Why the economic recovery is lagging—Posner

The U.S. economy is stagnant; the proposition that we had a mere “recession” which “ended” two years ago, is, like the terminology of sovereign default (“debt restructuring”), just an exercise in euphemism. Real (that is, inflation-adjusted) GDP per capita has declined by almost 3 percent since 2007. (This is on the assumption that the first-quarter 2011 increase in GDP at an annual rate of 1.8 percent, not adjusted for inflation or population growth, will be the full-year real per capita increase—in fact, if unadjusted GDP grows by less than 3 percent for the year as a whole, the real per capita GDP will decline.) At the same time, the national debt has soared (it is currently $14.3 trillion, of which $9.7 trillion is “public debt”—that is, debt owed bondholders rather than social security annuitants and other entitlement holders), and unemployment exceeds 9 percent, with about half the unemployed not having worked for at least six months. 

The sharp and rapid decline of the economy that began with the financial crisis of September 2008 was expected to be followed by a sharp and rapid rise (making for a V-shaped economic cycle) when the crisis was resolved by the bank bailouts and other emergency measures taken by the Federal Reserve and the Treasury Department in the fall of 2008, and by the $878 billion stimulus enacted by Congress in February 2009. The economy did pick up in the fall of 2009, but progress since has been fitful. 

Causal analysis is the Achilles heel of business-cycle economics. National economies are so complex, and so different from each other and over time (making cross-sectional and time-series analyses of business cycles inconclusive), that it is rare that a phase in the cycle can be explained satisfactorily, especially if an estimate of magnitude rather than just of direction is desired. 

For what it's worth, I think the major impediment to economic growth at present is uncertainty on the part of the key economic actors, namely businessmen and consumers. Businessmen are hesitant to hire and invest and consumers to spend, in both cases because of uncertainty about their economic prospects. 

I use “uncertainty” in the sense in which the economists Frank Knight and John Maynard Keynes distinguished between risk and uncertainty. Risk was a probability that could be estimated, uncertainty a risk that could not be estimated. The distinction is unpopular among economists because a nonquantifiable risk greatly complicates statistical analysis of economic phenomena, but it seems to me a real and important distinction when one is dealing with the business cycle. And there is a growing literature in economics on “ambiguity aversion,” by which is meant aversion to uncertainty in the Knight-Keynes sense. 

When a businessman has to decide whether to invest in a new product or a new plant or other facility, with the success of his decision dependent on future revenues and costs, there is bound to be an irreducible element—and possibly a very large element—of uncertainty; and likewise when a consumer has to decide on a major purchase, such as a house, or whether to seek a new job, or marry, or move to another part of the country, or retire, or seek more education. Any decision the success of which depends on future events is likely to involve uncertainty. And a common and usually sensible respond to uncertainty is simply to postpone the decision in the hope that the uncertainty will dissipate as new information becomes available. But the more postponement there is of investment, hiring, purchasing, and other economic decisions, the lower the level of economic activity. We observe this today with the enormous cash balances that large firms have accumulated and the drooping demand for houses. 

The greater the uncertainty, the less forward-oriented economic activity there is likely to be, with adverse effects on investment, employment, and consumer spending. At present the U.S. economy is afflicted with at least five major sources of uncertainty. One is the economy of the eurozone. If Greece defaults on its public debt, which remains a possibility in the near future (a year or two years from now), this may have a domino effect. The dominos are not just the other weak eurozone countries—Ireland, Spain, Portugal, and Italy—but also the French and other European banks that are heavily invested in those countries and the American banks and (especially money-market funds) that are heavily invested in European banks. 

Second is uncertainty about whether and on what terms Congress will raise the U.S. public-debt ceiling. Default is unlikely, but no one knows what deal the Republicans and Democrats will strike to avert default. Undoubtedly it will involve significant cuts in federal spending, and these cuts will hurt numerous businesses and individuals. 

Third is uncertainty about federal regulation of the financial and health sectors. The ambitious health-care and financial-regulation reform statutes enacted by Congress in 2009 are very long and complicated, but at the same time incomplete—completion of these regulatory edifices was delegated to regulatory agencies that have not come close to finishing their work. No one can know how tightly banks and other financial institutions are going to be regulated or how the price of health care is going to be affected; and the cost and availability both of credit and of health care are of immense concern to businesses and individuals alike. 

