The Slow Economic Recovery-Becker

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).

 

Comments

[El-Greco]

Germany is exactly the example of how the typical European Welfare State incentives squander the superior ability of a citizenry which is perhaps amongst the top handful most capable in the world.

By contrast American capitalism is (was?) the more dynamic environment that enabled “Dumb Americans” (as they are known in Europe) to be most prosperous in the world, outproducing the admittedly more competent average Europeans. Now that the plan is to marry the competence of the average American with the incentives of the German Welfare State (the central aspiration of “hope” and “change”) what you will get is prosperity levels similar to Spain, Greece and Portugal. And this is where you are headed dear Americans because this is what you want. You have been bamboozled by the demagoguery of higher prosperity based on lower incentives to produce and once you enter that vicious cycle there is no escape.

But I love how I hear progressive Americans who have never lived, worked or tried to set up a business in Europe claim from afar that the grass is greener in Germany.

While Germany has had a couple of strong (strong by European standards that us) temporary post crisis rebound growth quarters (unlike the US where the recession also coincided with a marked turn towards more socialism) Germany’s long term economic growth trendline is a rather unenviable 2% (actually just a tad less than that). Of course, such is the accepted pathetic future of Europe as a continent, that a 2% growth qualifies Germany as a tiger economy within the Eurozone. “Στους τυφλούς ο μονόφθαλμος βασιλεύει” : “Amongst the blind the one eyed is king”, as they would say in southern Europe. Since the world on average grows by 4-5%, Germans are loosing 2-3% of their standard of living per year compared to the rest of the world, relentlessly compounding year after year. While that is better than Spain or Italy (less than 1% long term growth) that is still a sure path to worldwide economic marginalization.

The equivalent to the American dream for a German family is to upgrade from the typical 900 sqf 2nd floor apartment (the average dwelling for the German middle class) to the “privileged” 1200 sqf “suite” on the 5th floor. If you live in a single family home in Germany (like most of the American middle class) you are said to live in a “villa”. The living in a “villa” status is a privilege reserved to less than 5% of the population living in German cities. Saying in Berlin, Munich, Hanover etc. that you live in a 2000 sqf single family home with an actual yard is like saying in America that you live in a mansion.

How does Germany manage with taxes? By taxing everybody and not just the rich.

Germany and most of Europe have already gone past the hope and change stage and have already taxed the rich to the top of the Laffer curve. Having exhausted the rich as a revenue source (and having sent many productive people to a more mediocre leisurely life – ever wonder why you encounter so many Europeans in the South Seas?) they had to turn to the middle and lower class for more revenue, something that will inevitably happen in America after a couple of miles down the road to “hope” and “change”. The middle class in America is essentially digging its own grave.

Top income marginal tax rates for the rich in Germany, and Europe in general, are similar to the US if one considers higher tax states like California and New York. The big difference is that in Europe EVERYBODY is highly taxed not just the rich. While in the US the top tax rates kick in when income rises to about 7-8 times the average income, in Europe, making about 2 times the average income already bumps one into the top tax rates. Add to that a 20% VAT tax, excise taxes and $9 gasoline, all paid heftily by the middle and lower class and you see how “free” really all those European social services are. In America, on the average salary, one could buy all those services offered “free” in Europe and still have more money left to spend. And that is, spend to buy goods generally priced quite a bit less and without the additional 20% VAT, the hidden taxes that increase the cost of everything (ever tried to eat in a restaurant in Germany?) and the $9 gasoline.

Try to haul 2 kids in and out of public transportation summer and winter in Berlin to do your daily shopping, take them to school, activities etc. and you will see why Europeans have even stopped reproducing, with birth rates ranging between 1.3 and 1.8 in most of Western Europe. If you ask most Europeans about having kids they’ll typically answer “Maybe we’ll have one. It’s too hard! It’s too expensive!”

