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

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