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Contents | Executive Summary | How to obtain this publication | Additional information
The following OECD assessment and recommendations summarise Chapter 1 of the Economic survey of the United States, published on 29 May 2007.
Contents
More than five years into the recovery, the economy continues to perform impressively
The economic expansion that followed the 2001 recession continues at a healthy pace. This is all the more remarkable since economic growth in 2006 – 3¼ per cent as in the year before – was achieved in the face of strong headwinds, such as surging energy prices until the summer and a sharp decline in home construction through the year. The resilience and continued good performance of the economy can in part be traced to past regulatory reforms that created a very competitive environment by international comparison and contributed to impressive efficiency gains over the past decade. With robust growth, labour markets have tightened and some capacity pressures have emerged. Still, given the energy price shock, core inflation has remained relatively well contained, as price and wage setters have expected the monetary authorities to keep inflation low. Although the fiscal stance has been broadly neutral, government finances have continued to improve thanks to an ongoing buoyancy of revenues that has outweighed additional spending. At the same time, the current account deficit has broadly stabilised relative to GDP – albeit at a high level, reflecting the strength of export growth and lower energy prices.
With the expansion less dependent on household spending, the near term outlook looks favourable
While household demand used to be the mainstay of activity in the first few years of the recovery, last year saw a shift of demand toward business investment and exports. This bodes well for a continuation of the economic expansion. Some spill over effects from the housing market correction are likely to damp activity in the near term, but growth should pick up again when the housing market adjustment has run its course. Easing capacity pressures and the fading impact of last year’s energy price increases would bring core inflation down to more comfortable levels, while strong exports, supported by increasing activity abroad and a favourable competitive position, would prevent the external deficit from widening. There are significant risks to such a benign scenario, however. On the one hand, the housing market correction and spill over effects onto consumption could be more pronounced than generally expected. On the other hand, consumer spending may hold up better than projected, despite the negative household saving ratio, and cause price pressures to increase rather than ease.
The challenge for monetary authorities is to rein in inflation without imperilling growth prospects
The Federal Reserve faces the difficult task of carrying out its dual mandate in an environment where inflation remains uncomfortably high and real economic growth, while still apparently solid, faces downside risks. In the first few years of the recovery, it has successfully balanced the need for supporting activity and preserving price stability. With increasing signs that the upswing had become self sustained, monetary stimulus was appropriately withdrawn over the two years to mid 2006, when the monetary stance turned slightly restrictive. Since then, the monetary authorities have refrained from further monetary tightening, although core inflation has remained above their comfort zone. This reflects their view that some of the factors that had pushed up core inflation are transitory, that inflation expectations apparently remain well anchored, and that the cooling housing market should, over time, ease resource and price pressures. There may be scope for reductions in interest rates once core inflation is on a clear downward trajectory. For the moment, however, it seems appropriate to keep policy on hold until a clearer picture of output and inflation trends emerges. Should core inflation fail to ease, a further policy firming might be needed to keep inflation expectations in check.
The key challenges in the long run are to boost growth potential and ensure fiscal sustainability
The Administration has emphasised economic growth as a top priority. Ensuring such an outcome will be a challenging task, however, despite recent accomplishments. The growth in the labour force is slowing as the population ages and participation among certain groups is levelling off. Thus, the economy will increasingly depend on productivity gains to achieve GDP growth that can maintain the rise in standards of living for both the working age and the dependent population. Policies and global trends that have made the economy more open, flexible and dynamic thereby boosting productivity and overall prosperity may have increased inequality. If unaddressed, concerns about inequality have the potential for eroding support for such policies. There is a crucial need to improve education outcomes, which are central both to reducing inequality and boosting efficiency. Population ageing, along with medical cost pressures, will also put enormous pressures on government finances that need to be addressed early on to avoid an excessive burden on future generations and eventually a fiscal crisis. While economic growth is unlikely to solve the country's long term fiscal problems, it can help mitigate budgetary pressures in both the short and long run. In view of these various long term challenges, this Survey focuses on the following important policy areas:
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How to respond to slowing labour force growth?
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What reforms to entitlement programmes could restore fiscal sustainability?
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Should public support to housing be reduced?
