July retail sales came in below expectations (0.0% vs. +0.2%), but the month-to-month volatility of this series makes this fact meaningless, as the graph above suggests. Retail sales growth may have slowed a bit in the past year or so, but there is no indication of any significant decline. And in any event, this is not one of those series that tends to be a leading indicator. If anything, it's a good lagging indicator. Careful readers of this blog will know that I rarely feature this statistic.
One subset of the retail sales number is the so-called "Control Group," which takes out the most volatile components: autos, building materials, and gas stations. Not surprisingly, it is less volatile than total retail sales. Regardless, it too was relatively weak, increasing only 0.08% for the month. But as the graph above shows, sales continue to trend higher, but at a slower rate than in prior decades. This is the "new normal" that everyone talks about.
We see the same "new normal" phenomenon in the inflation-adjusted Control Group, shown in the graph above. The economy is just not growing as fast as it used to, and the apparent "output gap" continues to widen to a significant degree—currently about 15%, or a little more than $40 billion per month of sales that would have occurred if the economy were back on its long-term trend growth path. That's pretty significant: about half a trillion a year in sales that have failed to materialize.
The main reason for the sales shortfall is obvious: job growth has been very modest during the current recovery, and there are still as many as 7-10 million people of working age who are on the sidelines for whatever reason. And the reason for that is obvious: business investment has been relatively anemic, despite record-setting profits. Even though capital is abundant, there's a shortage of people and corporations that are willing to take the risk of starting a business or expanding an existing business.
Capital goods orders, shown in the graph above, are a good proxy for business investment. In real terms, orders are still significantly below where they were in 2000, yet after-tax corporate profits today are more than double what they were back then. Without new investment in plant, equipment, machinery, computers, software, office equipment, and research, the economy is just not going to be able to grow very fast. And without more people working, retail sales just aren't going to grow as fast.
Note: as a supply-sider, I believe that more investment and more jobs are what drive retail sales; retail sales do nothing by themselves to grow the economy. It's the supply side of the economy that drives growth, not the demand side. Supply creates its own demand, to paraphrase the French economist Jean-Baptiste Say. Looked at from a global perspective, the world can "demand" goods and services only to the extent that it can pay for those goods and services. The vast majority of the world would love to buy and consume more than they do, but they lack the means. Give them a job and their purchases of goods and services will increase. And by the way, you can't augment aggregate demand by borrowing, since that only shifts the existing supply of money from one pocket to another. For that matter, all money earned (with the exception of what is literally stuffed under the mattress) is always spent: if I don't spend all I earn, then I must give my "savings" to someone else to spend, and I'll hope that he is able to spend or invest that money in a way that allows him to pay me back with interest in the future.
In order to have a stronger economy, I believe that we need to do everything possible to encourage work, investment, and risk-taking. A straightforward way of doing that is to make the tax rates lower and flatter by eliminating deductions and subsidies. Lower taxes increase the after-tax reward to taking risk, and it is natural to think we would see more investment if tax rates were lower, especially today, when marginal tax rates are unusually high, especially for businesses that have to compete in the world economy with offshore corporations that pay a much lower tax rate. In addition to lowering taxes we need to reduce the costs and complexities of running a business, since that lowers the hurdle rate for new investment. Complying with today's astonishingly complex regulatory environment just gets harder and harder as the number of pages in the Federal Register expands exponentially.
One thing for sure: exceptionally low interest rates are not going to stimulate more investment. The past five years is proof of that. Besides, the Fed hasn't so much depressed interest rates artificially, as it has accommodated the tremendous amount of risk aversion in the world that followed in the wake of the financial crisis and recession of 2008. Interest rates are low because people and corporations are reluctant to take risk. We've been living in a very risk-averse environment. We can break this cycle by increasing the after-tax rewards to taking risk and by reducing the regulatory burdens that plague new investment. Unless and until Washington adopts a supply-side agenda, we're likely to be stuck in a slow-growth world. Policymakers need to entrust the private sector with engineering a stronger recovery, and empower it with business- and work-friendly policies.
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