After four quarters of strong real GDP growth, investors may be lulled into thinking that we’re in for a period of sustained high real economic growth. Our models suggest that while the short-term recovery from the pandemic is certainly welcome news, there are good reasons for investors to brace for long-term real growth that continues to be below its historical (pre-2008 GFC) average. Moreover, uncertainty about the sustainability of the recent real growth spurt continues to be quite high. It is this macro-growth uncertainty that is important for long-term asset returns. 

Our earlier note Long-Term Inflation Risk Has Increased argued that investors should focus on the drivers of long-term growth and growth uncertainty rather than obsessing over short-term data releases. In this line of reasoning, the central questions for investors concerned about long-term asset returns are:

• What are the likely post-pandemic trend real growth rates?

• How long could it take for economies to recover those rates (i.e. what’s the range of uncertainty)? And,

• What are the drivers of long-term growth uncertainty?

We start by addressing the first two questions. Exhibit 1 shows our model’s projections for long-term real growth and growth uncertainty for the US, UK, Japan, China, Eurozone (1) Eurozone countries covered by Navega models are France, Germany, Italy, Spain, Austria, Netherland, Belgium, Portugal, Ireland, and Finland. , DM (2) Developed Markets (DM) countries covered by Navega models are the United States, Canada, United Kingdom, France, Germany, Italy, Spain, Portugal, Ireland, Austria, Belgium, Netherlands, Finland, Denmark, Norway, Sweden, Switzerland, Australia, Singapore, and Japan. , and EM (3) Emerging Markets (EM) countries covered by Navega models are China, Taiwan, South Korea, India, Russia, Brazil, and Mexico. countries pre-pandemic and as of July 31st.

Exhibit 1 - Navega Long-Term Growth and Long-Term Growth Uncertainty

There are three clear takeaways from this Exhibit. First, according to our models, the post-pandemic long-term trend real growth rates are likely to stagnate at their current low level in the case the Eurozone, or at even lower levels compared to pre-pandemic trends for all other countries. Second, long-term uncertainty has increased significantly, and is back to levels experienced during the 2008 global financial crisis. This means that the economic recovery - to lower post-pandemic trend growth rates – could be delayed. Finally, there are noticeable differences across countries’ long-term growth prospects.

Notably, the US is the likely long-run winner relative to the UK, Eurozone, Japan and even China, as controversial it may seem. Official statistics for China suggest that the Chinese economy was growing at about 6% pre-pandemic, and that growth rates seem to have nearly fully recovered. By contrast, our models suggest China’s trend growth was about 0.9% pre-pandemic (as of December 2019), and has now likely declined to 0.8%. Several more timely and reliable indicators - such as industrial production growth and interest rate levels - seem to support this contrasting view on China’s growth prospects.

These observations all beg the next key question: what are the sources of these lower real economic growth trends and higher uncertainties? Our models point to two main drivers: labor force growth and total factor productivity (TFP) growth (4) Total Factor Productivity (TFP) measures the impact of innovation and efficiency of reallocation of resources on growth, net of the effects of capital and labor. For more details about how we think of long-term growth, growth uncertainty and its drivers, see our earlier paper Less Macroeconomic Uncertainty But Lower Long Run Growth. . Let’s examine these in sequence.

Exhibit 2 portrays the evolutions of long-term changes in total hours worked - our measure of labor force trend growth - for the same major countries and regions. The trends are striking: since roughly 2000, growth in the labor force has been stagnating at near zero levels or declining on trend, driven in part by the relative decline in younger workers in aging populations. This downward trend clearly predates the pandemic. Moreover, these demographic trends are also quite predictable overall, with relatively small levels of uncertainty compared to real economic growth rates. Although labor force growth across these countries has declined secularly, Exhibit 2 suggests that recent trends in the US are more favorable than the rest of the world (5) Current demographic projections from the United Nations suggest that labor force growth rates of DM countries and China are projected to become even further depressed relative to what is portrayed by Exhibit 2, a trend that is likely to contribute negatively to expectations of long-term real economic growth for these countries. By contrast, the labor force of most EM countries (except China) are projected to grow at higher rates compared to the estimates depicted in Exhibit 2, a trend that could benefit these countries' long-term real economic growth prospects. .

Exhibit 2 - Long-Term Labor Force Growth

What about TFP? Exhibit 3 depicts the evolution of long-term real (inflation-adjusted) TFP growth trends, as measured by our models. Again, the direction of the trends is striking. Long-term TFP growth has been declining on trend since the late 1990s, also predating the pandemic! (It is worth noting that recent trends in TFP growth favor the US). By contrast to the changes in the labor force, TFP growth rates embed a much higher degree of uncertainty. In other words, the bulk of long-term real economic growth uncertainty can be attributed to uncertainty in real TFP growth (6) In the US, our models suggest that about 80% of the long-term real economic growth uncertainty can be attributed to long-term TFP growth uncertainty. Intuitively, by contrast to the drivers of labor force growth trends, it is much harder to evaluate how large, persistent macro shocks (such as the 2008 GFC and Covid-19) could affect long run changes in innovation and resource reallocations efficiency. . Thus, it is worth digging deeper into the potential drivers of TFP growth itself and TFP growth risk (7) Candidates include the (negative) impact of markups, industry concentration and regulatory burden, among others. For instance, there is evidence suggesting that since the 1980s, markups have increased. .

Exhibit 3 - Long-Term Total Factor Productivity Growth

These results carry important implications for investors. First, and to reiterate, investors should pay attention to the long-term trend in real economic growth, the uncertainty about this trend, and carefully examine the sources of this uncertainty. Second, our analyses so far suggest that there are clear limits on long-term prospects for growth, driven by secular trends in demographics and TFP growth, that are unlikely to dissipate anytime soon. And third, growth expectations and uncertainty are reflected in markets’ pricing of bonds and risky assets and investors’ portfolio strategies. We will explore the implications for bond yields and risk premia, and portfolio strategies in subsequent notes.