Secret to the US economy’s 2023 outperformance holds the key to 2024

The US economy is playing in a league of its own. It grew an impressive 3.1% year over year (y/y) in Q4 2023 surpassing the next fastest G-7 economy by 2 percentage points (ppt). While Japan entered a technical recession in Q4, robust early-2023 momentum meant that real GDP closed the year at 1.1% y/y. The eurozone continues to stagnate with real GDP growth barely managing to keep its head above water, at 0.1% y/y in Q4 2023. Meanwhile, economic output in the UK remains dormant with the economy entering a technical recession in Q4 and real GDP contracting 0.2% y/y.

 

We see five factors explaining the US economic outperformance:
 

  1. A labor market resilience story. The increased value of talent post-pandemic has meant that business managers are more reluctant to let go of their prized talent pool despite cost pressures and expectations of slower final demand growth. Solid employment growth combined with robust wage growth has translated into strong real disposable income growth (around 4% y/y in December 2023), which in turn has allowed consumers to continue paying high prices for goods and services.

  2. An ongoing services sector catch-up. While consumers spent freely on services last summer, there is still some way to go for the share of consumer spending on services to regain its pre-pandemic luster. As of December 2023, 65% of consumer spending was allocated to services and 35% to goods. This compares with a 68% and 32% split in January 2020, indicating that there is further scope for service sector expansion to drive consumer spending activity.

  3.   A beacon of productivity hope. The pro-cyclical acceleration in productivity appears to be sustainable. Business leaders are focused on strategic retention efforts, performance-based labor management, long-term training, and innovative technologies to improve labor productivity and efficiency amid a high-cost environment. At the same time, elevated interest rates have forced leaders to focus on strategic decisions with the highest return on investment. And business dynamism remains strong while the diffusion and adoption of new technological advances, including generative AI, remains rapid.

  4.  Healthy balance sheets and fixed-cost debt. Debt leverage ratios, debt servicing costs, assets-to-liabilities ratios, delinquency rates, profit margins and the amount of debt locked in at low interest rates indicate that households and corporations entered the pandemic on solid financial footing. In turn, this has meant that while credit growth has accelerated, debt servicing costs have risen and new delinquency rates have increased, the broad US credit picture is not alarming. What is more, with many homeowners locked in at low mortgage rates and corporations only gradually facing refinancing needs, the effects of the Fed’s historic tightening cycle have been much more muted than expected.

  5.  Strong government contribution to growth. In 2023, increased government spending added about 0.7ppt to the 2.5% real GDP advance — nearly a 30% contribution for a sector representing about 17% of the economy. Similarly, state and local employment has contributed about 30% of the payroll gains over the past six months while representing only 13% of total jobs. Part of this strong impulse comes from post-COVID-19 support programs that have largely expired; part of it comes from the impulse from the CHIPS and Science Act and the Inflation Reduction Act; and part of it comes from the gradual labor supply rebuild in the government sector. And importantly, these programs were structured in a way that has encouraged private sector investment instead of crowding it out.

Our positive outlook for 2024, with real GDP growth expected to average 2.2%, is primarily derived from the fact that the five factors behind the US economic outperformance in 2023 form a sustainable framework that could drive economic progression through 2024.

 

With disinflation on track for a rapid final mile, and Fed officials warming up to the idea of a late-spring or early-summer onset to the monetary policy easing cycle, the US economy will be on track for another solid outperformance in 2024.


The views reflected in this article are the views of the author(s) and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.