Good news and bad news for the US economy
There has been both good news and bad news for the US economy. Here are some of the highlights:
- On the positive side, the US labor market remains relatively strong. Employment growth was moderate in March, with the unemployment rate remaining historically low. Job growth was concentrated in professional and business services, health care, restaurants, and government. There was a decline in employment in manufacturing. Meanwhile, labor force participation is up, with the participation rate among prime-age workers (25 to 54) reaching the prepandemic level. In addition, immigration has rebounded sharply, helping to boost the size of the labor force while reducing inflationary pressure that might stem from a tight labor market.
- Another bit of good news concerns inflation. The US government reported that, in March, consumer prices were up only 5% from a year earlier, the lowest reading since May 2021. Recall that inflation peaked at 9.1% in June 2022. Thus, inflation has receded quite quickly. However, the bad news is that core inflation remains more persistent. That is, when volatile energy and food prices are excluded, core prices were up 5.6% from a year earlier, slightly higher than in the previous month. Still, core inflation is down from a peak of 6.6% in September 2022. Core inflation is being sustained, in part, by the lagged effect of rising home prices. The shelter component of the consumer price index was up 8.2% in March from a year earlier. It is expected that, later this year, the recent decline in home prices will help to dampen core inflation. Meanwhile, a debate rages about the persistence of inflation and whether the Federal Reserve should retain a tight monetary policy.
- Also on the positive side is the condition of financial markets. Recall that the Federal Reserve spent much of 2022 tightening monetary policy with the intention of weakening credit markets in order to fight inflation. For much of 2022, credit market conditions did, in fact, worsen. Risk spreads rose and financial market indicators worsened. Yet starting in October 2022, things reversed. Measures of financial-market stress improved while risk spreads fell sharply—at least until the banking crisis that began when Silicon Valley Bank failed. Then, risk spreads rose sharply. However, the successful intervention by the Fed and the US Treasury stabilized the banking sector and led to a quick decline in risk spreads to the precrisis level. Thus, a Lehman Brothers–type event was averted and markets appear to be in reasonably good shape. The perceived risk of financial damage has led to an expectation that the Federal Reserve will halt monetary tightening sooner than previously expected.
- One trend that could be considered both good and bad concerns manufacturing investment. The Financial Times conducted a survey of manufacturing companies and found that, in the United States, there has been a big increase in the volume of intended investment by manufacturers, especially related to semiconductors and clean energy technology. This stems from the subsidies provided in both the CHIPS Act and the Inflation Reduction Act. On the positive side, these massive investments will boost employment and, at least temporarily, boost economic growth. On the negative side, it is not clear that investments driven by government subsidies necessarily have as positive an impact on productivity as other types of investment, especially if the subsidies distort business decisions and drive investment away from more productive endeavors. Still, many technological leaps in the past were, in part, fueled by government intervention. In the case of the United States, such intervention often involved implicit subsidies due to military spending. Thus, such technologies as mobile telephony, the worldwide web, and satellite navigation exist because of military subsidies. Today’s clean energy subsidies could have a similar impact.
On the negative side, there are indications of a weakening US consumer. For example, retail sales fell sharply in March, down 1% from the previous month. In addition, retail sales were up only 2.9% from a year earlier. Considering that this was in nominal terms and that inflation remained high, real (inflation-adjusted) retail spending fell considerably from a year ago. From a month earlier, there was an especially sharp decline in spending at stores specializing in discretionary durable and nondurable goods. There was also a sharp decline in spending at gasoline stations, a reflection of declining energy prices. Spending online was up strongly and spending at restaurants was up modestly.
- The severe COVID-19–related restrictions on economic activity in China in 2022 caused very slow economic growth, especially in the fourth quarter when multiple cities were in lockdown. When the government removed the restrictions at the end of 2022, the goal was to boost economic growth. The evidence suggests that growth is rebounding nicely. However, it remains below the government’s target level. Here are the main data points that were released recently:
o In the first quarter of 2023, real GDP was up 4.5% from a year earlier, the fastest growth since the first quarter of 2022. However, it was below the government’s goal of 5% growth. Moreover, it was far below the average growth seen in the decade prior to the pandemic. Still, real GDP was up 2.2% from the previous quarter, the fastest pace since the fourth quarter of 2020. The principal areas of strength were retail sales (up 5.8% from a year earlier), exports (up 8.4%), and infrastructure investment (up 8.8%). The latter reflected the government’s efforts to boost growth through fiscal policy. Overall public sector investment was up 10%, a reflection of the government’s support for the state sector. On the other hand, private sector investment was weak, growing only 0.6% in the first quarter.
