Jefferies

Economics and Strategy

Secular Stagulation

— David Zervos, Chief Market Strategist

Since 2013, the concept of “secular stagnation” has become a key focus for both markets and policy makers. For those who need a quick refresher, the proponents of this idea argue that a combination of weak investment and strong savings causes a drop in both the equilibrium level of U.S. GDP growth and the risk-free real interest rate. Below is a non-exhaustive list of the standard proposed causes for this phenomenon:

  1. Aging demographics
  2. Increased income inequality
  3. Strong foreign demand for safe assets
  4. Labor market hysteresis
  5. Low levels of inflation at the ZLB (Zero Lower Bound)
  6. Financial sector deleveraging

Now, to be sure, since the financial crisis, annual U.S. GDP growth has averaged between 1.5-2% – a far cry from our post-war level of 3-3.5%. So there is no doubt that we have a little stagnation on our hands. And after almost nine years in this situation, it is certainly starting to feel a bit secular. Further, highly aggressive and unconventional monetary stimulus has failed to boost investment (or deter savings) enough to push us towards a more traditional growth outcome. As a consequence, the “stagnationists” continually argue that the cure for this problem rests upon a standard Cambridge/Berkeley/CUNY-style Keynesian fiscal stimulus program. If we just issue a bunch of debt and then use the proceeds to repair/build roads, bridges, trains, and airports, the glory days of 3-3.5% growth will quickly be upon us.

Of course, this conclusion should surprise no one. Economists trained in a traditional saltwater Keynesian style nearly always come up with the same policy solution for any problem: more big government deficit-financed spending programs. They particularly like the ones where they get to choose the winners and losers. But there is an alternative way to look at this stagnation issue, one that focuses on the supply side rather than the demand side.

With that in mind, I want to propose today that the largest driver of weak investment, low GDP growth, and low equilibrium real rates is actually REGULATION. In the post-crisis era (and even before the crisis) businesses in many sectors faced an ever-accelerating (and confusing) level of government red tape. And this has not just occurred in the obvious case of the financial sector – the healthcare, energy, and transportation sectors have also seen significant increases in their regulatory burden. The real story is NOT some sort of Hobson- or Hansen-style theory rooted in insufficient aggregate demand, it’s simply a supply-side-driven story associated with excess regulation.

In order to give you a little feel for the potential size of this burden, I provide the following link to a pie chart from a presentation by the Competitive Research Institute: jefferies.com/CRI (page 10). I try not to use charts in these commentaries in an attempt to keep things simple, but when I saw this one I nearly fell out of my chair. It suggests that nearly 10% of U.S. GDP is associated with the cost of federal regulation and intervention. It’s no wonder we can’t generate productivity growth: Economic activity requires an ever-increasing spend on “nonproductive” regulation!

Now I’m sure I will get plenty of pushback on this idea. In particular, the advocates of secular stagnation are wont to say, “If the regulatory burden is so extreme, why are corporate profits at record highs?” Well, there is a very easy answer to that. This excessive regulatory burden has reduced competition. We currently stand at multi-decade lows in terms of small business formation. And the high levels of fixed-cost regulation create significant barriers to entry, thereby allowing oligopoly or even monopoly rents to accrue to the existing larger businesses. In fact, some folks with a more Machiavellian view may even believe that the largest business conglomerates go to Swiss ski resorts every January to meet with global policy makers in order to keep resetting the regulatory barriers just high enough to stymy the competition and maximize their profits. But I digress!

The bottom line is that slow output growth, low equilibrium real rates, weak investment, high corporate profits, low productivity growth, and tepid new business formation are all consistent with the view that increased regulation is behind our stagnation. In addition, the market reaction to Trump’s victory, as well as the post-election surge is business optimism from survey data such as the NFIB (National Federation of Independent Business), suggests that Trump’s deregulation theme is registering positively with the business community.

I would therefore like to coin an alternative concept: “secular stagulation,” where the word stagulation is derived by combining the words stagnation and regulation. And whether or not you believe in this storyline, I hope I have at least got you thinking that the cure for our post-crisis economic weakness may not rest on some sort of Japanese/Keynesian/Cambridge/Berkeley/CUNY-style deficit-financed government spending increase. Rather, if we focus on the supply side and pursue a wholesale repudiation of excess regulation, the “new normal” concept will quickly revert back to just plain old “normal.”