To try to estimate where the real economy will be in 2013, we must first consider where growth might come from. Consumer spending is approximately 70 percent of the economy, so this will be the first area we consider.
Where does spending come from? From income—which can be broken down into wage income, transfer income, and investment income—and borrowing. Wages are the largest component of income, at just less than two-thirds, and also represent the only income source for a majority of families. Wages are also the most variable source of income.
Wage income depends on the number of jobs, which I believe has started a sustainable increase. After a substantial downward adjustment during the financial crisis and its aftermath, which was exacerbated by business downsizing, employment has resumed a historical growth level, as shown in Figure 1.
FIGURE 1. Employment Growth
It has done so despite business uncertainty due to the fiscal cliff and other factors, which has limited hiring. Uncertainty is historically associated with unemployment, as Figure 2 shows. Unemployment has started to recover, despite the uncertainty that persists. This chart uses the U-6 unemployment data series, known as the underemployment index, which is more inclusive than the more commonly reported U-3 series, and is, in my opinion, a better indicator of the real level of unemployment.
FIGURE 2. Unemployment
Looking into 2013, the following trends will be at work to improve employment, on top of the natural growth highlighted above:
- Businesses will start hiring and investing as the fiscal cliff uncertainty recedes.
- Government hiring will stop declining as tax receipts go up.
- Re-shoring of manufacturing—where jobs are relocated to the U.S. from other countries—will become an increasingly important factor, as U.S. wages have become more competitive and energy costs in the U.S. have decreased.
- The labor force will start to decline as baby-boomers age out.
- Labor mobility will improve as fewer borrowers will be underwater on their homes.
- The rebirth of the housing industry will employ many who last worked in the housing boom.
Because of these factors, I expect employment to increase faster than it has in the past year, with a consequent positive effect on the employment rate.
Another factor supporting greater employment growth is the hours worked by current employees. Current hours worked levels are within 1 percent of those in 2006–2007, suggesting that new demand will require additional hiring.
Wages will also increase. Current high unemployment levels have allowed employers to increase nominal wages at a rate below inflation, resulting in declining real incomes. An increase in overall employment levels will result in nominal wages at least increasing with inflation.
The net result should be for consumer wage purchasing power to increase in real terms over 2013, supporting continued real growth in retail sales.
Borrowing is also coming back. Consumers have largely paid off excess debt from the boom years, with debt levels as a percentage of gross domestic product (GDP) back down to 2003–2004 levels and debt service as a percentage of income back to levels of the mid-1980s. As banks become more willing to lend, consumers have the ability to borrow. The ability of consumers to spend and borrow is matched by the willingness to do so. Consumer spending and borrowing continues to increase, supporting the larger economy. This trend can be expected to continue, and even accelerate, through 2013.
Business is another story. Business has decreased investment substantially through the second half of 2012. The reason is uncertain, with the two main contenders being fear of the fiscal cliff and the ongoing slowdown in the rest of the world.
The investment slowdown
There are numerous factors that have led to an investment slowdown:
- The fiscal cliff. If the fiscal cliff is the primary driver of the investment slowdown, which appears reasonable, then its successful resolution could well unleash substantial new investment.
- A slowing world economy. If, on the other hand, the cause is the slowing world economy, then for companies that derive a large part of their sales from outside the U.S., business will be slow, and we will not see a bounce back in investment. This is also reasonable; in fact, it is evident in the recent results for many manufacturers.
The probable outcome is that the slowdown is a mix of both factors. The upside from a 2013 perspective is that there is tremendous room for improvement, depending on how much is due to the fiscal cliff. Some improvement is therefore likely.
Government spending and stimulus
Surprisingly, aggregate government spending at all levels has been substantially stable since 2010. Given the budget situation, spending cuts at the federal level are very probable, but even taking the fiscal cliff cuts as an estimate, the overall effect from such cuts will be relatively minor, especially when the offsetting effect of increases in state and local spending is taken into account. With state and local tax receipts moving to new highs, this is probable. So, federal spending cuts will quite possibly be a headwind, but they should not act on their own to bring the economy back into a recession.
One component of GDP is net exports, or exports minus imports. The bad news is that net exports have detracted from growth for the past several years; the worse news is that they will continue to do so. Still, though, the change from present levels is likely to be relatively small, as the slowdown in the rest of the world reduces exports but at the same time reduces import costs—for oil, for example—as well.
The total effect of all components of the economy for 2013 is therefore likely to be positive. Growing employment and wages, the recovery of the housing market, and availability of financing will continue to support consumer spending. Business investment is at low levels and will most probably increase following a fiscal cliff deal. Government spending may decline, but at a relatively low rate, and net exports will continue to be a drag, but a consistent one. Net, we expect economic growth in the range of 1.5 percent–2.5 percent, with growth being slower in the beginning and accelerating toward the end of the year.