Look no further than Thursday’s initial public offering of Snap Inc (SNAP.N) for a short course on why Donald Trump is highly unlikely to make his target of 3 percent annual economic growth.
The stock offering is a smash, soaring more than 50 percent on debut, but an economy which excels in innovating in the creation and sharing of “social stories” is a different beast from one which innovates in making steel or ships.
Different, and with a lower demand for people and capital and just possibly with a lower ceiling for economic growth.
Having at one point said he could attain economic growth of 4 percent or higher, Trump has trimmed that somewhat, most recently on Monday saying a “revved-up economy” can hit 3 percent or “maybe more”.
His transition team told Council of Economic Advisors staffers to base projections on sustained growth of 3 to 3.5 percent.
While a combination of stimulus spending, deregulation and tax cuts - and who knows what we will actually get - would goose growth somewhat, the economy has only managed as much as 2.6 percent once since the financial crisis.
Snap, the parent of social network Snapchat, gives a window into some of the forces Trump is up against, and which may not be amenable to the tools he has at hand.
Snap’s market cap of north of $40 billion makes it worth more than Hershey’s and Campbell Soup Company combined, but it employed just 1,859 people as of last year.
What’s more its industry is a comparatively light user of capital, making the multiplier effect of its activities much lower. Its business model, too, is a neo-liberal daydream: almost everything that can be is outsourced.
That means lower capital expenditure than in previous cutting-edge industries, and as Trump and his advisors well know, increasing capex is key to jump-starting growth.
“Since we use third-party infrastructure partners to host our services and therefore we do not incur significant capital expenditures to support revenue-generating activities,” Snap said in its SEC filing as part of a justification of why investors should use non-traditional valuation metrics.
I come not to argue with Snap’s business model, or its valuation, though both have their weaknesses, but to point out that one of the consequences of a structural shift in the economy to businesses which depend more on intangibles is a lower natural level of capex.
A DIFFERENT WORLD
We won’t have details for a couple of weeks of what in specific the Trump administration will propose, but tax changes are likely to try to make onshore capital expenditure more attractive, perhaps by accelerating the way it can be deducted from taxes.
That will help, but the structural issues are large. On the positive side, a recovery in the energy sector means capex there has been on the rise.
But with corporations sitting on over $3 trillion of cash, and with interest rates at post-industrial-revolution lows, there weren’t lots of good financing reasons holding companies back from investing.
For a better idea of why they weren’t, look at the Federal Reserve’s measure of industrial capacity utilization, which was just 75.3 percent in January. A reading above 80 generally indicates new capacity needed, but now companies faced with higher demand will likely just try to sweat their existing assets. World steel capacity utilization stood at just 69.5 percent in January, having been driven lower for years by over-investment in China.
“To get to the Trump vision of 3 percent growth, arithmetically we would need capital spending to begin to surge at a 20 percent annual rate or more, the sort of thing we have never seen happen before (at least over the past 70 years),” David Rosenberg of Gluskin Sheff Research wrote in a note to clients.
“So good luck with that.”
Ten percent capex growth, a very fine thing these days, would only get us to 2 percent GDP growth, Rosenberg argues.
Stimulus of the kind Trump has hinted may well be a good idea, but at this stage of the cycle, and with consumer debt where it is, it is hard to see the multiplier effects enjoyed by earlier fiscal boosts in earlier administrations.
Attempts to force more consumption of domestically produced manufactured goods may have an impact, but the knock-on costs of a round of global tariffs will be high. The least of these will be inflation, which would prompt the Fed to choke off growth with interest rate hikes, in my estimation well before we got to a 3 percent GDP clip. Remember, the Fed’s own estimate on longer-run sustainable growth is 1.8 percent in real terms.
Snap will have a multiplier effect, but we won’t all get rich sending each other pictures, even over and over and over again.
(Editing by James Dalgleish)