That is the prosperity level achievable by what is perhaps the most competent workforce in the world under the incentives of the Welfare State. So be careful what you “hope for” Americans because you would be indeed very lucky if a change to Welfare Social Democracy allowed you to maintain even German levels of prosperity, which in the end are simply just a slower path to decline compared to the rest of Europe. As I said above, marrying the competence of the average American with the incentives of the European Welfare State (the central aspiration of “hope” and “change”) will not even allow you to maintain German prosperity levels. Something akin to Spain, Greece and Portugal will be the more likely outcome of combining the competence of the average American with the indolent incentives of the European Welfare State.

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[rob matysiak]

Economy is not going to recover if we don't start bringing back our jobs!!!

[john morris]

China is going to own all of the U.S. if we don't stop borrowing money from them, wich devaluates the dollar!!!

[Sukarnoputri]

Why should your American companies move our Chinese, Indian, Brazilian, Russian, Taiwanese jobs, that pay us 3 times more than our old jobs, to America? Because you Americans insist and hope to continue exchanging 1 hour of your labor with 5 hours of our labor though we are finally learning to do the same things that you do? What are you going to produce? Children’s bicycles at $300 a piece (what they used to cost in 1960 in inflation indexed dollars?) and then force yourselves to buy them at these prices? or solar panels at 5 times the price than we do?

I’m happy making 3 times what I used to make. If you want to make 15 times that then do something 5 times more valuable than I do. Solar panels, for example, are low technology, not rocket science, I can make that type of stuff just as easily as you do and for a quarter of the cost. Either move up to higher value work that I am still incapable of doing or accept the fact that our standard of living will reach yours. Why should you have a standard of living that is 500% higher than ours?

Let’s see how your companies manage to survive paying you 5 times more for the same job. We are starting to have entrepreneurs that create companies capable of completely supplanting your entire companies. But please go ahead, do wage war against your entrepreneurs and companies. That will give our entrepreneurs and companies an additional opportunity to completely supplant your companies and catch up even faster.

You Americans are delusional. And judging from comments on blogs, lately, seems like you are now been fed the same stuff that the Europeans have been fed all these years on their way to extinction. Go ahead and prosper putting forth $0.50 of effort and resources to produce one kWh of energy from alternative sources. If you just look at it from a little further away you immediately understand how moronic of a delusion that is. If the rest of American economic thinking has degenerated to this level of populism, then, no wonder you’re in decline.

S. Sukarnoputri

[Dan]

I read hoping to get an objective opinion on the topic. However, when the author uses the term "Liberal Democrat" in contras to "Many Republicans", I can see the bias. It diminishes Mr. Becker's credibility on the issue.

[glasnost]

Absolute nonsense on stilts. An unfalsifiable hypothesis ("we're recovering slower than we might have been under some other unspecified set of policies!") with no attempt to draw empirical comparisons in history or even to describe exactly who's being hurt and how.

Here's a technique that doesn't rely on voodoo:
http://modeledbehavior.com/2011/02/05/gallup-poll-small-businesses-point-to-aggregate-demand-failure/

Becker might want to try on the radical concept that gigantic decreases in asset-to-debt ratios result in everyone in the private sector cutting spending at once, which leads to less purchases of goods and services, which leads to... economic decline! Which continues indefinitely as a state of nature, because no one is able to be the first person to start making gigantic investments when no one is buying anything!

It's not rocket science. It's all market incentives.

From an economics standpoint, this is genuinely illiterate stuff.

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This time about reasons for the slow economic recovery in the US. Becker thinks that the US needs a favorable tax environment, a clean up of the public household and better predictability of regulators

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As for Europe...Europe's ongoing demographic collapse heralds a sharp downgrade in prosperity, beginning with southern Europe and moving inexorably northward. Formerly prosperous welfare states, without taxpayers, generate historical ruins and little else.

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Well the slow-down in the American economy is undoubtedly due to problems in the world economy... When we eventually look back at our times in a historical perspective we will realize what a time of precipitous American decline the early 21st was under hope and change.

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