A Tale of Two Economies

“This American carnage stops right here.”

– Donald Trump, Inaugural Address

“The Fed's goal is to promote financial conditions conducive to maximum employment and price stability... So where is the economy now, in relationship to them? The short answer is, we think it's close.”

– Fed Chair Janet Yellen, January 18

It goes without saying that there is a sharp contrast between the economic views of the incoming administration and those of the Federal Reserve. President Trump, and most of the individuals who voted for him, sees a weak economy, devastated by job losses in manufacturing. The Federal Reserve sees an economy nearing full employment. So who’s correct?

Most economists will tell you that we are in a “new normal,” defined largely by demographic changes. In the final decades of the 20th century, labor force growth was boosted by the entrance of the baby-boom generation into the workforce and a rising trend of female labor force participation. Those trends are well behind us, and the labor force is currently growing at about a third of the pace seen between 1960 and 2000 (slower labor force growth is a worldwide phenomenon). Hence, unless we see a sharp rise in immigration or a unprecedented increase in productivity growth, real GDP growth will be a lot slower than a few decades ago (1.5-2.0%, rather than 3.0-3.5%).

The trend in manufacturing employment was roughly flat between 1960 and 2000, but that masked a lot of flux in the sector. Factory jobs have always come and gone, but manufacturing output has increased substantially over the years. The number of manufacturing jobs dropped in the last two recessions, but failed to rebound as they had in past recoveries. Foreign trade, particularly with China, has been a factor, but it’s estimated that about half of the factory job losses have been due to technology improvements (robotics).

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Note that much of the increased trade with China came at the expense of other Asian nations. China appeared to be manipulating its currency about 10-15 year ago, weakening it to encourage export growth. However, that’s not the case now. China is actively trying to prevent its currency from weakening.