No Way Out?

Many recent books and articles by economists and policy analysts ask how the US can recover rapidly from the worst economic crisis since the 1930s. They usually merely assume that the ideal objective is to return to the stable economic growth that preceded the crisis of 2007 and 2008. The underlying assumption is that once adjustments are made, the economy will continue again much along the path it had for a quarter-century.

This optimism isn’t at all warranted. The recession that began in late 2007 was declared over in mid-2009 by the National Bureau of Economic Research, which keeps track of business cycles. But nearly fifteen months later, the unemployment rate remains at 9.6 percent, leaving nearly 15 million Americans out of work. Another 11.5 million, some 7.5 percent of the population who are ready and willing to work, have given up looking for a job or are working part-time because they can’t find a full-time job. The nation’s Gross Domestic Product is growing so slowly that it has not yet reached its prerecession level. By this point in the recovery from all of the nine previous recessions since the end of World War II, GDP had attained its former peak.

What makes this recovery different is clear. Consumers have record levels of debt compared to income and some $12 trillion in losses on their houses and financial investments. They are not going to spend money as they usually do—perhaps not for a long time. A damaged financial system is also not lending significantly, partly because business clients aren’t seeking loans unless they directly generate more sales, and consumer demand is low. Business investment, propelled by piles of cash on the balance sheets, is nevertheless slowing after rising strongly from low levels for the past year.

The economy could slide back into an outright recession again. A fragile financial system could also again be pushed to the brink by a new round of mortgage and other defaults. Fortunately, the number of jobs in October rose by 159,000, breaking a trend of even more modest job creation. More jobs will mean more income and perhaps rising consumer confidence. A “double dip” recession may well have been avoided, but as the Economic Policy Institute points out, the economy will have to produce 300,000 jobs a month, twice a many as this October, for several years to return to the unemployment rate of 5 percent in December 2007. Economists at Goldman Sachs calculate that if historical precedents apply, it would require four years of GDP growth of 4 percent a year, after inflation, to return us to full employment. Many economists believe the nation cannot attain that rate.

The US economy is growing so slowly that the case is strong for another multibillion-dollar investment in government spending to stimulate it. The nonpartisan and usually cautious Congressional Budget Office estimates that theUS GDP could easily be 6 percent higher without threatening inflation—that is, it is 6 percentage points below what the CBO estimates as its optimal level. But both the President and Congress are avoiding any substantial stimulus now because of the current surge in the deficit. The Republican leaders of the House in the newly elected Congress say they will demand $100 billion in immediate spending cuts to reduce the budget deficit even as they seek the permanent extension of the tax cuts passed under George W. Bush that are set to expire this year.

Those tax cuts, if extended permanently, will add considerably to the future deficit. But this contradiction does not deter the politicians who are apparently more interested in reducing the size of government than of the deficit itself. In addition, pressure is growing from nations like Germany, China, and Brazil to reduce the US deficit as a way, they say, for the US to cut its reliance on foreign capital and thereby reduce its trade deficit. They fear that current Federal Reserve policies to reduce interest rates will lower the value of the dollar abruptly and make their exports to the US more expensive.

Right now, the best hope is that heavy cuts in government expenditures will be postponed for two to three years. But such a delay will probably not be long enough. Erskine Bowles and Alan Simpson, the cochairmen of the fiscal commission President Obama appointed to propose ways of reducing the deficit, are calling for sharp cuts in spending but say they want to delay the first reductions until 2012, when the economy will have sufficiently emerged from the recession. This would be a severe miscalculation. Barring a surge in growth, the unemployment rate in 2012 will probably be at least 8 percent, roughly the highest level reached since the end of the recession of the early 1990s.

If this poorly considered advice is the best that this commission can give the President, the nation is in trouble. An obsession with taming the deficit, provoked by the rapid rise in the current deficit to $1.5 trillion for 2010, will make a large stimulus impossible. But the sharp surge in the deficit was mostly caused by the recession itself, which reduced tax revenues and raised the level of spending—such as unemployment payments—in response to the recession. President Obama’s stimulus package of $800 billion passed in early 2009 also added to the deficit, but that spending was only temporary and kept the economy from sinking further.1According to a convincing economic model by the economists Alan Blinder and Mark Zandi, without the stimulus the deficit would have been substantially bigger in coming years.

If we presume that there will be an economic recovery, almost all of the projected deficit through 2020 will be the result of three factors: the recession, the tax cuts of the early 2000s under George W. Bush, and the hundreds of billions of dollars of war spending. In the 2020s and 2030s, however, projected increases in Medicare and Medicaid spending could raise deficits dramatically—and the amount of government debt and the interest paid on it could grow to alarming levels. Social Security spending will increase only modestly by comparison. But dealing with such long-term problems by abrupt cuts in spending now will likely consign the nation to a decade of slow growth, lost jobs, and low wages—and unnecessary, painful reductions in Social Security and other social programs that Americans value most.

What is rarely recognized is that even if the US can emerge from a weak economy within a few years, the economic foundation that existed before the cataclysm of 2007 and 2008 may not be adequate to restore the widely shared prosperity the USneeds. For more than three decades, economic growth had been largely dependent on rapidly rising levels of debt and on two major speculative bubbles, first in high technology and dot-com stocks in the late 1990s, then in housing in the 2000s. What will now replace them?

Income inequality widened sharply in these years and average wages stagnated for the many while record high fortunes were made by the few. The financial security and access to adequate health care and education for children that had defined the middle class since World War II have eroded rapidly. Meanwhile, investments in infrastructure such as transportation, as well as clean energy and education, have been badly neglected. All this raises doubts about America’s future economic vitality whether or not it balances its budget, and it does so at a time when international competition from Asia and the Southern Hemisphere will pose serious challenges during this century. How will Americans live a decade from now?


Meanwhile, austerity economics could well leave the nation with a lost decade of slow growth and high unemployment. The case for a substantial new stimulus has rarely been stronger. But we are not likely to get it. The Federal Reserve’s so-called quantitative easing may push interest rates on long-term debt down through the purchase of hundreds of billions of dollars of bonds, but lower rates without strong demand will not be enough; ways must be found to encourage the economic demand that will cause firms to borrow money so that they can produce more goods. That combination of rising demand and borrowing by business to meet it is now lacking, and renewing it should be a central concern of Congress and the administration.

After the Republican election victory it seems far less likely that any bold vision will emerge from the Obama White House. Good jobs and secure benefits are what matter today. Obama has begun to talk more consistently about jobs, but it will take policies that are now much harder to push through in the new political environment. Washington has its eye almost only on deficits. Meantime, the frustrations of workers in the lower and middle classes run high. Political fanaticism raised its head this election and more may be lying in wait. (Link to more. Emphasis added.)



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