Tuesday, July 22, 2003

Time to Be a Demand-Sider?-Part I-The Ideopolis Hangover-Megan McArdell had a good post last week on the macroeconomic picture that's a good jumping-off point for some thoughts that have been floating through my brain. While we've officially been out of the brief recession since November 2001, unemployment has been going up
So why doesn't it feel like the recession is over? One of the major factors, as the article points out, is that unemployment is a lagging indicator, which is to say that it continues to rise even after the recession is over. (Stock prices, by contrast, are a leading indicator: they start to fall ahead of the recession). And it's lagged more in recent recessions -- the jobs are a lot slower to come back, which is what killed George Bush's father in '92. The recession had been over for a year, but the unemployment numbers were still bad. Remember "the jobless recovery"? We're having another one. We've lost nearly a million payroll jobs since 2000, and it still hurts.
If productivity is growing faster than demand for goods is, it'll require less people to make stuff, thus creating the oddity of GDP going up while unemployment goes up as well.
In general, recessions have been getting steadily shallower since WWII. The problem is that recovery takes longer, which is psychologically very hard. Fewer people are out of work -- fer gosh sakes, the unemployment rate is below what some economists used to think was the lowest possible rate of sustainable unemployment. It's well below what continental Europeans enjoy during their booms. But while fewer people may have actually lost jobs, more people fear losing their jobs, for longer. ("Is this recession worst than 1981?" I asked my mother recently. "Every recession is the worst recession when you're in it" was her sage reply.)
Since our economy has become more just-in-time oriented, there are less inventory stockpiles. When things slow down, that means more short-term layoffs, but it also means quicker hire-backs, since firms won't have the big stockpiles to sell before needing to hire back workers. Our employment system, with less generous unemployment benefits, easier layoff rules and greater reliance on temps, makes hiring workers less risky and getting rid of them easier when things slow down. With less freebies from the government and lower tax rates on work, there is a greater incentive for blue-collar folks to work in the US. This last recession was a lot lighter than the one in the early 1980s. If we can compare recessions to the ups and downs of the stock market, the 2001 recession was a correction rather than a bear market. It was due to the end of the Internet boom, 9-11, Enron and high oil prices, and people knew the problems that caused the recession were likely to be temporary. The 1981 recession was being caused by high oil prices, Cold War queasiness, high interest rates thanks to the Volker Fed and a general cultural pessimism that we don't have today. Reagan came along at just the right time; four more years of liberal pessimism might have sent the US into European stagnation. 1981 was a lot worse than 2001, since we weren't sure things were going to get better. We're a lot cockier than we were in 1981, and Reagan, for his tax cutting, his winning the Cold War1 and general optimistic attitude, deserved the plurality of the credit for where we've gone in the last 22 years. The computer industry deserves the second star (and possibly the first, for they've driven the growth in the 90s) and Volker (in 20/20 hindsight) and Greenspan deserve the third star for keeping inflation at bay; people who didn't live through the late 70s don't quite have a handle on how debilitating double-digit inflation can be to one's economic mind-set.
For another thing, even if GDP increases at quite a clip, a lot of us aren't going to be able to increase our consumption along with it, because we spent a nice chunk of the nineties increasing our consumption above sustainable levels based on unrealistic expectations. If we were technology workers, for example, we assumed that the demand for our services would be always and forever strong, while the sky-high wages we were able to demand would not attract any new entrants into the job market to compete for our jobs and thus drive wages down. If we had money in the stock market, we figured that it was okay to use our credit cards to buy a 72-inch HDTV system because, after all, our portfolio was going to double every six months, which would leave plenty of money to pay the bill and the accrued interest. If we were homeowners, we took out extra loans on the rising equity in our home on the assumption that it would be easy to sell the house for a comfy profit if we needed to. If we were practically anyone, we assumed that a loan at 7-8% was a good deal because inflation would chew up a lot of that over the life of the loan.
This is an interesting premise, especially for young people in the Ideopolis. If we combine the Permanent Income Hypothesis with the tech boom of the late 90s, we have people who have expectations of rising incomes spending more than they "should" since they expect to have the money to pay for it in the future. People tend to spend towards their expected average income over the foreseeable future, and the foreseeable future looked so bright, they had to wear shades. Now that the future isn't so bright, their expectations about income growth have come down, and people have geared their spending down accordingly.
Now inflation is practically nonexistent, the technology job market is glutted, the housing market is stalling out, and we're choked with debt that no measly 3-4% increase in GDP is going to get us out of. A lot of us will be putting any future income increases into paying down debt, not improving our lifestyle, for quite a long time. (And I am included in that number: my decision to attend business school was predicated on drawing a salary a lot higher than a journalist's when I got out.) Even if things get better, they aren't going to get as much better as they were getting just five short years ago. Of course, they were only getting better because we were borrowing part of now's "better" to pay for it. But that doesn't make it easier to face that cabinet full of Top Ramen when you get home from a hard day's work.
For the Gen Xers (and others) who overspent (in 20-20 hindsight) in the late 90s, they are having to gear their lifestyle down a notch below their normal levels for a while in order to pay down their home equity loans and credit cards. They're saving more than their age-income profile would suggest they should. That savings may not come in the form of adding to the 401(K), but in paying off debt. This will have an economic fallout, as the demand for consumer goods will be lower than income growth would indicate it should be. It will be good for businesses looking to raise capital, for the decrease in consumer debt will free up loanable funds for business purposes. However, the decreased demand will slow the recovery a bit.
So even though the economy is getting better, it feels worse. Though I'm no Austrian, you might call this The Great National Hangover. It won't kill us.
For a 20-something like Megan, the '00s are a popping of an emotional bubble. They hit college in the 90s, where human capital and a college education was the key to making the big bucks. The computer boom of the 90s placed a premium on human capital, promising high wages and a fast-growing economy. We've had a correction in that sector, and the future, while still bright, wasn't as rosy as it was a few years ago. For us oldsters who went through "real" recessions in the 70s and 80s, the early '00s were a modest bump in the road. However, it was a bump that took the air out of a lot of high-flying balloons. This may make the effects of the Bush tax cuts a bit harder to see and give liberals more ammunition. However, if you cut demand, it will tend to slow down the economy. While free-market economists like to focus on the supply-side of the equation, we need to remember that there is an aggregate demand curve as well as an aggregate supply curve. Just because Keynesians are fixated on it doesn't mean we can ignore it. ______________ 1If you use the baseball rule to credit the win to the pitcher who was on the mound when the team went ahead to stay, Reagan gets the W. We weren't leading in January 1981, given Communist successes in Nicaragua and Afghanistan, and we were in 1989, in large part due to an active anti-Communist efforts and a strong military buildup. That's not to say that other presidents didn't help, but Reagan put us in the lead to stay, while Bush 41 picks up the save.

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