Monday, 24 August 2009

The Sky Has Fallen, So What Comes Next?

It was silly months ago to compare the global downturn to the 1930s depression. The recession has already turned the corner.

3 comments:

Guanyu said...

The Sky Has Fallen, So What Comes Next?

It was silly months ago to compare the global downturn to the 1930s depression. The recession has already turned the corner.

By Gary Becker
24 August 2009

(Caijing.com.cn) The latest output and unemployment figures for the United States indicate that the recession in that country is very probably over, given the usual definitions of recession turning points. Aggregate output fell for the fourth quarter in a row during the second quarter 2009, but the decline was small. All indications point to an increase, although not sharp, for American GDP during the third quarter.

The unemployment rate actually fell slightly in July. This may be a one-month statistical anomaly since unemployment usually lags the economy. But the rates of decline for jobs and unemployment have been slowing for several months now.

Recessions in China, India, Brazil and a few other countries have also ended, so it looks like the global recession is over as well. Some countries, such as Spain, have still not turned the corner, but they will be helped when the global recession ends. It was a severe recession -- in many respects the most severe global recession since the 1930s, as shown by factors such as the cumulative decline in aggregate output. But even that only amounted to about 4 percent.

Moreover, it was not the most severe in all the important dimensions. For example, the latest unemployment figure for the United States is 9.4 percent. That’s high, but it is well below the 10.8 percent reached at the end of 1982 after a pair of severe recessions in the early 1980s. Unemployment will probably continue to rise for awhile, since unemployment usually lags the turn in output. However, it now appears that unemployment will very likely peak below 10.8 percent, perhaps well below that previous high. In addition, productivity held up better during this recession than in many others.

While this has been a severe global recession, it is very far from resembling the Great Depression of the 1930s. That era saw American unemployment peak at around 25 percent with a more than 20 percent decline in output. The many comparisons made to the Great Depression by economists and others during the dark months of late 2008 and early 2009 now look kind of silly -- and I said so at the time -- although admittedly there was then considerable uncertainty about how bad this recession would become.

Although the severity of the worldwide financial crisis was unprecedented (aside from the 1930s depression), the real side of the economy has followed traditional recession patterns. For example, as usual, output for durables such as cars, tractors and houses fell far more sharply than services, especially in the education and health sectors.

Much ink was devoted to the many educated employees of the financial sector who lost jobs -- and they have had a tough time. But as in previous recessions, the least educated were hit the hardest. As of the end of July, the unemployment rate among high school dropouts was 15.4 percent compared to 9.4 percent for high school graduates, and only 4.7 percent for persons with a bachelor’s degree or higher. In addition, the percentage point increases in unemployment rates during the past year were much higher among the less educated. Similarly, black unemployment clocked at a 14.5 percent compared to 8.6 percent for whites, while during the past year black unemployment increased by 4.6 percentage points compared to 3.4 percentage points for whites. The fraction of those unemployed that have been unemployed for six months or longer -- 34 percent -- is one significant employment statistic that is unusually bad during this recession. This is apparently the highest percentage of long-term unemployed Americans in 60 years.

Guanyu said...

How effective were monetary and fiscal policies instituted during the past year in preventing a far more serious recession? Only time and further research will permit confident answers to this question, but I will offer a tentative opinion. Fed open market policies that bought financial assets from banks and others, and created huge amounts of excess bank reserves in the process, gave banks a financial cushion that helped dampen their retreat from risk. Treasury decisions under Henry Paulson and Timothy Geithner have been a mixed bag, sometimes helping banks deal with toxic assets, while at other times adding to the uncertainty by being erratic and indecisive.

The decisions to let Lehman fail but to merge Bear Stearns and force a merger of Merrill Lynch on Bank of America will be debated for a long time. I continue to believe that the bailout of GM and Chrysler by the presidential administrations of George Bush and, especially, Barack Obama were serious mistakes that will eventually cost taxpayers more than US$ 100 billion. It would have been far better to let both companies file for bankruptcy in fall 2008, for they would have emerged from bankruptcy court with lower labour costs and considerably more streamlined than they are now. To be sure, Chrysler may have closed shop, which would not have been a bad development, and sold its Jeep division and up to two other strong units to other companies.

Not surprisingly, the Obama administration is taking credit for ending the recession. According to The New York Times, Obama said his administration “rescued our economy from catastrophe.” The administration in particular is pointing to the stimulus package -- the American Recovery and Reinvestment Act – as a reason for the relatively good employment report for July. Yet this stimulus package could not have had much direct effect on employment, since only about US$ 100 billion, or less than 1 percent of GDP, out of a US$ 787 billion package has so far entered the economy. And much of that US$ 100 billion has been directed to service sectors that do not have excessive unemployment rates.

As I mentioned, some Fed and Treasury policies helped a lot, but the capitalist American economy continues to show strong momentum as well. Recessions always end and usually evolve into booms. While this has been an unusually long recession, the incentives for firms to find profitable opportunities, and the desires of consumers to spend, helped in important ways to bring an end.

Where will the world economy and the American economy in particular, go from here? Most economists are predicting a flat recovery for the United States that will not take off toward robust growth until late 2010 or even 2011. It is notoriously difficult to predict turning points and how fast economies come out of recessions. The 1930s had a fast recovery for a couple of years during 1934-’36 before it fell back again into severe depression.
One main reason for pessimism about the strength of the current recovery is that banks are generally afraid of taking additional risks, since they still hold many assets of dubious value. In addition, companies are wary of investing and building employment because of remaining and considerable uncertainty about the economy, and because consumers are continuing to rebuild their wealth portfolios after taking hits during sharp declines in stock markets.

Guanyu said...

I am more optimistic about the world and U.S. recovery than the consensus, although I do not expect a sharp expansion during the next few months. My reasons for greater optimism include the robust recoveries in China, Brazil and some other countries that will boost world output and raise demand for U.S. exports. The large, excess reserves created by the Fed -- some US$ 800 billion -- will induce banks to look for more profitable investments than the meagre interest they earn on these reserves. The working down of housing and auto stocks during the past couple of years will result in demand for new residential construction and cars that will stimulate these depressed industries. Firms are still hiring in large numbers, although not as rapidly as they are letting go. One indication of the growing strength of the U.S. labour market is that -- as my colleague Casey Mulligan has pointed out -- seasonally unadjusted employment has risen this summer.

Still, I do have some concerns about the U.S. recovery, beyond the overhang of many billions of dollars of rather worthless assets held by banks. Mulligan has been stressing that the federal government is creating many programs that discourage the unemployed from finding jobs, and encourage the employed to become unemployed. These include programs to reduce student loan repayments and mortgage payments for low-income people. Proposed caps of various kinds of executive pay, especially in the financial sector, the large government debt being created due to huge fiscal deficits that will put upward pressure on interest rates, the European-style reorientation of anti-trust policies toward protecting competitors rather than consumers, the enormous excess in reserves that have considerable inflation potential, the federal government’s likely incompetent management of two of the three American auto companies and a major insurance company, and the planned creation of a consumer czar that will interfere with the goods and services offered consumers are examples of policies that are likely to discourage business investment and risk taking.

So legitimate reasons exist for concern about the speed and strength of the American economy’s recovery. However, I worry much more about various regulations, spending and controls being introduced by Congress and Obama than by intrinsic difficulties in the American economy.