Fourth is a widespread suspicion in the business community that President Obama is in the pocket of the labor unions, is viscerally hostile to business, and is entirely focused on winning reelection. The suspicion is (in my opinion) greatly exaggerated, but is real. 

Fifth, there is a sense that politicians the world over, notably including the United States, are preoccupied with the very near term and are simply postponing the day of reckoning with the world’s economic problems that grew out of the financial crisis of September 2008 and the ensuing global economic crisis, which is still with us. The Greek example is a good one. Because Greece is stuck with the euro, it cannot climb out of its economic hole by devaluing its currency, a tried and true recipe for dealing with a severe economic downturn, because it increases exports and reduces imports, and both effects stimulate domestic employment. Greece as a result is broke, and if it had defaulted last year the eurozone might by now be in tolerable economic shape. Instead Greece seems about to receive a fiscal bandaid that will keep it going for a year or two, which means that any U.S. firm that has a stake in the eurozone and a planning horizon of at least a couple of years must cope with the uncertainty of Greece’s economic future. 

A parallel example is the efforts of our government to revive the housing market by providing relief to mortgagors; the efforts appear to have prolonged the depression of the housing market, which had it been allowed to hit bottom might be on the mend today. Similarly, the federal fiscal imbalance and mounting deficit are unlikely to receive more than bandaid treatment until the November 2012 elections; businesses and consumers will be tempted to hold their breath until then. Suppose that finally after those elections the government gets serious and closes the fiscal gap through some combination of higher taxes, reduced government spending, and programs designed sensibly or otherwise to stimulate economic growth. Because the gap is so large, and will probably be larger 16 months from now, and because the combination that will close it is likely to have profound and uneven economic consequences, many businesses and consumers alike will want to put many of their own economic plans on hold until they have a clearer idea of the terms of the gap-closing combination, which they may not have for years. 

I don’t want to give an exaggerated picture of the consequences of Knight-Keynes uncertainty. It does not paralyze economic activity, but it slows it down and may be a large factor in the current sluggishness of the U.S. economy.

 

Comments

[Thomas Rekdal]

Once again, both Judge Posner and Professor Becker provide a plausible analysis of the factors explaining our current economic plight. If the research of Kenneth Rogoff and Carmen Reinhart is accurate, perhaps it should not even be surprising to find ourselves stuck in the mudd this long after another balance-sheet depression. Still, I am inclined to think that the uncertainties surrounding our debt situation does make this time different.

Some years ago, the economist James Buchanan argued (I forget where) that it was a grave mistake to abandon the moral bias in favor of balanced budgets, because, once that norm has been weakened, there is nothing in the American culture or political system to brake an unending upward spiral of spending.

That does seem to be the way things are working out. As a result, many businesses and investors are just plain scared. I know I am.

[Ralph Lauren Giacche]

Now that’s the type of post I like to read. I am really very impress with your article. I want to get more knowledge about this.

[BRS Labs]

Nice post!!The scope of the earnings rise will strongly depend on the further improvement of the overall economic situation and the possibility to compensate price increases on the procurement side.thanks for sharing...

[MBT Shoes Clearance]

good news.

[MBT Shoes UK]

it is very good /

[Pradeep Despandee]

Meanwhile Americans live under the “Hope” that “Change” to lower incentives to produce will lead to prosperity. But this may be even worse than the 70’s. Three billion people in the developing world have woken up to economic freedom and they are not going to wait for the outcome of America’s experiment with socialism (as if we don’t have enough data as to where that leads).

You can be blond, brown, tall, short, skinny, fat, light skin, dark skin. It does not matter. Only the policies matter, and if your policies are the same as Jimmy Carter’s you will get the same economic results. Good-bye American exceptionalism means good-bye prosperity.

[Pradeep Despandee]

Diverting attention from the fundamental problem facing the West (decreasing competitiveness under the invitation to indolence offered by the European Welfare States and now the emerging American Welfare State) by blaming Greece is rather comical. Much bigger economies in Asia and Latin America have failed over the years without much fanfare.