o The strength of exports was relatively concentrated in exports of automobiles and exports to Russia. This alone may not allow for sustained growth. Thus, it is reasonable to worry that China’s strong export growth could peter out in the coming months, especially given the continued weakening of the global economy and the risk of recession in large markets such as the United States and the European Union.
o The strength of the retail sector was especially notable in March when sales were up 10.6% from a year earlier, the fastest since June 2021. Recall that, the removal of pandemic-related restrictions was followed by another outbreak of COVID-19 that initially had a negative impact on consumer spending and mobility. That outbreak ran its course in January: The March data reflects the rebound following the outbreak. Among the retail categories that saw very strong growth were jewelry (up 37.4%), clothing (up 17.7%), and automobiles (up 11.5%). On the other hand, spending was weak for home appliances (down 1.4%), building materials (down 4.7%), and furniture (up 3.5%). These categories were likely hurt by the weakness in the housing market.
o China’s industrial production grew at a modest pace, up 3.9% in March and up 3% in the first quarter versus a year earlier. The one bright spot was the automotive sector where output was up 13.5% in March versus a year earlier.
o Fixed asset investment in China grew 5.1% in the first quarter versus a year earlier. This included a 7% increase in the manufacturing sector. Investment in the property sector, meanwhile, fell 5.8%. Housing starts were down 19.2% in the first quarter versus a year earlier. In addition, home sales by area were down 1.8%. However, home prices have started to recover, rising in March at the fastest pace in 21 months. This likely reflects government efforts to boost transactions in the sector. Still, despite the government’s policy of supporting the completion of existing projects, it is expected that development of new property will remain suppressed for a while.
Going forward, most analysts expect China’s economy to accelerate in the second quarter. However, there remain significant headwinds. Export growth could slow down given weakness in the global economy. In addition, the evident weakness of private sector investment suggests that private sector sentiment has been shaken by the government’s efforts to strengthen the state sector. Plus, private sector businesses that are export-intensive might be thinking about boosting capacity outside of China in order to avert the impact of Western sanctions and tariffs. In releasing the GDP data, the government stated that domestic demand remains “inadequate” and that “the foundation for economic recovery is not yet solid.”
China’s growth matters not only for China but for the world. The economy accounts for about 19% of global GDP and a larger share of global trade. If the recovery accelerates, this will be good for global growth. It could also cause an increase in global commodity prices at a time when the world is just starting to get inflation under control. For now, the government’s focus appears to be on growth rather than inflation. Monetary policy and, to a lesser extent, fiscal policy, are relatively easy. This is not likely to change any time soon.
- There is growing alarm among policymakers and economists about the increasing fragmentation of the global economy. This concern is based on the increase in protectionist actions by major countries (especially the United States) in recent years, the implementation of industrial policies meant to boost domestic manufacturing in major markets, the restrictions imposed on technology exports to China and China’s threats of retaliation, and the perception that these factors will lead to the creation of trading blocs rather than a fully integrated global economy. The risk is that this fragmentation could reduce trade, reduce cross-border investment, lead to more inefficient supply chains, and reduce the sharing of information and ideas that generate innovation and boost productivity. Moreover, there is concern that, just as in the 1930s, such fragmentation could increase the risk of military conflict.
One important critic of this fragmentation is Christine Lagarde, president of the European Central Bank (ECB). In a major speech this week, she said that “we may see more instability as global supply elasticity wanes; and second, we could see more multipolarity as geopolitical tensions continue to mount.” She expressed concern that the conflict between China and the West will disrupt global supply chains in key industries. She noted that Europe depends on China for 98% of its rare earth minerals and that the United States depends entirely on imports for 14 critical materials. China is reported to be considering restricting exports of rare earths as retaliation for Western export controls.
Lagarde also suggested that the current high inflation will be difficult to suppress in an environment of economic fragmentation. She said that, “if global value chains fragment along geopolitical lines, the increase in the global level of consumer prices could range between around 5 per cent in the short run and roughly 1 per cent in the long run.”