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What Drives Growth

REAL ECONOMIC GROWTH is driven by increasing the number of workers and by raising their productivity. The latter is the reason innovation is so important. If productivity rises, we increase GDP per capita, which means the standard of living for the average American ought to rise.

As both the number of workers and their productivity rise, GDP should grow. Over the past 50 years, the U.S. has enjoyed 2.7% annual growth in real GDP, with roughly half coming from productivity gains and half from increases in the working population.

That GDP growth should, in turn, propel corporate earnings higher. As corporate profits rise, share prices will also tend to climb. The two, however, don’t move in lockstep, and there’s a chance that, in future, shares will lag behind economic growth.

Still, if you’re a stock market investor and hence hoping for higher corporate earnings, you might cheer for greater immigration, while also being concerned about the aging population and the falling birth rate. Greater immigration should mean more workers and hence faster economic growth. But fewer babies and lots of workers reaching retirement age isn’t so good, because that means fewer workers and potentially higher taxes to pay for retirees’ Medicare and Social Security benefits.

Over the 10 years through 2031, the Bureau of Labor Statistics projects that the workforce will grow at just 0.5% a year, versus an average of 1.3% a year for the 50 years through year-end 2021. That slowing growth is one reason some observers argue that we’ll see disappointing GDP growth in the years ahead—and possibly modest stock returns.

Our Humble Opinion: While the U.S. and other developed nations will likely grow more slowly as their populations age, this isn’t yet an issue for emerging markets such as India, Malaysia and Mexico. The implication: You may want to include a healthy allocation to emerging markets in your portfolio.

Next: What Drives Stocks

Previous: Economic Growth

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