The main problem with the “Domino effect” is not the fact that the first domino falls. But the fact that all the other elements are also well, …dominoes. In European terms that means moribund economies with anemic, severely and permanently sub-par growth trendlines compared to the world as a whole. America is now joining the same club of Western decline by transitioning to the same Welfare State incentives – also known as “hope” and “change”. “Hope” that facilitating indolence will not lead to “change” towards lower economic growth.

[Jim]

Most of my friends and family are hunkered down and are most concerned about protecting themselves from what they consider an incompetent president and congress sitting on top of a country which has been mismanaged for years. Not a hopeful scenario.

[Sam]

Once again, another Keynesian disciple gets it completely wrong. The very idea that the answer for Greece or any country to climb out of economic problems is to devalue or inflate their currency is exactly what has led the world into this mess. Until people realize the complete failure of Keynesian economics as a long term viable economic model, we will continue to live in a world where inflationary monetary policy leads to bubble burst cycles instead of real production based economic growth.

[NEH]

As has often been said, "Fear is the great mind killer and makes slaves of us all". The issue of "Uncertainty" is certainly one of the underlying causes of "Fear" and uncertainty is clearly a component as itemized in the following list:

1. uncertainty in the minds of key economic actors, business, consumer and government
2. uncertainty in Congressional action regarding the "Debt Ceiling"
3. uncertainty regarding Regulation in the Financial/Health Sectors of the Economy
4. outright fear in the Business community that the Administration has become a captive of the evil Union
5. a short term mentality (that has plauged Business, Commerce, Industry, Agriculture for years)regarding world economic problems and more local problems

The Knight-Keynes "Uncertainty Principle" clearly has some application in the lagging economic recovery, but the real problem is more psychological in nature. This was recognized by FDR in the depths of the Great Depression when he said, "We have nothing to Fear, except the Fear itself".

As for our current Economic Crises, and the mindset currently held by the Economic actors which are holding back a recovery, a new "Can-Do" mindset needs to emerge. Such that; "Either Lead, Follow or get the Heck out of the way"...

[Barb Minter]

Great article!

[Red Sole Shoes]

It is wonderful!I like it very much!

[buy.com promo code]

Nice info for economic passion people...

[james c]

Deleveraging.

[an observer]

Amazing---using old forecasts intended as facts

Posner writes:

The sharp and rapid decline of the economy that began with the financial crisis of September 2008 was expected to be followed by a sharp and rapid rise (making for a V-shaped economic cycle) . . .

According to whom?

I don't know a single Democrat or Democratic economist (not spinning in an attempt to get Congressional action) who thought this was going to happen. Krugman and Stiglitz were crystal clear that we had driven off a cliff and had destroyed our economy through de-industrialization and globalization. Others like Robert Dugger were blunt that 2006 was America's "last good year," because the World would never again buy our private equity and debt. Watch the program "Recent Credit and Loan Industry Practices," here:

http://www.c-spanvideo.org/program/RecentCr

As for "uncertainty," argument, such is just BS, spin, and mendacity, pumped out by spin doctors for billionaires, solely for political gain.

Keynes was correct---business do distinguish between risk and uncertainty---however, the uncertainty that grips our economy is not over political issues (which are the tail wagging the dog). For example, the uncontrolled cost of health care was killing business before and has continued to kill business, since Obama's election. Businesses, logically, should have been helping Obama pass a health care plan that truly controlled costs.

The uncertainty that faces the country is that this time it is different. There ain't no bounce back because there is nothing there to bounce back. Give me (or anyone I know) $100 million to invest in a business or business and I would give it back, except farm land that won't flood but has nearby water for irrigation. The are no opportunities. Look at the dwarfs the GOP has running for President. Have you heard one suggest one good idea. No.

[Gordon Longhouse]

I agree with the observer above. I can't see how anyone could have expected a V shaped recovery after the kind of crash we experienced.

Likewise "uncertainty" is less about this or that program or proposal than about the ability of the political system as a whole to come up with any sensible solution to any major political or economic issue.

