There is only one way President Trump can square a circle, a circle in which he will meet himself coming around as he tries to deliver on his promises. Call it the 3-1/2-percent solution. No, not a cocaine shot half as potent as the 7-percent solution self-administered by the world's most famous detective in order "to escape from the commonplaces of existence." It is the growth rate that Trump needs if he is to cut taxes for corporations and the middle class, raise spending on the military, leave entitlements untouched, eliminate the revenue-generating features of Obamacare, and lower or at least not raise the deficit. It is the rate that will allow him to escape from his predecessor's "commonplace" 2 percent or less, which official forecasts expect to be with us, give or take a few decimal points, for the foreseeable future.
By any reckoning, growing at 3.5 percent (in expansive moments Trump talks of 4 percent and 5 percent) rather than last year's 1.9 percent, would generate tax revenues sufficient to fund both some tax cuts and increased spending without ballooning the deficit. Circle, squared.
The Trump target has been hit in the past. In 12 of the 20 years prior to 2006 the growth rate equalled or exceeded 3 1/2 percent; and once Ronald Reagan and Paul Volcker brought down the runaway inflation inherited from Jimmy Carter, growth exceed 3.5 percent in the remaining six years of Reagan's terms. But the past is rarely prologue. There seem to be constraints on growth now that did not exist in "the good old days."
The problem does not seem to be primarily an inadequate demand for the goods and services our economy produces—demand-side constraints. If it were, we could loosen fiscal policy, and run deficits to prime the pump, as former treasury secretary and the "stagnationists" have been proposing. There was always disagreement with that diagnosis and prescription —the prescribing physician was one John Maynard Keynes, anathema to budget-balancing Republicans—but in general it seemed to make sense.
In any event, the demand side will take care of itself. Vehicle sales remain at record levels, and although that requires heavy discounting, the high volume of sales does not suggest consumers are zipping their wallets. The housing market, with the exception of $20 million-plus condos in New York City, is healthy. Holiday sales rose a satisfactory 4 percent in response to rising wages and low unemployment. And the wage increases seems to be benefitting even the previously forgotten men and women at the lower end of the wage scale: both Dollar General and Dollar Tree have "benefited from rising wages among core customers" according to the Wall Street Journal.
And new shots-in-the arm for demand are in the making. Share prices are up some 10 percent since Trump was elected, and the price of existing homes rose to their highest level in 10 years last month. Both of these increases in asset prices should produce more spending, the "wealth effect", and soon. An infrastructure spending plan, which has bipartisan support, should begin to have an effect in a year or so.
It is the supply-side that seems to be restraining growth. There are two ways we can break a supply-side constraint. The work force can work more hours turning out stuff, and/or their productivity can increase so that they turn out more stuff every hour they work. We have problems on both scores. Total hours worked in the US increased at an average annual rate of around 2 percent until 2000, but have hardly increased at all since then. And productivity growth began slowing even before the Great Recession, and does not seem to have picked up significantly. In short, slower growth in hours worked, and slower growth in productivity have resulted in slower growth in the economy, more than one-and-a-half percentage points lower than Trump's target.
So Trump's problem is a supply-side problem. Consumers can be ready to buy lots of things, but if there aren't enough workers, and those that are available are not increasingly productive, growth will not accelerate. Instead, bidding for available goods will drive up prices more quickly than the Federal Reserve Board would like, causing it to raise interest rates faster than the pace almost certain to start this month with one of three increases this year, creating a headwind to growth. And imports, which don't create growth and jobs here, will flood in to make up the gap between healthy demand and inadequate supply.
Here is the odd part. At the same time as a record number of Americans have dropped out of the workforce and are no longer looking for work, severe labour shortages are developing in many industries. The National Homebuilders Association says there are 200,000 unfilled construction jobs, and that even rising wages are not attracting workers with the relevant skills, since most of those laid off in the housing bust are not trained to use new technologies and materials that homebuyers are demanding. Oil companies complain that they can't find enough skilled workers to maintain existing facilities and drill new wells, which can be profitable at current oil prices. Fast-food businesses are competing for workers: "It's a hot jobs market. Every employee, whether they're 17 years old or 40 years old, has options", one fast-food operator told Bloomberg Businessweek. About half of small businesses report job openings they cannot fill. The list goes on. There are 5.5 million job openings in America, a record high, while over 2.3 million unemployed workers are not actively hunting for jobs. There's a mismatch between the skills employers need and what workers have to offer.
Let's assume that long-run measures that include better education resulting from greater competition for students, and effective job training will eventually remove this barrier to more rapid growth. That doesn't do Trump any good. He promised results in the here and now, not pie in the sky in the sweet by and by, to borrow from Joe Hill's 1911 parody of the psalm-singing Salvation Army. He wants his army of supporters, augmented by won-over doubters, to deliver to him complete control of the senate in 2018, in which he now holds only a slim majority.
Which is why he is pressing Congress to act on health care without delay. He wants it out of the way so the legislators can concentrate on tax reform. His plan includes provisions that will provide a "yooge" incentive for companies to invest in productivity-enhancing technologies (immediate write-off of capital investments), make work a more lucrative alternative to the couch (lower personal tax rates), and make exporting more attractive relative to importing. Meanwhile, he will continue to pressure American companies to move jobs home, and his cabinet to roll back job-killing regulations.
If he can get that done, he will have his 3-and-1/2-percent solution. Share prices are signalling that investors regard that as a certainty. They should know better.