State of the US Economy: Growth, Risks, and Outlook

Overview of the US Economy

The United States has the largest and most technologically powerful economy in the world, with a per capita gross domestic product (GDP) of $40,100 (Index Mundi, 2005). It is best classified as a market-oriented economy, with private individuals and business firms making the majority of economic decisions, and federal and state governments purchasing necessary goods and services mainly in the private marketplace.

American companies enjoy more flexibility than their Western European and Japanese counterparts in decisions to expand capital plant, reduce labor, and develop new products (Index Mundi, 2005). However, they face more barriers to entry in their rivals' home markets than foreign firms encounter in American markets.

The United States is at the forefront of technological advances, particularly in the fields of medicine, computers, aerospace, and military equipment (Index Mundi, 2005). With a major increase in technology and related fields, the US economy has seen the gradual development of a "two-tier labor market" in which those at the bottom lack the education and skills of those at the top. As a result, workers at the lower tier increasingly fail to obtain comparable pay raises, health insurance coverage, and other benefits. Since 1975, the majority of gains in household income have gone to the top 20 percent of households.

According to Index Mundi (2005): "The response to the terrorist attacks of 11 September 2001 showed the remarkable resilience of the economy. The war in March–April 2003 between a US-led coalition and Iraq, and the subsequent occupation of Iraq, required major shifts in national resources to the military. The rise in GDP in 2004 was undergirded by substantial gains in labor productivity. The economy suffered from a sharp increase in energy prices in the second half of 2004. Long-term problems include inadequate investment in economic infrastructure, rapidly rising medical and pension costs of an aging population, sizable trade and budget deficits, and stagnation of family income in the lower economic groups."

Economic Recovery and Labor Market Trends

The United States entered a period of recovery and has been steadily growing for several years (Kohn, 2005). Most measures of economic recovery support the perception that the US economy is performing well overall. Real gross domestic product growth shows a significant rebound from the 2001 recession, and improvements in both the labor and product markets are evident across the country.

For a lengthy period after the 2001 recession began, there was little or no increase in employment (Kohn, 2005). In the early part of 2005, payroll gains increased to an average of 160,000 per month, and the unemployment rate fell to approximately five percent — nearly one percentage point below its 2003 level. Consumer spending on goods, services, and housing remained strong throughout this growth, and business investment in capital equipment increased dramatically.

This increase in output goes hand-in-hand with large improvements in labor productivity that, since 2002, have exceeded even the accelerated pace of the mid-to-late 1990s (Kohn, 2005). However, a drastic rise in energy prices negatively affected consumer confidence and spending. Even so, with financial conditions still healthy, profits and cash flow strong, and incomes continuing to rise, most forecasters expected growth to remain steady.

According to Kohn (2005): "Excluding food and energy, the rate of inflation has fluctuated around 1–1.5 percent over the past few years, measured by the chain-weighted price index for personal consumption expenditures. Core inflation has been running somewhat faster more recently, in part because of increases in the prices of energy, commodities, and imports that began last year. Nevertheless, barring further sizable increases in the prices of oil and natural gas, both core and headline inflation rates should moderate later this year. Buttressing this view, long-run inflation expectations have been, on balance, fairly stable in the face of these price gyrations."

Consumer Spending and Productivity

The consumer market is critical to the state of the economy. In 2004, household spending on homes and cars increased (Minehan, 2005). Throughout most of 2004, households continued to spend on homes and automobiles, buoyed by rising house prices, low interest rates, and a stronger stock market. Consumers were eager to purchase homes and stocks because doing so boosted their net worth. This steady increase in confidence and spending helped sustain general demand and production in 2004.

Consumer confidence also increased as unemployment declined. Between 2001 and 2004, job growth was slow (Minehan, 2005). In post-war history, it had never taken as long to regain the jobs lost during a recession — let alone to begin creating jobs at the pace required for an expanding labor force. During the second half of 2004, job growth increased, and over the six months prior to mid-2005, employment growth averaged approximately 180,000 per month.

The US economy appeared to be growing faster than any other major industrialized nation. Small businesses were performing well, workers were earning more, and new opportunities were expanding — all signs of a strong economy.

Productivity is another important aspect that affects the state of the US economy. After an approximately five percent pace of growth in early 2004, the rate of productivity growth declined slightly, but only to a still-healthy three percent for the year overall. According to Minehan (2005), "the major surge in underlying structural productivity that we have seen in the US economy over the last 10 years or so can have a remarkable impact in raising standards of living over time. And in the very near term, productivity growth has been key to the economy's good track record on inflation."

The future of the United States economy appeared positive. Economists predicted a continuation of the recent acceleration in job creation as the economy continued to grow (Minehan, 2005). Inflation, which had caused some concern due to its elevation above the 2004 pace, seemed likely to remain stable on the whole — though this depended on a series of favorable factors.

One of the main drivers of economic growth throughout history has been the US consumer. It was therefore important that household spending continue to support GDP growth at its current pace. Because the momentum from the 2003 tax cuts was fading and 2005 fiscal policy offered little new stimulus, growth in household disposable income — a major determinant of consumption — depended more heavily on employment growth (Minehan, 2005). Recent hiring data were encouraging, suggesting that job creation would provide the income growth necessary to support future consumer spending.