Abacus: State of the US Economy

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The Bureau of Economic Analysis released the Annual Gross Domestic Report for the year 2018, this past week on 28th Feb 2019. Delayed due to the infamous government shutdown, the report came out almost two months late citing a strong 2.6 percent growth in the fourth and the final quarter of 2018. The US saw a 2.9 percent rise in its real GDP in 2018 after the Trump Administration projected a 3 percent growth last fiscal year.

In other words, the U.S. economy is booming according to President Trump. But for an average American, things have remained pretty much the same if not changing for the worse. A rising GDP indicates that more goods and services were produced and sold in the economy.

Employment rate and wages affect the GDP more than people think. A high employment rate with rising wages means more people are earning in the economy which leads to more people buying goods and services. Thus, a rising GDP should be linked with high employment rates along with rising wages. Unfortunately for the blue-collar American worker, things aren’t going as they should be.

Overall wages are increasing at a satisfactory rate. Wages increased by 1.1 percent in the last quarter of 2018, despite an ongoing expensive trade war with China. The U.S. has seen a 14 percent increase in wages since 2006. This seems like good news for the average worker, until real wages are looked upon. Real wages are the wages that are left with the worker after factoring in inflation and cost of living. With a mere growth of 1.9 percent of overall wages in 2018, real wages have fallen 9 percent since 2006. In simpler words, the income for a typical worker today buys them less than it did in 2006.

Graph - https://tradingeconomics.com/united-states/wage-growth

The blue line represents wages, and the red line represents the Consumer Price Index. CPI is the average of the amounts paid by an urban resident to buy a basket full of goods. In the past couple of years, real wages have diminished while CPI rose to lead to a rise in living expenses. An increase in GDP is usually accompanied by an increase in purchasing power of the population. People tend to invest more in goods and services during economically stable times, which in-turn, increases the GDP.

A higher purchasing power leads to higher demand for goods and services. The golden rule of economics is what creates trouble when everyone is on a shopping spree. A rise in demand for goods, lead to a rise in price or in simpler terms - inflation. A high inflation rate might destroy the economy. Rising inflation will keep on pushing the prices of goods and services higher and higher until things become unaffordable (Current state of Venezuela). To prevent this from happening, the Federal Reserve, who enjoyed its 116th Independence Day on 3rd March, keeps a check on interest rates.

The Federal Reserve is like a friend who will hide alcohol just when the party is about to start so that no one gets too drunk and creates a mess. In this analogy, alcohol is the return on investments. The more people have it, the more they will let loose and spend more. To not trash the place, the Fed increases borrowing interest making it more expensive for people to borrow money.

Following President Trump’s tax cuts last year, inflation spiked and reached 2.9 percent in July 2018. People were left with more money to spend so they did. The Federal Reserve quickly acted upon the issue by raising prices to gain control over excessive spending by people. President Trump was not a fan of rising interest rates and criticized the Fed for raising rates.

Interest rates were raised from 2 percent to 2.5 percent gradually over the course of six months to control inflation.

The U.S. saw another strong economic growth year, one of the biggest tax cuts, one of the lowest unemployment rates, the Feds controlling inflation well under a healthy 2 percent, but why the average US worker is still not benefiting?

The U.S. economy faced a slow income growth since the end of the recession in 2010. Wages didn’t grow as fast as the cost of living, despite a shrinking unemployment rate in a growing economy. The economic paradox has raised a lot of economists’ eyebrows. During the time of low unemployment rate, companies will find it difficult to keep their workers, forcing them to pay more, which ultimately leads to risen wages. But, in the past two years of historically low rates of unemployment, wages haven’t seen a rise as compared to the cost of living.

In 2018, prices rose in accordance to 1.9 percent healthy inflation rate. When this cost of living is factored into wages, it shows an actual change of 1.8 percent only. That means in the past year, wages have risen only about 1.8 percent, while CEO salaries saw an increment of 17 percent in 2017 alone. An average worker earned 20 times less than an average CEO and 321 times less than a CEO of an S&P 500 company.

The highly celebrated major tax cuts did nothing but flush the economy with a lot of cash, leaving a heavier fiscal deficit. Tax cuts provided a short-term sugar rush to the economy, but the economic growth is supposed to slow a bit down in the coming year. The Trade war in China hasn’t been helpful too. Economic uncertainty is always bad for the economy. Despite a well-sustained economy, workers might suffer the brunt of this expensive trade war. In times of economic uncertainty, companies tend to keep their expenses limited in anticipation of a bad economic turn. Meaning, wages remain constant.

Surprisingly, despite a decade long economic growth after the depression, wages have remained the same. Economists predict a slow but steady growth this year, but see the economy shrinking at the turn of the decade in 2020.

AnalysisVaidik Trivedi