US Economy

Why Donald Trump may have the recipe for a 3% economy half right

Here's what a 3% economy looks like...

What's the secret sauce for making the economy boom, and does President Donald Trump have the right recipe?

A detailed look at the years the economy has grown more than 3 percent since 1990 suggests Trump will have a tough time getting there and that he may have the right ideas for some parts of the economy but the wrong ingredients for others.

The economy has achieved 3 percent or better annual growth in gross domestic product just nine times in the past 27 years, and the last one was 11 years ago. So it's fairly rare occurrence, and Trump will be lucky to hit that number, let alone the 4 percent he pledged during the campaign.

President Donald Trump speaks at a meeting with union leaders at the White House on January 23, 2017 in Washington, DC.
Getty Images

The analysis shows that boom-like growth requires an economy firing on all cylinders. Consumer spending, which accounts for 65 percent of growth, needs to sport annual gains of 3.5 percent or better. But that's not enough.

Productivity has to surge. It has averaged just over 1 percent annual gains since 2010. It averages 2.7 percent during the boom years and 2 percent since 1990. Population usually grows about 1 percent, compared with the 0.7 percent of the current expansion.

Business spending and exports play a vital role in getting the best growth — two areas where Trump has promised to focus. But so do government spending and imports, places some economists fear Trump's policies could fall short.

When the economy booms, business investment grows on average 9 percent a year, or more than double its long-run average. Currently, total private investment is rising about 1.5 percentage points below the average growth for the boom years.

"The biggest thing you need is more business investment, that's the piece that's been pretty lackluster," said economist Stephen Stanley of Amherst Pierpont. "A good tax reform program and regulatory relief done well and you could see significant improvement on the supply side."

And the data suggest Trump is right that exports could use a boost. Export growth is now about normal compared to the long run average of 5 percent annual gains, but it usually ratchets up above 7 percent during the boom years.

Where Trump could be wrong is imports and government spending. Imports surge during the boom years, often rising by double digits in the best years of growth. There's no way of telling if this a reason for the boom, or the result of it. But the last two times growth surged above 3 percent — in 2004 and 2005 — the trade deficit surged as imports rose more than exports. It could be that imports surged to satisfy booming consumer demand. Or it could that companies bought goods and commodities overseas and sold them more profitably in the United States. This underscores a debate among economists about just how harmful the trade deficit really is.

While Trump has portrayed the trade deficit as a negative for the economy, this analysis suggests otherwise. It shows imports rise with economic growth and they rise even more when the economy booms. So Trump could hurt his own efforts to boost growth by slapping tariffs on goods and curtailing import growth.

Federal government investment is trickier. It is all over the map during the boom years, but it is never negative. In general, government spending has grown about 1 percent a year since 1990 and averaged 1.5 percent growth during the boom years.

But a look at the current expansion shows that government spending was, in fact, one of the weakest parts of GDP growth. From 2010 thru 2015, federal government spending fell an average of 1.1 percent a year. It only turned positive in the past two years and would need to rise another half percent to look like the boom years.

Again, it's unclear if federal government spending rises because of better growth, or if growth boosts spending. It could play a different role in different expansions, providing essential investment for some booms while in others, it's just the result of politicians spending the money from a treasury flush with revenue. But in none of the nine years of 3 percent plus growth has government spending fell.

Trump's plans for government spending are unclear. He has pledged to cut nondiscretionary defense spending by 1 percent a year, at the same time that he has talked about big infrastructure projects and increased defense spending.

The analysis also shows that boom years, not surprisingly, are very good for stocks. They tend to rise at twice the average rate during the boom years, or 16 percent on average. Here the averages can be deceptive: The S&P was up only 2 percent when the economy hit 4 percent growth in 1994 but surged 24 percent in 1998. Timing can be perilous. The year after the strong growth of 2000, the S&P fell 16 percent.

But inflation tends to tick up only slightly, running on average at 2.7 percent during the boom years, compared with a 2.5 percent average since 1990.

If Trump does engineer higher growth, it could be more complicated when it comes to inflation. The unemployment rate averaged 5.4 percent the year before each of the nine boom years, from a high of 6.9 percent in 1993 to a low of 4.2 percent in 1999. The current unemployment rate is 4.7 percent, which means Trump would start with a tighter jobs market than other boom years, raising the prospect of sparking higher inflation.

Trump's best hope is that a faster expansion brings in some of those not in the labor force, especially those who have dropped out, pushing up the participation rate and providing the workers needed to fuel stronger growth without inflation. The unemployment rate fell in each of the boom years except for 1992. Leaving that year out, the unemployment rate declined an average of 40 basis points compared with the year before when growth exceeded 3 percent.

That could have a critical effect on rates, which don't necessarily have to soar when growth rises. The 10-year note has averaged 5.8 percent during the boom years. But when GDP topped 3 percent in 2004 and 2005, the 10-year yield averaged just 4.3 percent. That seems to be part of a long-term trend of lower rates over time, both nominal and inflation adjusted.

So rates may not go up as much if Trump can engineer a rise in growth with strong productivity and finds the workers to do it. The Fed will be watching these metrics carefully, and it's a reason some officials have spoken skeptically of the need for broad tax cuts and fiscal stimulus at a time of full employment.