The U.S. Economy: In Rude Health

Did Kamala Harris lose the election because of the economy or in spite of the economy? Listening to pollsters, pundits and analysts on both parties the answer is clear: the American people are in a sour mood about where the country is heading: high grocery prices, lack of housing affordability, and a perceived deterioration in real incomes are among the main reasons given by many of those that decided to cast their votes for Donald Trump, despite reservations about his character and positions in other areas. And yet, the numbers tell a very different story. A recent survey in “The Economist” magazine came with a title in the cover-page that summarizes well what the most relevant economic indicators tell us about the US economy: “The Envy of the World”.

Start with some recent statistics. GDP growth in Q3 was 2.8% and it has averaged 2.9% since the beginning of 2023, way above other industrialized economies and higher than the US long term trend. Inflation, the scourge of the Biden administration, has come down from a high of over 9% two years ago to 2.6% on an annualized basis, close to the 2% target of the Fed. And Public Consumption Expenditures (PCE), a measure preferred by the Fed to calculate inflation, is running essentially at the 2% target. One might argue that GDP and inflation indicators bear little resemblance to the actual economic wellbeing of the average American. In this regard, personal after-tax income in real terms, a better measure of the purchasing power of consumers, has risen over 2.5% in 2024 and is now above the pre-pandemic levels, which helps explain the rise in real consumption of close to 3% that is keeping the economy growing at a healthy pace. It is often said that the best way to assess the health of the economy (and the mood of the voters) is to look at the labor market. On this score, the numbers also point in the right direction. The unemployment rate sits at about 4.1%, one of the lowest of the last 50 years. It’s too early to tell, but it is unlikely that the low September number of jobs creation of 12,000 is a sign of trouble, as it was heavily influenced by the impact of two hurricanes and the Boeing strike. Most importantly, the rate of labor participation for people aged 25-54, at over 80%, is close to historic highs. While some of these jobs have indeed gone to immigrants, including some of the recent illegal immigrants, the fact is without that additional supply of workers the labor market would be running red-hot, and inflation would not have come down.

So, the question is: what explains the resilience and remarkable performance of the US economy? Granted, a fiscal deficit of over 6%, the highest since the end of the Second World War and a main cause of inflation, has provided substantial stimulus, and largely explains the fact that consumers continue to spend at an impressive pace while keeping the savings rate at 5%, one of the highest in recent times. The preeminence of the dollar, and the insatiable appetite of world markets for US treasuries, allowed the US government to respond to the financial crisis in 2009 and the pandemic in 2020-21 with huge fiscal stimulus that would be hard to sustain in Europe or Japan. However, the strong performance of the US relative to other economies dates back to at least the 1990s and goes way beyond recent changes in economic policy. In 1990, the US accounted for about 40% of the GDP of the G-7 group of large rich economies; today, it accounts for 50%. On a per capita basis, the gap in output per person in the same period has doubled. The US has grown 10% since 2020, double the growth in Europe. In a famous speech at the UN many years ago, Fidel Castro, Cuba’s dictator, declared that “news about my death is premature”. The same can be said of the US economic power. In the 1990s, the fear was that Japan would overtake the US with its social consensus, higher quality products and company loyalty culture. As it turned out, GDP per person in the US is now 60% higher than in Japan and the Japanese economy is still trying to shake out three decades of stagnation. More recently, the fear has been that China would not just challenge the US for global leadership but overtake it in economic terms. In fact, there were no lack of predictions by economic forecasters and multilateral institutions that China would be the largest economy in the world, not just in purchasing power parity terms but at market exchange rates, by the end of this decade, if not sooner. Yet, the gap between the two has widened, with China’s economy representing about 65% of the US economy today, down from 75% in 2021. Goldman Sachs now predicts that in nominal terms the Chinese economy will not overtake the US until at least 2050, if at all.

Many factors account for America’s relentless economic dynamism, but two are particularly relevant: the shale boom that turned the US into the world’s largest oil and gas producer; and the technology revolution that has produced the likes of Open AI and Nvidia. Both share the same underpinnings: a low regulatory environment that allows companies and investors to experiment; vast and liquid capital markets that provide equity financing to new companies that would be difficult to replicate in any other country; and yes, for all its shortcomings and failures, government intervention in key areas. Of particular importance is the work of the Defense Advanced Research Project Agency (DARPA), that has provided funding and backed many of the projects behind America’s technological leadership. Add to this a large domestic market, a generous geography of continental size that has bestowed the country with plentiful natural resources, an attachment to the rule of law, and the best universities in the world.

There is, of course, no guarantee that the American economic miracle will continue indefinitely. The country’s debt-to-GDP ratio, the best measure of the fiscal health of the economy, has reached a level of almost 100%, three times higher than in 2007, and is now projected by the non-partisan Congressional Budget Office to exceed 150% in the next twenty years. No one knows at what level it will become unsustainable, but there is a risk that the market for treasuries will start to show strains at some point. So far, America’s dysfunctional and growingly acrimonious political environment has had only a moderate effect on the economy. However, both parties in Congress have been toying with disaster by driving the country to a near debt-default twice since 2023 and keeping the government constantly on the verge of shutdown. Even the shale boom could prove a liability if it traps the US into an economic engine powered primarily by fossil fuels while the rest of the world transitions to clean energy. Fortunately, despite all the rhetoric about reversing environmental regulations and eliminating most of the provisions of the Inflation Reduction Act (IRA), investment in solar and wind power continues apace and it seems likely that the main climate change provisions of the IRA will remain in place, as red and blue states enjoy the generous handouts of the federal government. And then there is the AI revolution that has the potential to transform the way we work and live. Goldman Sachs estimates that the increase in productivity triggered by the adoption of AI on a commercial scale could add 7% to global GDP growth over the next ten years, with America as the main beneficiary, though some other studies by reputable economists are more skeptical. The US currently accounts for about half of the world’s investment in AI, and it is poised to lead in its adoption by businesses and consumers and reap its benefits.

Finally, the policies the new administration of president-elect Trump will play a pivotal role in either the continuation or demise of the US economic pre-eminence for years to come. On the positive side, a good dose of deregulation and a reduction in government bureaucracy will likely provide lasting economic benefits. But set against this is the expectation of high import tariffs across the board that could prove highly inflationary. There is a not insignificant risk that tariffs, unless well targeted, could lead again to higher interest rates, an even larger cost of servicing the government debt, and push the country into a recession. The republican majority in both houses of congress, if confirmed, makes it very likely that the tax reductions of the first Trump administration will be extended beyond 2026, and that at least some of the campaign promises about extending tax exemptions to tips and overtime will be approved. Lower taxes, while good for businesses and consumers in the short term, would not only add fuel to an economy that doesn’t need it but would increase the fiscal deficit to even more unsustainable levels. The hope is that the more radical proposals will be tamed by moderate republicans and democrats in the Senate.

A dispassionate analysis of the US economy in the last three decades leads to the conclusion that it has performed well under both republican and democratic administrations. Despite toxic politics in Washington, the parties have always found ways to agree on the right policies when major crises demand action. The odds that Warren Buffet’s dictum that “betting against the US is never a good idea” continues to apply, remain high.