Smythe: Economy doing well at midyear, but more is required

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At the start of 2018, Furman University business and accounting professor Thomas Smythe gave us his thoughts on what the 2018 economy would hold. We checked back with him for a mid-year update.

GSA: Halfway into 2018, how are the nation and state doing economically?

Smythe: Generally speaking, we are doing well. At the national level, GDP is growing in the mid-2% range, unemployment is at an all-time low and the Fed has quickened its pace with interest rate increases. Normally, one might see that as negative, but it suggests that the Fed is confident we no longer need loose monetary policy. More specifically, the Fed sees the bigger risk as being inflation.

However, there are three significant headwinds in my mind. The first is the fact that the economy is not growing anywhere close to the 4% the administration projected when it was selling the tax cut at the end of 2017. Some would argue, and rightfully so, that the tax change has not had time to work through the economy. However, most economists outside of Washington, D.C., scoffed at the possibility of 4% growth, especially for an extended period. I fall into that camp. The idea of prolonged 4% growth without inflation seems highly unlikely. So, if we then dial back our growth estimates, the basis for the tax cut falls apart. The result will be a more rapid growth in the country’s debt and a sooner-than-expected debate on the debt ceiling — again.

The second headwind is that while employment numbers have improved substantially, wage growth has not. There was a great deal of fanfare when a number of large companies gave bonuses at the end of 2017, indicating that it was a direct response to the tax cut. While any increase in pay is good, it now appears that the bonuses might have been a one-time gesture, and the skeptic in me says it was mostly for show. While some employers, like Walmart, committed to raising hourly wages, the aggregate data to this point indicates Walmart is the exception, not the rule. As an employee, I would much rather have my hourly wage or salary rise instead of a bonus because it is permanent, and my next raise will build upon it. Again, one could argue that it is too early to tell if the corporate tax cut will flow through to employees on a more permanent basis, but the data to this point suggests not.

Finally, the biggest head wind is one I alluded to earlier this year — trade. In January, my concern was based on threats by the administration about tariffs. Well now those threats have become reality. We will suffer as a result of these actions. In fact, by imposing these broad tariffs, it will counteract positive effects from the tax cuts for consumers as prices will likely rise. We will not be able to ramp up production quickly enough to offset supply restrictions, therefore leading to increases in prices. Of course, this will further slow GDP growth at some point, meaning the debt problem will be even worse. Simply stated, this is bad policy and a significant departure from a decades-long policy initiative of Republicans. The retaliation from our trade partners has been swift and significant. I think the problem is most acute with Europe. The last time we had a significant trade spat with Europe, it was with a set of more than 20 independent countries. That is no longer the case. With the growth of the European Union as a bloc, they now have a market that is 50% larger than that of the United States. We are no longer engaging in tit-for-tat with Poland, Belgium and others, but Europe as a whole. Having lived in Brussels the first five months of this year, I can assure you that one of the things that all of Europe is united on is that they are ready for a battle with the U.S. economically.

GSA: What economic advantages/disadvantages do you see or expect from recent tax cuts?

Smythe: I outlined some of my concerns on the employee/personal side in the 2018 preview piece in January, like the fact that the personal tax cuts are set to phase out, and in my answer above, prices rising from trade policies may offset, at least partially, the tax benefits.

The reality is the corporate tax cuts are a huge boon for companies. It’s a little too early to tell how they are responding, but there are essentially four things they can do. Firms can invest more in research and development; they can invest in physical assets; they can invest in their people, and/or they can distribute more to shareholders in the form of dividends or stock repurchases. It’s a little early to tell which of the four approaches or combination of approaches firms will target with the additional cash. The first two may take time to realize because of the nature of the investments; they are long-term by their nature. It’s not clear at this point if training programs for employees have increased, but from my earlier answer, firms do not appear to be investing in employees in terms of higher wages. Finally, over the last 15 years, an extremely high proportion of firms have been repurchasing stock at ever higher levels, even at the expense of the other three categories. By year-end, we will be able to determine if firms are giving shareholders the bulk of the tax cut. The key is that just because rates were lowered for firms does not mean that they will invest it in research and development, assets or people. They may simply pass that benefit on to shareholders.

