The financial crisis produced the most severe recession since the end of World War II in all the important measures of economic performance, aside from unemployment rates. Unemployment peaked at 10.2% in 2009, whereas it peaked at 10.8% in December 1982 at the end of the deep recession that spanned 1981-82. The recovery from that earlier recession was rapid, as unemployment was down to about 7.5% by 1984, and GDP grew rapidly in 1983 and 1984. By contrast, as Posner indicates, GDP growth has been slow to moderate in the two years following the official end in 2009 of the past recession. Real GDP is about 10% below the level it would have been at if growth in GDP continued after 2008 at its long term rate of 3% per year.
At the height of the financial crisis, the media frequently had discussions of the “failure of capitalism”, and the need to radically rein in the private sector through extensive regulations and other government activities. The politically liberal Congress elected in 2008 along with President Barack Obama reflected these views. In addition to taking various steps to try to fight the recession, leading members of the new Congress, and President Obama as well, considered they had a mandate to reengineer the American economy through more radical government interventions (see the discussion of uncertainty and the recovery by Steven Davis, Kevin Murphy, and myself in the Wall Street Journal, January 4, 2010, “Uncertainty and the Slow Recovery”).
In addition to repeated attacks on American business, especially banks (some of the attacks on banks were well deserved), Congress passed an expensive stimulus package that did not stimulate much. The health care bill Congress passed seems likely to increase the cost to small and large businesses of providing health insurance for employees. Congressional leaders proposed high taxes on carbon emissions, large increases in taxes on higher income individuals, corporate profits, and capital gains as part of vocal attacks on “billionaires”. Many in Congress wanted to cap, or at least control, compensation of executives. Proposals were advanced to make anti-trust laws less pro-consumer, and more protective of competitors from aggressive and innovative companies. Congress passed and the president signed a financial reform bill that is a complicated and a politically driven mixture of sensible reforms, and senseless changes that have little to do with stabilizing the financial architecture, or correcting what was defective in prior regulations.
It is no surprise that this rhetoric and the proposed and actual policies discouraged business investment and slowed down the recovery. Yet, I had expected the recovery to speed up after radical approaches to the American economy were repudiated in the 2010 Congressional elections, when many of the more liberal members of Congress lost their seats. For a while the economy did began to pick up, as unemployment declined quite rapidly from hovering around 10% to about 9% at end of 2010, and GDP started growing faster. But then the economy stalled. The challenge is to explain the drift in the unemployment rate during the past several months, and the rather tepid growth in GDP that have raised fears of a “double-dip”.
Some of the slow-down in the American economy is undoubtedly due to problems in the world economy: the excessive Greece debt and other serious economic problems facing a slowly growing European Community, the nuclear disaster in Japan and the sluggishness of the Japanese economy, and the possible slowing of the rapid growth in both the Chinese and Indian economies. Another part is explained by the policies that slowed the early stages of the recovery, perhaps especially uncertainty about the effects of the financial reform act, and lack of clarity about the cost implications to business of the health care act.
I am persuaded that an important third part is due to concerns that the US will be unable to control its fiscal situation. The ratio of federal government spending to GDP grew from about 21% in 2007 to 25% in 2011, a very rapid change compared to the relative stability of this ratio during the prior 25 years. Unfortunately, there is not yet a strong enough will in Congress and by the president to lower this ratio during the coming decade. Indeed, with the looming enormous growth in entitlement spending, especially Medicare, the spending to GDP ratio could well increase sharply in the coming decade, along with the fiscal deficit and the federal debt.
Liberal Democrats continue to be reluctant to agree to big cuts in government spending. Many Republicans have come out against increasing any taxes, even though sensible tax reform toward a flatter and broader based income tax would raise the taxes paid by some taxpayers. The most attractive reform of Medicare put forward by any member of Congress is Paul Ryan’s proposal to provide grants to the elderly to buy health insurance, with the size of the grant falling with the income of the recipient (see our discussion of his “Roadmap” in posts for April 4, 2011). But Ryan’s Medicare proposal has been rejected not only by Democrats, but also by leading members of his own party.
To many investors, the future of the American economy looks dim and also uncertain. I am a perennial optimist about America, but even I have moments of serious doubts: not about the ability to solve these problems, but about the will to do so. The best way to get American fiscal and other economic problems under control, and thereby “stimulate” the economy, is to institute growth oriented policies that would increase the long-term growth rate beyond the 3% average annual GDP growth rate of the past 130 years. These policies include tax reform, cuts in entitlement spending, and more sensible regulations that are less dependent on discretion by regulators (see my post for December 6, 2010 for a discussion of these and other proposals).