2013 U.S. Economic Outlook
Election years always make for good political theater, and this year was no different. Unfortunately, they are generally not good times for making serious policy. As a result, a slew of tough economic and tax policies were pushed to a lame-duck session or beyond. While Congress and the administration were able to pass legislation to avoid the fiscal cliff, the comprehensive tax reform and entitlement reform needed to put our fiscal house in order were left unattended. And it is difficult to tell whether Congress and the administration will be able to address these issues in the upcoming session.
Now that the new Congress is seated and the Obama administration is back in place for another four years, we thought it might be time to turn our attention back to jobs and the U.S. economy. Both the economy and the labor market are gradually improving, but progress is painfully slow. Last year ended with what appeared, at first glance, to be a surprisingly weak GDP report. Real GDP growth in the fourth quarter of 2012 fell 0.1% at an annual rate, the first decline since the trough of the recession in the second quarter of 2009. However, a slightly deeper look into the data suggests a somewhat rosier interpretation.
A Mixed GDP Report
Personal consumption, the main component of GDP, grew 2.2% at an annual rate in the fourth quarter, up from 1.6% in the previous quarter—a pace consistent with about a 2% growth rate in the whole economy. Financial markets have contributed to recent improvements in household wealth. In the third quarter, the latest data available, net worth rose by $1.7 trillion. Financial assets are now performing better than they were prior to the recession and while real assets—i.e., real estate assets—are still slightly below those levels, improvements in household wealth should brighten the outlook for consumer spending in 2013.
Business and especially residential investment were also relatively healthy. The overall weak GDP number was due primarily to a big drop in government spending and inventory gains that were well below the prior months’ readings. Together, these two components accounted for more than a 2.5 percentage point reduction in the overall growth rate. A more complete picture thus can be gained by averaging the last two quarters together and noting that the economy softened in the second half of last year but ended the year with a growth rate of 2.2% in 2012, up slightly from 1.8% in 2011.
Business investment rose moderately in the fourth quarter, with investment in equipment and software up 12.5% at an annual rate after a small 2.6% decline in the third quarter. Going forward, businesses will be reluctant to boost investment without stronger and more sustainable demand.
Capacity utilization rates have steadily increased since the end of the recession; however, at 78.8%, significant unused capacity remains. As a result, we expect only modest investment growth averaging about 5.0% next year.
A Tepid Labor Market
While a small improvement over the prior year, last year’s growth was not sufficient to make much headway in creating new jobs and driving down unemployment. Last year, the economy was only able to generate an average of 180,000 net new jobs per month. Despite this relatively poor performance, however, the unemployment rate dropped from 8.5% to 7.8%, a drop that was only possible because of a plummeting participation rate. The participation rate ended the year (and the Obama administration’s first term) at an abysmal 63.6%—nearly a 30-year low!
The tepid growth has led to an equally tepid labor market, and there are few, if any, signs of acceleration. In January, the economy added 157,000 net new jobs, and the private sector added 166,000. This jobs number is less than the 180,000 monthly average for all of last year. The household survey showed only 17,000 net new jobs, and the unemployment rate rose 0.1 percentage point to 7.9%.
Moreover, the current unemployment rate understates the true slack in the labor market because it fails to account for about 2.4 million people who have not actively sought a job in the four weeks prior to the survey date. Also, 8 million people are working part time even though they would prefer to work full time because they cannot find a full-time job. If we were to include these groups, the rate of unemployment and underemployment is 14%.
Initial claims for unemployment insurance are gradually trending lower, but at an average of 350,000 per week, claims remain high by historical standards. Further, for many millions, a layoff now results in a longer period of unemployment. The duration of unemployment is well above historical norms, with an average duration of 35.3 weeks and a median duration of 16.0 weeks.
Going forward, we expect the economy to recover from the fourth quarter’s recent low, but we do not expect stellar growth. The first half is expected to average about 1.75% and increase throughout the year, reaching about 3.0% by year-end. There are a number of factors underlying this projection.
Bright Spots in the Economy
One bright spot in the economy is the continued expansion in housing markets. This growth has not been uniform on a month-to-month basis but is consistently trending up. In December, starts jumped 12.1% after falling 4.3% in November. Sales of existing homes fell 1.0% in December following a 4.8% increase in November. New home sales fell 7.3% in December after rising 9.3% in the prior month.
Housing prices have finally stabilized. Median prices of existing homes rose 11.5% in December following a 1.4% increase the month before. Prices for new homes rose 1.4% in December following a 1% increase the previous month. Over the last year, existing home prices are up 11.5% and new home prices are up 13.9%.
The recent improvement in the housing market has reduced the inventory of unsold homes. Subprime delinquencies and foreclosures remain high but are slowly trending downward. Finally, low interest rates are keeping housing affordability near historic highs.
Interest rates are expected to remain subdued over the next year because of the continued actions of the Federal Reserve. In addition, the Fed will continue its current policies of buying $40 billion in agency mortgage-backed securities and $45 billion in Treasury securities each month. The Fed remains committed to maintaining an accommodative stance on monetary policy at least until the unemployment rate drops below 6.5% and inflation remains below 2.5%.
Events in Europe remain tenuous, but the risk of a Eurozone breakup no longer seems imminent. However, serious problems remain even though they have been kicked down the road for now. Europe appears to be coming out of a recession and, Germany, in particular, will do better in 2013. Even modest improvements will improve our trade performance and boost the prospects of U.S. companies.
Modest oil prices will also help consumers. Prices fell from over $100 per barrel at the start of last year to just over $87 in December. Prices have begun to climb in the new year, but we expect these gains to be modest and short lived amid weak global demand.
The outlook for the economy is solid but not spectacular. We are still not growing fast enough, but we have thus far avoided compounding problems through downright stupid policy decisions. There are headwinds however. Both businesses and households will have to adjust to higher taxes and the prospect of further uncertainty as Congress and the president deliberate over sequestration, the prospects of tax reform, and actions to get our fiscal affairs in order.
Brian Higginbotham, an economist at the U.S. Chamber of Commerce, is the primary author of this article.