GSA: Counties in the Upstate are reporting low unemployment numbers. To what do you attribute that, and will it continue?

This is a natural outcome of economic growth, which is occurring nationwide, but has been particularly robust here in South Carolina. This also is evidence that South Carolina companies are expanding, and likely investing, for the future. You need not look further than Greenville and its surrounding areas to see this in the real estate market. But, as real estate is developed, more people have money to spend on everything, which of course leads to more jobs in the firms that serve people, which is all firms. Whether or not this continues, and at what pace, is a bit of a loaded question. Job growth will level off at some point. I also think it depends heavily on how the international trade issue flows through, and South Carolina is particularly exposed to this issue. Job growth will not instantly stop, so in the short-term, things are good.

GSA: How does the low unemployment in this region affect wages?

Economics suggests that as unemployment declines, there is pressure on wages to rise as firms compete to find the skills they need. As stated earlier, this has not happened to this point. I feel confident that it will, but we are much deeper into a recovery/growth period without wage growth than at any time I am aware of. It’s not clear to me why this is the case. One issue that I have heard rumblings about is that there is a growing gap between the skills that companies need and the skills that our high school graduates have. While our technical system in South Carolina is second to none in the U.S., if high school students are coming out less prepared, technical schools cannot necessarily overcome that. There are basic skills that are now required, math and problem-solving skills, in particular. Our technical schools are not set up to remediate these skills but to enhance from a certain level that some seem to suggest is not being met. This is not an indictment of our educators in South Carolina. I address this in the next question. I feel that we simply are not investing in our children, and we are starting to reap the repercussions of that.

GSA: In looking ahead to 2018 you told GSA Business Report the state needs to pay more attention to and invest more in K-12 education. Have there been any moves in that direction?

Smythe: In the interest of full disclosure, my daughter-in law is a committed, third-grade teacher in Pickens County.

Absolutely, categorically no! While teacher pay is not the only issue, it is the issue. Starting salaries in South Carolina are approximately $33,000, and require a four-year college degree, often with student loans involved. If my research is correct, South Carolina teachers will receive a 1% pay raise for 2018-2019, which is insulting. With inflation at 2% to 2.5%, teachers are receiving a pay cut in real terms. Here is an example of how bad the situation is. When doing a Google search to confirm the raise, there is nothing on the first page of the search to confirm it. Yet, I hear frequently from friends and coworkers about how frustrated they are with the state of our education system. Yes, teachers work nine months a year, and in theory, part of their decision to teach is altruistic, but altruism simply is not enough. More importantly, investing in human capital is one of the single most valuable investments we can make. Collectively, our country’s competitive advantage is human capital. That is eroding quickly. Reports from earlier this year indicate that 5,000 teachers left teaching in South Carolina last year. That is the equivalent of having the towns of Edgefield, Travelers Rest or Walhalla simply disappear in terms of population. This problem is made worse because we are having an incredibly difficult time recruiting teachers. Monetary incentives matter. Having a chance at the best and brightest demands higher pay and a 1% pay raise (at a time when the economy is doing well, and therefore tax revenues should be higher) and starting salaries of $33,000 just won’t cut it. Our educational crisis (and yes, it is at a crisis stage) is even more critical than the road network in South Carolina, and we finally found a way to at least address roads. The problem is, politicians see one-year budgets and not 20-year outcomes, which is what investment in education is. And before readers pile on the politicians, we as citizens need to take a long, deep look in the mirror, because we are telling our legislators to cut spending, keep taxes low and improve our education system. Those tradeoffs are incompatible after some point, a point we passed a number of years ago. Until we as South Carolinians demand this issue be addressed, and be willing to pay the price, we will not see better outcomes. I just hope it isn’t too late.

Editor's Note: This story originally appeared in the July 9, 2018, issue of GSA Business Report.