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With this month’s commentary, I return to the economy. Growth is continuing, but the growth rate is slowing. The jobs market is cooling, as the unemployment rate is now 3.9% versus 3.4% reached a year ago,¹ and some measures of consumption activity are weakening.

Consumer sentiment data remains reasonable, but people remain focused on higher prices. I recently wrote a piece that covered the concept of “reference pricing.” Reference pricing is what we as consumers are used to paying for something, but current prices are higher than our reference. Reference pricing tends to lead to delayed purchases, soured sentiment and disgust—note the chart below of consumer optimism, an average of Consumer Sentiment and Consumer Confidence indexes—from our friend Ed Yardeni. By the way, I have always viewed sentiment data as a proxy for the willingness to consume.

Our gross domestic product growth expectation for 2024 remains at 1.5% to 2.0% this year as compared to the full-year growth rate of 2.8% reached in 2023.² 

Inflation Expected to Ease

We believe the slowing in growth should eventually lead to less pressure from the aggregate demand side of the economy, softening growth in inflation pressure. I’m looking for “core” inflation to fall to 2.5% by the end of the year. Currently, the Core Consumer Price Index is at 3.6% over the last year as compared to 5.5% a year ago.³ Inflation has been declining slowly and should continue to do so over the remainder of this year. If so, this should provide the cover the Federal Reserve needs to soften monetary policy moving forward.

In the meantime, I want to provide an update on two of the major themes that I have been working on: worker productivity and labor force expansion—which, when added together, equals GDP growth.

Boom in Business Start-ups

Over the last two months, I have written commentaries that have focused on individual worker productivity growth. I have shown that over long periods, “societal wealth” goes hand in hand with worker productivity growth. From a historical standpoint, life expectancy has correlated with worker productivity trends as well.

Innovation and capital spending are key factors that lead to higher worker productivity trends. The Economist magazine recently reported that the U.S. is experiencing an “extraordinary” business start-up boom. 

Small-business start-ups tend to go hand in hand with innovation and the entrepreneurial spirit. Why take the risk of starting a new business unless you can build a better mousetrap? According to The Economist article, the creation of new businesses as measured by business start-up applications had declined over the 36 years ending in 2018, just prior to the Covid pandemic. In 1982, about 38% of the nation’s businesses were less than five years old. By 2018, just prior to the pandemic, the ratio of young versus older businesses had shrunk to 29%. Business animal spirits had arguably declined.

Innovation Powered by AI

Silicon Valley has been the home of serious technology prowess, and the technological giants—Google, Microsoft, Apple, Meta, you know the cast of characters—seemed to be the employer of choice for many young, talented engineers. Over time these young, talented engineers surely learned the Apple/Microsoft/Google way of doing things. Perhaps this employment preference has led to a decline in the spread of new productive ideas—ideas that could bolster worker productivity growth rates. 

The U.S. Census Bureau’s recent data shows applications to form a business rose to 5.5 million last year, an all-time high. According to the report, the 2023 application rate was about 80% higher than the average rate experienced during the decade prior to the Covid pandemic. The report notes that many of the start-ups are involved with applications and developments in the artificial intelligence (AI) space.

“It feels like a step-change increase across the economy in entrepreneurial potential,” said Kenan Fikri of Economic Innovation Group, a think tank, in The Economist. Fikri goes on to say, “You never know which firm is going to be the next growth firm, so the more shots on goal you have, the better.”     

Start-ups and Increased Worker Productivity

Of course, the big unknown is if the start-up boom will translate into increased worker productivity. Some of yesterday’s start-ups have become today’s producers of video games and social interaction applications. I suggest that these types of technology products may actually generate lower levels of worker productivity, rather than higher. 

However, some believe the development and build-out of AI will prove a boom to productivity growth rates. Labor productivity growth increased nicely last year but lagged in relation to historical norms for a period prior to 2023. Data from the St. Louis Fed shows annual productivity growth rates averaged a mere 0.3% from the end of the pandemic through 2022. Last year the growth rate increased to +2.9%.  

How may the AI build-out impact worker productivity? That is the big question. Interestingly, the International Monetary Fund (IMF) has produced a research report that estimates AI is expected to aid future annual worker productivity growth rates by 0.1% to 1.0%. From 1990 to 2023, the U.S. experienced an average annual increase in worker productivity of 1.9%.⁴ If the IMF report’s view is reasonable, AI may indeed drive productivity growth rates significantly higher than has been the case on average over the last number of decades. 

Perhaps the development of a new technology needs new businesses and ideas. Welcome to the recent technology entrants.   

Immigrant Labor Fuels Economy

When we ponder the state of economic growth, along with productivity, we need to also think of the size of the labor force. I addressed this issue in detail in one of my commentaries over the last two months. Since that writing, I uncovered an editorial in The Wall Street Journal that highlights the view that much of the improvement in our jobs market has been supplied by the “foreign-born” portion of the workforce. I have followed the work of Don Luskin, the author of this editorial, over the years. I find him to be a very good thinker and someone who doesn’t pull punches. His writing can be enlightening, as he can bring a new angle that is thought provoking.    

Luskin notes that data from the government shows us 3.2 million people have come into the U.S. via our southern border since July 2022. According to the Labor Department’s “household survey” (which is part of the monthly jobs report and is used to calculate the unemployment rate), foreign-born employment has increased by 1.8 million workers since July 2022. This means that about 56% of those who crossed our southern border have become employed over the last two years (the 3.2 million includes young children).

Foreign Born Drive Population Growth

Over the last two years (July 2022-April 2024), the U.S. economy generated 5.24 million new jobs.⁵ Of those, foreign-born workers took/earned 1.8 million, or 34.6%, of added jobs.⁶ This is one of the silver linings of a high immigration rate. If those workers hadn’t been here, it seems clear the U.S. economy wouldn’t have grown as strongly as has been the case, or labor costs—and inflation—would have risen more rapidly than what occurred.

Now, I’m as worried about illegal immigration as most people. Sovereign states all control their borders—all except for the U.S. This is a real issue the federal government has failed to successfully address. 

But from an economic standpoint, data from the Labor Department shows that immigrants have supplied 35% of the added manpower behind the current economic expansion. Looking at all the data, we need to remember that most immigrant adults, be they documented or undocumented, work.

Sources:

^1-6St. Louis Federal Reserve

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