to vineyards in the world, ranking second behind Spain.

On top of that, WSJ says that quality of Chinese wines is improving and have begun to win awards outside China. In addition, French luxury-goods conglomerate LVMH Moët Hennessy Louis Vuitton has built a winery in a place called Shangri-La in the Himalayan foothills that aims to produce China’s best, and probably most expensive, wine. Moët Hennessy, the LVMH unit that makes Dom Pérignon Champagne, already produces sparkling wine in Ningxia, with a bottle selling for $27.

You’ll know when Chinese wines have really hit the U.S. market when you see them on the shelves of Costco or Trader Joe’s.

Can education pass the economic development smell test?

Economic growth is probably the single most studied topic in economics, dating back at least as far as Adam Smith’s 1776 book, An Inquiry into the Nature and Causes of the Wealth of Nations.

After almost 250 years of study, you’d think we have the answer to what causes the wealth of nations.

But, alas, science is never settled, so economists keep coming up with new answers.

For example, the idea of microlending has been all the rage lately. Especially after Muhammad Yunus was awarded the Nobel Peace Prize for his work in microcredit.

But, does it really matter?

Harvard development professor Lant Pritchett describes a “Eureka!” moment when he realized that maybe micro efforts produce only micro results.

Pritchett was in West Bengal with a World Bank team researching a program that built and financed women’s self-help groups as a means of increasing women’s productivity and incomes. At one point, one of the women asked: “You all are from countries that are much richer and doing much better than our country so your country’s women’s self-help groups must also be much better, tell us how women’s self-help groups work in your country.”

That’s when it hit him:

We all looked at each other blankly as none of us had any idea whether there even were at any time in our countries’ history such a thing as “women’s self-help groups” in our countries (much less government program for promoting them). We also had no idea how to explain that, yes, all of our countries are now developed but no, all of our countries did this without a major role from women’s self-help groups at any time (or if there were a role we development experts were collectively ignorant of it), but yes, women’s self-help groups promote development.

Think about that for a second.

A bunch of First World experts are telling a bunch of women in a Third World country that microlending is a path to economic development. But, the “experts” don’t know of any such lending in their own countries. If the US, UK, Germany, New Zealand, and other “developed” countries advanced so far without microlending, why would anyone expect microlending to be the path to economic growth for developing countries?

Pritchett’s “Ah Hah!” moment led him to develop a four-fold “smell test” for determining what is important to development:

  1. More developed countries must have more X (e.g., natural resources, access to warm water ports, educational attainment) than less developed countries.
  2. The developed countries must have more X than when they were less developed; in other words, they unlocked some potential.
  3. Recent development successes must have more X than development failures.
  4. Countries that are developing rapidly must have more rapid growth of X than those that are developing slowly.

Economist Paul Romer jumped on this observation and applied the “smell test” to urbanization. He concludes that urbanization passes the smell test, meaning that urbanization is important to economic development.

Can education pass the smell test?

Here at Econ Minute, we decided to perform our own “smell test” on education and economic development. We chose education because there is very little debate that greater educational achievement is associated with better economic growth. Because it is relatively uncontroversial, it’s a good test of Pritchett’s Smell Test.

We used data from the World Bank on education and per person gross national income see the relationship between lower secondary education completion and per capita GDP. (Details of the data—including why education completion rates can be greater than 100 percent—are available from the World Bank.)

The first figure (below) shows the education completion rate and gross national income per capita. The figure shows the strong correlation of education completion with GNI per capita.

 

EconMinute-Pritchett-Education-Figure1

 

The second figure (below) is the same as the first, only GNI is on a natural logarithm scale because economists love natural logs. As with the first figure, the figure below shows the strong correlation of education completion with GNI per capita.

 

EconMinute-Pritchett-Education-Figure1-ln

 

The third figure (below) shows one simple way to get at the cross-sectional variation, by looking at only a single year, 2012. That year was chosen because it was the most recent year with many observations. The data suggest that in 2012, more development countries had higher education completion rates than lesser developed countries.

 

EconMinute-Pritchett-Education-Figure2-ln

 

The fourth figure (below) looks at the changes over time. For each country, over the interval 1970 to 2013, it shows the 10-year percentage point change in educational completion and the 10-year percent change in GNI per capita.

As noted in Romer’s post, this kind of relationship measuring changes is less tight than the relationship in levels, but the simple correlation is still positive, and a fitted curve that allows for constant plus a nonlinear relationship suggests that the association between the two is particularly strong for countries that experience a rapid growth in the secondary education completion.

In other words, the figure suggests that countries that have a bigger increase in GNI per capita also tend to have a bigger increase in secondary education completion.

 

EconMinute-Pritchett-Education-Figure4

 

The fifth figure (below) provides an overlay of China’s experience. In contrast to Romer’s analysis, the World Bank data begins in 1990 for China, so we do not have the clear before- and after-reform break. Also note that what appears to be a big jump simply reflects missing data between 1997 and 2007, so what appears to be a big jump is actually a 10 year jump. Nevertheless, increases in China’s GNI per capita have been accompanied by increases in educational completion.

 

EconMinute-Pritchett-Education-China-Figure5

 

At this point, you begin to hear a chorus of voices turn to shouting, “Correlation is not causation!”

And, the chorus is correct. Indeed, one could make a very good argument that improving incomes cause greater educational attainment. As incomes improve, family can afford the time and money it takes to better educate their children. As a country’s national income improves, greater resources can be devoted toward public education.

Nevertheless, this exercise was not meant to end the debate, but really to start a conversation about what matters in economic development and how to measure it.