As we all know, President Obama is planning a major stimulus spending program—and there are all sorts of debates concerning what kind of program is best, in terms of size and composition. Key here is a correct understanding of the nature of our current difficulties—short term recession or longer term crisis or an overlay of one on top of the other. My answer—the latter.
We often talk as if the goal of the stimulus is to restore our economy to its previous health. But how should we evaluate economic conditions in the pre-crisis period. As a Washington Post story of January 12, 2009 notes:
President Bush has presided over the weakest eight-year span for the U.S. economy in decades, according to an analysis of key data, and economists across the ideological spectrum increasingly view his two terms as a time of little progress on the nation’s thorniest fiscal challenges.
The number of jobs in the nation increased by about 2 percent during Bush’s tenure, the most tepid growth over any eight-year span since data collection began seven decades ago. Gross domestic product, a broad measure of economic output, grew at the slowest pace for a period of that length since the Truman administration. And Americans’ incomes grew more slowly than in any presidency since the 1960s, other than that of Bush’s father.
Looking at a longer time period, and focusing just on Oregon, over the period 1979-2004, the bottom 20 percent of earners suffered, on average, a 15.1 percent decline in real income; those in the next highest quintile lost 3.4 percent, those in the middle quintile lost 4.4 percent, those in the next highest quintile gained only 0.3 percent. Only those in the top 20 percent enjoyed real income gains over this period, an average increase of 37.1 percent.
In reality, however, the majority of the gains for this top group went to the top 1 percent. Households in the top 1 percent saw their real adjusted gross incomes beat inflation by 135 percent. The rest of the top 20 percent saw gains of only 19 percent. In fact, the gains were really more concentrated then that. It was the top 1/10 of a percent that was the big winner. Those households saw their real adjusted gross income rise by almost four times, from $733,000 to $2.6 million. The rest of the top 1 percent, by contrast, saw their incomes only double, from $238,000 to $500,000 on average. In short, although the economy has grown over the last several decades, conditions for the vast majority of Americans have deteriorated (and here I include the declining percentage that have access to health care, etc.). In short, I don’t think our goal should be to recreate “the good old days.”
Actually, the choice we face is quite different. Even if we wanted to recreate those days, there is no obvious way to do it. The fact is that growth over the last fifteen years or so was driven by a series of bubbles, first a stock market and then a housing bubble. Those bubbles are over and there are no new ones on the horizon.
As earnings stagnated over the last few decades, people drew upon their appreciating stock and housing wealth to borrow. In other words, our recent growth was largely based on debt, which was tied to appreciating stock and housing prices. In particular, people used their homes almost like ATM machines. Between 2001 and 2007, homeowners withdrew almost $5 trillion in cash from their homes; as prices of their homes would rise, people would take out a new mortgage, borrowing ever greater amounts of money in the process. About a third of the total growth in consumption over this six year period was financed by so-called mortgage equity withdrawal. At the peak of the bubble in 2006, consumers were cashing out some $780 billion a year from (then rapidly rising) home equity. But the resulting rise in debt levels was clearly unsustainable—household debt (mortgage and credit card debt) as a percent of disposable personal income rose from 59% in 1982 to 77.5% in 1990 and 91.1% in 2000 to 128.8% in 2007.
The bubbles have now popped, with prices of houses and stocks falling sharply. The shaky financial sector then collapsed along with consumption, triggering the current ever deepening recession. What then is to replace these bubbles as drivers of economic growth after the effects of the stimulus spending dissipate? Consumers are deep in debt and consumer spending is unlikely to magically be renewed as the country’s main economic driver. Business spending on plant and equipment has been weak and unlikely to grow substantially under current conditions. The entire world economy is in recession, so forget exports. All we have left is government spending. And we now come back to the stimulus program: if we conceive of the government only as supplier of short term spending to end the recession we are in big trouble.
Yes, government spending is necessary to shorten the recession, but if that is all that is being planned then we face a period of long term economic stagnation, with the great majority of us suffering further declines in the quality of our lives. It is against this future that we have to plan and judge any new program of government activity. Unfortunately it is not clear that the President or his advisors yet grasp the extent of the real problems we face. Let’s hope they do so quickly.
Reports from the Economic Front 