[insanity]

Just want to say what a great blog you got here!

[TANSTAAFL]

Becker and Posner raise good ideas about why the economy remains in the doldrums. A major cause they left unmentioned is the many hapless voters who are not old enough to remember Jimmy Carter and, therefore, made a poor choice in 2008. A plain fact.

[an observer]

Tanstaafl,

As Observer knew Carter, even before he ran for President, all I can say is that you have no idea what you are talking about.

To believe for a moment that things would be better with McCain as President---nuts. Keep in mind that no sharper honest critic of Obama exists. Given his potential, he has deeply disappointed. But to suggest that we would have been better with McCain/Palin

[El-Greco]

With the exception of his warmongering tendencies and the delusional cost/benefit ratio that he seemed to assign to American interventionism, McCain would have been better on balance.

However, the fact that Obama or McCain are the choices that attract American voters, is yet another indication that the dynamics of American decline are firmly rooted.

[Uiop]

The only thing that matters is that the productive class be able to make money. People who no longer can pay their mortgages should be forced out of homes like the slobs they are, so that those in the housing industry can go back to making money.

And how dare we feed poor people, especially the elderly who are no longer productive and are only a burden. Grandma, go to hell.

[A reader]

I agree with the comment above- I can't remember almost anyone "expecting" this to be a v shaped recovery, liberal or conservative.

Also, it is kind of funny saying that Greece's fiscal situation is the reason Americans, especially ones that only have a high school diploma, are out of jobs. Most americans I know don't follow internatonal finance like they do football. And that includes business owners. Besides, do we import from or export to that much with Greece? Posner focuses too much the banking industry's concern with holding bad Greek loans. As if the banking industry is going to hire thousands in America if Greece's loans were good, and as if they are not looking for opportunities to lend since the fed has pumped them with so much capital.

Businesses are not investing because no one has jobs that will give them the income to buy their proucts. There is "demand" uncertainty, not future tax uncertainty, or regulatory uncertainty, or deficit uncertainty, or whatever other uncertainty. No demand, no investment. Classical arguments are too concerned with expectations. They overestimate an individual's sophistication and concern for the future. Also, most people don't have enough money to worry about future investment considerations, they just have enough to live and spend. And they don't even have that now that unemployment is high.

Short term- government infrastructure products that hire undereducated workers to increase employment, and thus demand, for products businesses sell

long term- complete revamping of the entire education system to train individuals who are not college material for gainful employment. This includes privatizing a lot of it, making it actually pay to be a teacher, creating unique curriculums, etc.

I do agree, however, that creating new regulations in health care and the banking industry does create uncertainty. Obama should have waited to his second term to tackle these. He should've been laser focused on the economy. Whether you agree with them politically or not, these changes created uncertainty at a time when we couldn't handle it.

But the short term problem is demand, which monetary policy couldn't solve. Thus, government solutions, or we'll have sluggish growth for the next few years.

[TANSTAAFL]

Begging your pardon, Observer. I worked for a living, paid taxes, and suffered for four long years under Jimmy Carter. When Carter left office I hoped America would never again see such an inept president. As stated, in 2008 Obama was elected by voters too ignorant of history to know better.

So please explain why you apparently think Obama is a better president than Carter was. Go ahead.

[an observer]

TANSTAAFL:

Indirect proof: When Shrub (bush II) was President, "I Miss Nixon," bumper stickers and buttons were, appropriately, very popular.

I have not seen any I Miss Carter bumper stickers or buttons.

Near the end, Shrub turned to Nancy Pelosi, with McCain in the room and asked her, "Do you miss me yet?"

Direct proof: Osama Bin Laden is dead

[james moylan]

I have a web site where I give advise on penny stocks and stocks under five dollars. If their is anyone that is interested in these type of stocks you can check out my web site by just clicking my name. I would like to comment. I do not think that we will see real improvement in the economy until we see sustainable job growth. Recently the number of jobs created has been running around two hundred thousand a month. The GDP report that just came out recently was only 2% this is not nearly high enough to sustain employment growth of two hundred thousand jobs a month Another factor holding things back is stagnation of wages and benifits. This is good for business owners but terrible for workers.