Tax reform naysayers should scan the latest GDP report

Tax reform naysayers should scan the latest GDP report
© Greg Nash

The long-delayed fourth quarter GDP report showed that the economy continues to grow at a solid pace despite the widespread pessimism in financial markets that the expansion could be losing steam. 

Real economic growth advanced at a 2.6-percent annualized pace, propelled by a solid rise in consumer spending and a surprisingly robust gain in business investment.

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Consumer spending in the fourth quarter increased in real terms at a 2.8-percent annualized clip, a little slower than the third quarter rise but in line with the average for the year. The result was fine, but it could have been so much better. 

The December retail sales report, one of the first data releases delayed by the 35-day federal government shutdown, showed an implausibly steep drop that was in sharp contrast to the broadly positive reports from private surveys and companies’ own sales and earnings announcements. 

It is not clear how or why the shutdown might have distorted these figures, but the odds are very good that the December retail sales figures and, in turn, the fourth-quarter consumer spending reading, are lower than the underlying reality. 

In fact, we appeared to be on pace for a quarterly advance approaching 4 percent in real terms, which would have been one of the best quarters in several years, before the stunning retail sales disappointment. 

In any case, the U.S. consumer remains in good shape, as a robust labor market is generating low unemployment and — finally — accelerating wage gains, while household balance sheets in the aggregate are as clean as they have been in decades.

Meanwhile, the prevailing narrative has been that business investment enjoyed a brief pop in early 2018 on the back of corporate tax reform but was already losing steam by the second half of last year. Thursday’s GDP data will require an update to that narrative. 

While investment in structures slipped, outlays for business equipment jumped at a 6.7-percent annualized rate, easily exceeding the gains seen in the second and third quarters.

Even more impressively, business expenditures on intellectual property (mainly research and development and software purchases) exploded at a 13.1-percent annualized pace, the third quarter out of four in 2018 when this category has posted a double-digit advance. Apparently, the death of business investment has been greatly exaggerated. 

The continued gains in the intellectual property component of GDP are fantastic news for the economy. Through most of the current economic expansion, business investment has underperformed historical norms. 

The dearth of investment contributed to an unusually slow pace of productivity gains, as, for a variety of reasons, firms have not invested in the sort of new plant, equipment and software necessary to rapidly advance the productivity of their workers. 

This in turn has generated a disappointing pace of trend GDP growth (the Fed’s latest estimate is below 2 percent). However, a more favorable economic outlook and the massive inducements to invest offered by the 2017 corporate tax reform are, in my view, continuing to encourage businesses to spend more aggressively to improve their operations. 

Major investment projects often take years to work their way from the planning stage to placing an order to taking delivery and then fully integrating the new plant or equipment into the production process. The notion that the benefits of corporate tax reform would evaporate after a mere six months is not credible. 

We are still a long way from economic perfection, but the economy did achieve roughly 3-percent growth in 2018 (2.9 percent on a year-over-year basis but 3.1 percent from fourth quarter 2017 to fourth quarter 2018), something that skeptics thought was not possible. 

Today’s stronger-than-expected data on business investment also bodes well for productivity growth going forward and thus further tips the scales ever so slightly toward a higher potential run rate for economic growth in the future, an outcome that should be widely cheered.

Stephen Stanley is the chief economist for Amherst Pierpont Securities, a broker-dealer providing institutional and middle-market clients with access to fixed-income products.