Setting the stage for growth in 2011

The latest from Robert Barr in this week’s SAF Trend Tracker:

The nature of this recession – caused by a financial panic – means that the recovery is not playing by the customary script this time.  Housing, for example, usually leads the economy out of a recession, as low interest rates spur new residential construction and home sales.  But the number of troubled properties on the market remains high, even though much of the excess supply is concentrated in just a few markets.  In terms of being a source of strong economic growth, housing will likely sit on the sidelines for a few more years.

The good news is that the economy is growing, albeit at a slower pace than we’d hope – and too slow a rate to bring down the unemployment rate, for now.  In fact, the unemployment rate climbed in November to 9.8%, up from 9.6% in each of the three previous months.  But the labor markets are always a lagging indicator of economic recovery.

Other important figures reflecting conditions more “upstream” in generating economic growth tell a different and much more positive story.  For instance, corporate profits are up 28% over year-ago levels (fueling the stock market improvement).  And business investment in software and equipment is booming, up 19% in the past year.  That’s the strongest four quarters of growth in that segment in 26 years – even surpassing the build-up to Y2K.  These developments do follow the usual story for economic recovery, as business owners, prodded by lower interest rates, add to business investment.  As entrepreneurial activity and investment grow, corporate America lays the groundwork for stronger economic growth in the coming quarters.

Mix the strong activity here with the relatively strong kick-off to the holiday shopping season, and you get a strong sense that the recovery is in fact taking root – and that fears of a “double-dip” recession are overblown.  And not only are the early reports from the nation’s large retailers positive, they also indicate that consumers are spending money on themselves, too – in contrast to the last few holiday seasons, when spending was more constrained.

Finally, the tax compromise that was coming together in early December could, if enacted according to the announced framework, provide some important fuel to stronger economic growth.  The extension for two years of the current set of income tax rates – rather than the increase currently slated to go into effect on New Year’s Day – not only helps the entrepreneurial segment, but it ends some uncertainty, at least for now, about tax rates.  The one-year cut in the Social Security payroll tax also generates a bit more cash for households, but, more importantly for economic growth, the investment expense provisions and the lower capital gains tax, currently at 15 percent, should prove to be an important business incentive.

Robert Barr is an economist based in Virginia.

Sources: Bureau of Labor Statistics (Dec 3, 2010); Bureau of Economic Analysis (Nov 23, 2010); Moody’s Analytics.

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