K-Shaped Productivity Growth

There are stark differences in productivity across sectors. The productivity of the information sector (which includes much of the technology sector) has grown rapidly. The growth preceded the most recent wave of AI innovation. The sector is still small – making up 8.6% of total value added – but its rapid growth is fueling much of the overall productivity growth.

The rest of the economy’s productivity growth is much more sluggish. A few other sectors – utilities, finance, and mining & logging – also display high productivity. But only mining & logging (a tiny sector at 2% of total value added) shows both high productivity and high productivity growth.

Although the information sector is clearly a “winner”, the concerning point for the U.S. economy is that total hours used by the sector has plateaued. Even discounting the decline in the labor force after the pandemic, the sector has stabilized at around 2.3% of total labor hours in the economy. That means only a relatively few lucky winners working in the information sector have been benefiting from its outsized growth. The substantial productivity gains of the U.S. economy are in fact narrowly distributed.

K-Shaped Divide Between Manufacturing and Services

The ISM Services index ended the year at 54.4, its highest reading all year. All four subindices were also in expansion. At the same time, the ISM manufacturing index fell to 47.9 – the lowest level recorded in 2025. The manufacturing index has been in contraction territory for 34 out of the last 36 months, and only two out of the 15 tracked industries reported growing in December.

Even as talk about tariffs has subsided, high prices are likely disproportionately affecting manufacturing firms, many of which expect their woes to continue at least through the first half of 2026. We expect the upcoming mid-term elections and ongoing geopolitical tensions to cause continued economic volatility and uncertainty.

K-Shaped Profits

There is also a divide between larger and smaller companies. 

Corporate profits are doing well. Public companies are moving from strength to strength, even as tariffs raise the cost of goods sold. Publicly traded earnings grew by more than 25% in the first three quarters of 2025, even as sales grew by around 7%, displaying extraordinary resilience.¹ A broader measure, corporate profits as a share of GDP, has been remarkably high and stable at around 13% since 2021.

Proprietorships have been fairing less well. Their income as a share of GDP has fallen to 6.8%, the lowest since Q3 2007-Q3 2009. After a brief period of strength during the pandemic, proprietorships saw a sharp decline in either earnings, total market share, or both. The most recent data from Q3 elicits further concern as the measure shifts another leg down.

All of this is consistent with what we would expect from current economic policy. The smallest businesses generally are much more vulnerable to the abrupt changes in policy: they are mostly less resilient, have fewer financial and other resources, are less likely to have fat to cut out, and may have more difficulty keeping track of rapid changes in tariffs or other policies. Pain is ongoing for small businesses, although optimism has improved.

Outlook

We have revised our forecasts for 2026 and released a new forecast for 2027. We expect 2026 growth to be just marginally higher than 2025, driven by stable consumption and solid non-residential investment. We expect net exports to remain strong as U.S. businesses try to shift away from import-driven businesses. The labor market remains moribund; we believe both labor supply and demand will remain lackluster while remaining in a low-growth equilibrium.

We expect inflation to continue to decline, but do not expect headline CPI to reach 2% this year. Price shocks from tariffs appear to be partly behind us, but some pass-throughs are likely to continue in the first half of the year (even barring additional tariffs). The Fed is facing enormous pressure from President Trump to cut rates, and we expect them to cut by a total of 75 bps given the ongoing weakness of labor market demand.

Risks

The most significant risk is a risk to the upside. With pressure on the Fed toward lower rates, tax refunds expected to be high, and perhaps other stimulus-type measures (Affordable Care Act subsidies?) yet to come, there are several ways in which we may see an economy running relatively hot. The number of cuts – slightly more than 2 cuts by year end as of publication date – may underestimate Fed pressure, and longer-term yields may underestimate the persistence of inflation.

Although we expect the wealthier consumer to remain engaged, there continue to be risks to the upside to an even stronger consumer – both in the U.S. and, as the dollar remains weak, abroad.

Some risks are likely to be resolved in the near term: the Supreme Court fights over IEEPA and President Trump’s attempt to dismiss Fed Governor Lisa Cook. Others are likely to remain persistent throughout the year, including those emanating from the suddenly active geopolitical tectonic movements. President Trump’s actions with respect to the U.S.’s influence over the Western Hemisphere, including its effect on Japan, Korea, and NATO, are all in play – and while we do not expect anything approaching outright war as a baseline, the risks are clearly elevated.

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¹ Bloomberg. Accessed Jan 14, 2026.