The US economy is in second gear, but that still beats reverse

While the U.S. economic rebound reaches maturity, many Americans are still feeling the pain of the Great Recession. Despite the longest modern expansionary period in history, the recovery has and will likely remain at half-speed.

Annual gross domestic product (GDP) growth of around 2 percent in the United States is simply lackluster. Looking at post-slump recoveries since 1950, the average for a five-year expansionary period is around twice that. Although we see the recession risk in the next 12 months as fairly low, at a 20 percent to 25 percent chance, our forecast is for expansion to hover in the mid-2 percent range.

On the bright side, the domestic half of the equation remains healthy with private demand and robust hiring. Along with job gains, wages have finally begun to rise in earnest. This will help further fuel consumer spending with Americans’ balance sheets in good repair. Additionally, oil price stabilization could spur business spending.

{mosads}Against this backdrop, it’s worth remembering that economic expansions don’t die of old age. They often perish at the hands of a central bank that got behind inflation, forcing it to raise rates faster, slowing inflation, but with it the recovery. If U.S. inflation does heat up, the Federal Reserve may need to raise its benchmark interest rate faster, increasing the risk of recession, especially if the economy is still just toddling along.

Another expansion-killer would be the sudden imbalances in the economy from running too hot, too long. This may lead to either excessive inflation or an economic correction and recession. While we’re not at that point, we do see other risks. Foremost may be potential policy risks. The United Kingdom’s vote to leave the European Union, Italian voters’ rejection of government-backed constitutional changes, and far-right politicians rising in countries such as France, all pose some risk to the global economy.

In the United States, increasing trade isolationism represents a substantial threat to growth. President Trump has called for tariffs on China and proposed a 20 percent tax on Mexico, significantly raising the costs Americans pay for imports. However, should his tough trade talk be the start of a negotiation and not a steadfast stance, American workers could benefit. In the end, prohibitive tariffs’ costs to U.S. consumers could outweigh the benefits for American businesses. Furthermore, if production does return to the United States, ongoing automation may still mean less manufacturing jobs.

Promises aren’t policy. With the past in mind, we see President Trump making progress slowly, even with Republican control of Congress. While President Trump has often defied conventional wisdom, history shows very few campaign pledges become law as originally shaped and often require reaching across the aisle.

All told, President Trump inherits a much stronger economy than his predecessor, and there are areas where swift progress is possible. Foremost is American corporate tax reform. The current code—last reformed more than three decades ago and written for a manufacturing-heavy economy rather than today’s service- and technology-oriented one—desperately needs updating. At 35 percent, the U.S. federal statutory corporate tax rate is higher by half than the top E.U. average rate of approximately 22.5 percent. (However, by varying estimates, the average effective U.S. corporate federal tax rate was lower, but still higher when compared to non-U.S. global companies.)

Truly sweeping tax reform, combined with regulatory reform, could incentivize businesses to invest in the United States, giving the U.S. economy an extra boost. To do so, company managements would need to feel comfortable that the economy is strong. Compared to our major trading partners, it is. As such, we expect companies to raise their domestic investments.

Increased infrastructure investment also would be a boon to GDP growth. In a 2015 analysis, S&P Global found that every dollar spent on infrastructure returned almost $1.70 to the economy through the so-called “multiplier effect.” While that effect is now smaller given our economic strength, we would still see a benefit.

As part of the modestly healthy economy President Trump inherited, job gains averaged 183,000 a month last year and wages are now nearly 3 percent higher year-over-year. Still, there remains some slack in the economy with the labor participation rate near a 35-year low. While retirees may have left the job market, about half consists of able-bodied working-age Americans who may have quit looking for employment because they couldn’t find a job (or became convinced so). The longer these people stay out of the job market, the harder it will be for them to get back in. While the jobs market is getting stronger, there are still folks struggling to get back on their feet.

All of this has informed a Fed policy that has kept borrowing costs at historic lows. While the nation’s central bank has indicated it may raise rates more so than previously thought, it’ll still look to read the tea leaves on underlying economic progress.

Like the Fed, we are also taking a wait-and-see approach to viewing the prospects of the world’s biggest economy. Our current assessment is based on where the legislative process is right now, given the myriad uncertainties that exist with regard to government policy under the new administration, and when the effect may be felt. As such, we maintain our current forecast of 2.4 percent growth in 2017, and 2.3 percent in 2018.

Beth Ann Bovino is U.S. chief economist for S&P Global. The views expressed here are hers. While these views can help to inform the ratings process, sovereign and other ratings are based on the decisions of ratings committees, exercising their analytical judgment in accordance with publicly available ratings criteria.

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