GRANTHAM: Here Are The Basic Forces That Will Send Growth To Near-Zero For Decades

jeremy grantham

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Jeremy Grantham recently released his quarterly letter to GMO clients.Titled “On The Road To Zero Growth,” the note was pretty depressing.

Grantham sees real U.S. GDP growth trending at 0.9 per cent through 2030, then falling to 0.4 per cent from 2030 to 2050.

Click Here To See How Grantham Got Those Numbers >
“Someday, when the debt is repaid and housing is normal and Europe has settled down, most business people seem to expect a recovery back to America’s old 3.4 per cent a year growth trend, or at least something close,” he wrote. “They should not hold their breath.

“A declining growth trend is inevitable and permanent and is caused by some pretty basic forces.”

Those basic forces include unfavorable demographic trends, decelerating productivity growth, tightening resource constraints, and rising environmental costs.

These are trends that have been developing for years. However, they have gone unnoticed thanks to the tech, housing, and financial booms and busts of the last 10 or so years.

We pulled the key charts and stats from Grantham’s note which help illuminate his thesis.

Let's start with demographics

Growth in the working age population has been falling rapidly

Hours worked per worker are also falling

The positive effect of women entering the workforce has leveled off

'This added about 0.25 per cent a year to work input up until 2000 when the trend ended. The demographic inputs peaked around 1970 at nearly 2 per cent a year growth (there are many ways to do these calculations, each yielding slightly different results). They fell to about 1 per cent average growth for the last 30 years and demographic effects are now down to about 0.2 per cent a year increase in man-hours where they are likely to remain until 2050, with possibly a very slight downward bias.'

Source: GMO

And now let's consider productivity

GDP per capita is falling

'It shows that productivity gains were negligible for centuries (as was population growth, for the record). We can see how growth slowly picked up first in the British Agricultural Revolution and then in the Industrial Revolution, rising to a then dizzying 1 per cent growth rate around 1900. With the surge of innovations -- steam engines, electricity, telephones, autos, and the full use of the stored energy of coal, oil, and gas -- the rate soared to a peak of 2.5 per cent at mid-century. And then it started to decline, with the estimated trend reaching 1.8 per cent in the year 2000. (The dotted line is his prediction of a further fall in the trend of productivity growth to 1.3 per cent by 2025.)'

Source: GMO

Declining education; income inequality; globalization; and debt overhang are all hindering productivity growth

Grantham references the recent work of Northwestern University economics professor Robert Gordon.

'Professor Gordon offers a further thought experiment by speculating that possible future growth in productivity might continue to go down, all the way back to the original growth rate of about 0.2 per cent. This argument is worth a look. Professor Gordon covers four topics of particular interest to me: declining education; income inequality; globalization; and debt overhang, all relevant issues in regards to growth.'

Source: GMO

Capital spending is abnormally depressed, which is bad for future growth

'(The savings and investment rate has a 25 per cent correlation with long-run GDP growth.) Mostly the data in Exhibit 5 reflects a lower capital spending rate responding to slower growth. The circled area, though, suggests an abnormally depressed level of capital spending, which seems highly likely to be a depressant on future growth: obviously you embed new technologies and new potential productivity more slowly if you have less new equipment. This currently reduced investment level appears to be about 4 per cent below anything that can be explained by the decline in the growth trend. If this decline is proactive, if you will, and not a reflection of earlier declines in the growth rate, then based on longer term correlations it is likely to depress future growth by, conservatively, 0.2 per cent a year.'

Source: GMO

Manufacturing productivity has been strong, but manufacturing has been falling as a share of the US economy

'A large long-term drag on past productivity gains has been the steady growth of the service sector and the commensurate decline in first farming and then manufacturing, which is shown in Exhibit 6. (The counter example of China is thrown in for contrast.) Productivity in manufacturing has actually held up remarkably well over the years in the U.S., as can be seen in Exhibit 7. We turn out to have an apparently inexhaustible supply of clever ideas in the making of cars and television sets and solar panels.'

Source: GMO

The services sector has been growing as a share of the US economy, but productivity has been falling

And now let's consider resource constraints

Resource costs have gone from declining to rising

'...in general the global picture until 2002 was one of erratic but generally declining resource prices. The average decline for 33 equally weighted commodities was 1.2 per cent a year. This negative 1.2 per cent is the sum of a positive increase in marginal extraction costs -- deeper wells and thinner ores, etc. -- tending to push prices up and a more than offsetting negative force from technology -- finding and digging wells more efficiently, etc. -- pushing prices down.
...
Today, I believe that resource prices probably still have about 20 per cent fat in them, representing short-term supply catch-up, some judicious foot dragging in increasing supply, some speculation, and, more recently, a decline in Chinese growth, which seems very likely to settle onto a materially lower trend in the intermediate term of, say, 5 per cent or 6 per cent a year.
... To capture this I am mentally allowing for a further decline of 20 per cent in all commodities including grains, where I cannot get my brain around the idea of a fourth consecutive terrible global growing season! However, even after an imputed 20 per cent markdown, the prices will still have doubled in 10 years or compounded at 7 per cent a year. This is far higher than global GDP growth and painfully higher than growth in the U.S. or other developed countries. This 7 per cent a year increase, in my opinion, represents a paradigm shift in costs. Let us take this conservatively marked down 7 per cent a year increase in costs and compare it to that of the previous 100 years. Here I have assumed a steady productivity/technology benefit of 3.25 per cent a year.'

Source: GMO

Rising commodity prices will squeeze GDP for years to come

'The net effect of these price rises is to squeeze U.S. GDP growth and corporate profits, at least those outside the resource companies themselves. If the price trend of commodities continues upward, which I believe is nearly certain, then commodity company profits and their stock performance will continue to outperform as they have magnificently since the game changed in 2002, as we showed in last quarter's exhibits of the high correlation between real commodity price moves and relative performance of commodity stocks. Conversely, the squeeze on the rest of the economy will continue.'

Source: GMO

And now environmental costs

'Our farming weather is being hurt too often -- the last three years in a row have been extreme outliers -- and we have plenty of other food problems without making it unnecessarily worse. Increasingly severe floods and storms have other high costs. Of the 10 extreme floods in NYC since 1920 three have occurred in the last two and a half years! This September 21st, the Arctic ice had lost 75 per cent of the volume it had on average over the last 30 years. Not 2.3 per cent. 75 per cent! It used to reflect a lot of sunlight that will now be absorbed into the grey ocean. It could easily be all gone in 5 or 10 years.'

Source: GMO

Melting Arctic ice is causing a negative feedback loop

'Other self-re-enforcing feedback loops such as the melting of the Arctic Tundra and release of methane, a hundred times worse than CO2, may start up anytime and run out of control. We might well destroy the planet as livable for all but a small fraction of us in extreme latitudes. It is not worth taking the risk and it may not be too late.'

Source: GMO

Putting it all together, you get Grantham's depressing long-term growth outlook

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