Happy third anniversary
June 2012 marks the third anniversary of the end of the Great Recession, the most severe of the 11 U.S. recessions since World War II ― although the 1981-82 recession was comparable. Conventional wisdom is that the strength of a recovery is related to the depth of the recession. That has not happened three years into the U.S. recovery.
How bad has it been? The growth in real (inflation adjusted) gross domestic product (GDP) has been 2.4 percent since the start of the recovery in July 2009, about half of what real GDP growth would normally be three years into a recovery. The growth rate also lags the long-term (1997-2007) U.S. GDP growth rate of 3.4 percent.
The unemployment statistics appear to be better than GDP growth, but they are deceiving. During the Great Recession, 8.8 million jobs were lost and 4.5 million jobs created thus far during the recovery, so there are fewer jobs in the U.S. today than in December 2007 when the recession started. Even though employment is still several million below its peak, the unemployment rate has dropped from a peak of 10.1 percent to 8.1 percent today.
Why the significant drop in the unemployment rate? The big reason is the drop in the civilian labor participation rate which measures the number of people (16 years of age and older) who are working or looking for work versus the number in the total population. The labor participation rate has dropped from a peak of 67.3 percent in 2000 to the current rate of 63.6 percent, the lowest since 1981-82. The continued decline is unusual in an economic recovery because more people usually seek employment as the economy improves. Since the recession ended, the rate has fallen from 65.7 percent to the current 63.6 percent, thus the lower unemployment rate.
While the potential number of workers has increased during the recovery, the number leaving the workforce has increased even more, taking down the unemployment rate. So where have all the workers gone? Some of the baby boomers (those born between 1946 and 1964) may be retiring early, marginal workers may not have entered the workforce because of slow job growth and stagnant wages, and more are opting for government subsidies. Medicaid spending, disability payments and food stamp usage have all risen sharply under the Obama administration. The bottom line is that no one has a good grasp of the numbers and why people are leaving the workforce.
There are numerous reasons why the U.S. economic recovery continues below average. First, the Great Recession was caused by the severe financial crisis of 2007-2008. As a result, households have had to pay down debt, and banks have had to increase their capital base by extending less credit. Evidence shows that recoveries from financial-caused recessions are slower than other recessions because of the deleveraging that has to occur. It may take more time for this to work its way through the system, so slow economic growth may be the norm in the U.S. and Europe for several more years.
As the experience of Japan has demonstrated, asset bubbles such as in housing can impede an economic recovery. U.S. home prices have fallen about one-third from their 2006 peak because of the speculative bubble in housing prices and over supply of houses. Usually construction, housing and commercial, leads an economy out of a recession, but not this time. Construction jobs are still 25 percent below their 2007 peak in the U.S. So until housing prices stabilize and the excess capacity is worked down, this important segment will be a drag on the economy.
The U.S. corporate sector is sitting on more than $2 trillion in cash and cash equivalents. They are investing less in plant and equipment than normal in a recovery. Why the reluctance to invest? The main reason is economic uncertainty caused by the problems in the Eurozone, a slowdown in China, regulatory reform, healthcare costs (including Obamacare), the so-called fiscal cliff facing the U.S. in 2013 when the Bush tax cuts expire and mandatory spending cuts to the U.S. budget take place, and escalating public-sector debt. Because of below-normal corporate investment and gains in productivity, manufacturing jobs in the U.S. are still 15 percent below their 2007 peak.
What can be done to stimulate the U.S. economy? Probably not much. Monetary policy has pretty much been played out with historically low interest rates, several rounds of quantitative easing, excessive bank reserves, and massive amounts of liquidity. Fiscal policy also is constrained. The U.S. has already borrowed more than $5 trillion to cover fiscal deficits since the start of the Great Recession. Some may argue that there has not been enough stimulus, but $5 trillion has resulted in GDP growth of less than $1 trillion. The bond markets are also closely monitoring public-sector debt and will quickly raise bond yields if government debt and deficits appear unreasonable.
What the U.S. economy needs more than anything is confidence. Confidence that government can control spending and deficits, that consumers can spend but also not take on too much debt, that banks can provide credit again but also manage risk, and that regulatory reform is reasonable and not anti-business. Otherwise, it is difficult to see what will get the U.S. economy back to a normal growth rate. The worst economic recovery since WWII may continue on its present path. Or worse, it may result in another recession, and there may not be a fourth anniversary of the recovery to write about. Time will tell.