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What are the appropriate policies to raise educational achievements and facilitate access to higher education?
While productivity performance has been impressive, slowing labour force growth is limiting economic growth
Trend GDP growth is slowing because labour productivity gains, albeit remaining high, no longer suffice to compensate for the deceleration in potential employment. The latter reflects a levelling off of labour force participation of women and the fact that the baby boom generation is entering low participation years. Productivity growth has weakened recently, but this is attributable, to a large extent, to cyclical factors. Over the past decade or so, productivity performance has been above the OECD average by a wide margin. The initiating force behind the productivity resurgence in the mid 1990s was the information technology revolution, together with the fact that, given the favourable economic environment, the United States has been better placed to benefit from the opportunities provided by technological advances than most other countries. In recent years, strong productivity growth has spread from the high tech sector to other sectors, in particular service producing industries, where it has outpaced that in (non high tech) goods producing industries. The diffusion of new technologies and their application to more firms and sectors should continue to underpin productivity gains, although their pace is likely to fall short somewhat of the brisk growth recorded in the first half of this decade.
Structural reform can help sustain productivity gains and boost employment
Even if productivity growth can be sustained at a reasonably good rate, this is unlikely to prevent potential output growth from slowing, given the trend decline in labour force participation. This suggests that it would be prudent to deal with unfinished business in structural reform. For instance, further efficiency gains could be achieved by reducing trade distorting support to agriculture, and continuing trade liberalisation. As to labour market trends, many of them reflect changes in preferences and demography that governments cannot influence. Nevertheless, there are some policy measures to boost employment that should be helpful. For instance, the disability insurance system appears to be discouraging a rising share of the population from staying in the workforce, probably to an unnecessary degree. This partly reflects replacement rates that have risen to unusually high levels, partly as a result of trends in health costs. To combat adverse incentive effects, these high replacement rates should be reduced and screening requirements tightened. Moreover, raising the age at which workers become eligible for full Social Security benefits would discourage premature retirement and also make the Social Security system financially more secure. Finally, with some evidence that increases in tax rates tend to reduce labour supply, efforts to restrain taxes and government spending may also be beneficial in this regard.
Growing inequality is undermining the support for successful free market policies
As noted earlier, the very factors that have contributed to economic success and rising overall standards of living market liberalisation and globalisation have had some side effects that risk undermining the support for such policies. Workers and households experience variability in their earnings and income from year to year and, over the past 25 years or so, income inequality has increased considerably. To a large extent, the rise in inequality reflects an increase in returns to investing in skills. This, in turn, is associated with technological advances, such as improvements in information technologies, which tend to raise the productivity and hence the wages of high skilled workers relative to those of low skilled workers. In addition to technological change, globalisation has been a factor behind rising inequality, though probably a less important one. There is some evidence to suggest that immigration has depressed somewhat the wages of domestic low skilled workers, and outsourcing appears to have had a similar effect. As to international trade more generally, any effect on the rise in income inequality appears to be small. Nonetheless, with a view to attenuating the adverse side effects of skill biased technological change and globalisation, consideration should be given to expanding trade adjustment assistance programmes (including wage insurance and health care support) to include additional, if not all, dislocated workers, regardless of the cause of dislocation. With skill differentials a major source of inequality, focusing on improvements in education is of key importance (see below). Raising the minimum wage is a poor means to address inequality and poverty. Even though the effects of recent legislation are likely to be limited, such a measure helps many workers who are not poor, fails to help many who are poor, and risks job losses. The Earned Income Tax Credit should be raised, because it reduces poverty more effectively than the minimum wage and delivers more favourable employment outcomes.
How to obtain this publication
The Policy Brief (pdf format) can be downloaded. It contains the OECD assessment and recommendations but not all of the charts included on the above pages.
The complete edition of the Economic survey of the United States 2007 is available from:
- SourceOECD for subscribing institutions and many libraries
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OLISnet, under "Publication Locator", for government officials with accounts ( subscribe)
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Additional information
For further information please contact the US Desk at the OECD Economics Department at eco.survey@oecd.org. The OECD Secretariat's report was prepared by Hannes Suppanz and Peter Tulip under the supervision of Patrick Lenain.
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