Jewish World Review Dec. 4, 2001 / 19 Kislev, 5762
http://www.jewishworldreview.com -- THE American economy is in deep trouble-deeper than the common awareness that the long '90s boom is over. As best we can, we have to understand what has happened and direct public policy to reverse a potentially even more damaging downward spiral.
The intellectual and political deadlock in Congress has to be broken-immediately. We were caught off guard by the sudden descent into recession, and now I believe the pessimists are right in thinking recovery will not come as soon or as strongly as the optimists believe. The National Bureau of Economic Research has finally declared that we have been in a recession since March.
Contradicting growing confidence that the recession is bottoming out, a Federal Reserve study, the "beige book"-a report on economic conditions throughout its 12 Reserve districts-indicates additional slowdowns in most regions, outweighing signs of recovery in a few districts. The optimists woefully underestimated the depth of the re- cession. Now they overestimate the strength of the recovery and how quickly it will start. It is the pessimists, so far, who have been proved to be the realists.
So the critical questions remain: How deep will the recession be, how long will it last, and when will we recover to the point where growth begins to approach the 3 percent or 4 percent rate we are capable of? The answer? Nobody knows. But to decide where we might have leverage, let's look at the four elements that make up the gross domestic product: capital spending, consumer spending, exports, and government spending.
Capital spending. This was the nose cone of the decline, the surprising investment bust that began last year following an equally surprising investment boom in the 1990s. At the peak of the boom, annual capital spending was at about $1.4 trillion and growing approximately 15 percent per year. Now it is falling, by about 15 percent to 20 percent annually. It is the most dynamic multiplier factor in our economy, and its decline is accelerating, according to indexes of the National Association of Purchasing Managers. Orders for new technology are down over 40 percent, and, according to the Federal Reserve, traditional low-tech sectors like transportation account for as much of the slowdown as high-tech sectors. Industrial output has now shrunk for the longest period since the 1930s. Businesses are looking at capacity utilization in the "old economy" of 74 percent and in the "new economy" of only about 60 percent. Corporate profits are plummeting. They dropped 55 percent in the third quarter and 52 percent in the second quarter, according to Business Week's measurement of 900 companies, the largest drop in 25 years. This is a much more dramatic downturn than expected, with no letup in sight.
The corporate sector is in a major recession. Business confidence has virtually collapsed. Businesses with depressed and still-declining profits, vast overcapacity, virtually no pricing power, and reduced stock prices will not be increasing capital spending anytime soon. Slumping investments have got the economy by the throat. The decline in corporate profits begat cuts in capital spending and inventory investment, and then business began to cut labor costs to defend profits. The result is a contraction of about 2.5 percent of GDP from declines in capital spending alone.
Consumer spending. Another critical consequence of capital cutbacks is an outright decline in payrolls, cutbacks in average weekly hours worked, and cutbacks in overtime. When bonuses are slashed at the end of this year and wage raises for the next year are not forthcoming, wages and salaries will continue to be depressed. Jobs, and the fear of losing them, and the perceived ease of getting them, are the single, greatest influence on consumer behavior. And the outlook for all of them is negative, putting great pressure on consumer expenditures, which make up about two thirds of our GDP.
Unemployment looks set to rise. Help-wanted advertising has hit an 18-year low. The weekly levels for new claims for jobless benefits, while somewhat off their highs, are still consistent with monthly job losses in excess of 200,000. The unemployment rates will easily top 6 percent, on the way to 7 percent. We have already had a drop in consumer confidence to its lowest level in nearly eight years, and the trend will continue as companies announce more layoffs, slowdowns, and shutdowns. There is little hope here for a consumption binge that could offset the investment collapse. Indeed, preliminary statistics indicate that retail sales for the Thanksgiving weekend were down about 1.5 percent, the first decline since they have been measured. This took place despite lower interest rateswhich have stimulated car sales, home purchases, and the refinancing of homesand lower energy prices, which are adding about $10 billion a month to consumer wallets. Offsetting these positive elements is the fact that incomes are no longer being buoyed by huge capital gains. They had exploded from 2.6 percent of disposable income in 1995 to 7.6 percent in the year 2000. Now it's the stock- market bubble that has exploded. Consumer psychology is critical. The atmosphere of 9/11, with the anthrax scare and FBI warnings, is hardly encouraging. Even Americans who have money may be inhibited. They have started to save instead of spending. The savings rate has risen to 4.7 percentup from about 1 percentand that bite out of consumer spending will be painful. The economic anxiety that promotes savings tends to be concentrated in upper-income households, those earning between $75,000 and $150,000, and 40 percent or more of those being laid off are among such higher-paid white-collar workers. Even the minor telltales of consumer psychology are worrisome. Lipstick sales are soaring. Good news? Not so good, some say, because lipstick, which sells for anywhere from $2 to $20 a tube, is a reasonable pick-me-up when the consumer cuts back on life's other luxuries, like an expensive new dress.
The good news is that the American people are fundamentally optimists who like to shop. Shopping is one of the great American pastimes, fueled most recently by the residual effect of the enormous wealth created in the past decade. The real danger is that people worried about jobs may retrench, especially if they focus on the high levels of debt that households have taken on since the beginning of the 1990s. Can the propensity to shop be stymied by this sudden case of the jitters? If the Thanksgiv- ing decline continues, and consumer spending declines by 1.5 percent or more as the savings rate goes up, we will lose an additional 1 percent to 1.5 percent of GDP.
Exports. We have seen the sharpest drop in exports in decades, reflecting a simultaneous recession in the United States, Europe, and Japan for the first time in 30 years. The decline will almost certainly extend well into next year. If it does, we lose a half of 1 percent of GDP.
Government spending. State and local entities spend about twice as much as the federal government. Today, we're looking at lower revenues in at least 44 states and higher costs, especially for security, in many. The estimate is that there will be a shortfall this fiscal year in spending of about $50 billion. That's another half-a-percent drop in GDP.
The cumulative risk, then, is that the elements of GDPcapital investment, consumer spending, exports, and government spendinglook like the four horsemen of the apocalypse, bringing us a 4.5 percent to 5 percent decline in GDP.
What can be done? The only option is monetary and federal fiscal stimulus. Recent tax cuts, a very aggressive reduction of 4.5 percentage points in the federal funds rate, and a very sharp rate of monetary growth of about 10 percent year after year, have added several points to potential growth. Potential because so far the tax cuts and tax rebates have had a very limited impact on spending, while the effect of monetary policy has been muted. The recent Federal Reserve survey of senior bank executives reported the most rapid decline of commercial and industrial loans since the survey began years ago.
Now Washington is looking to inject additional fiscal stimulus. But this has been stymied by congressional stalemate. Both Democrats and Republicans argue that their opponents are offering bills that have more to do with partisan politics, their ideological agendas, and their political interests, and less to do with getting the economy moving. The Democrats were outraged by the Republican program, which offered big tax benefits for corporations and the wealthiest Americans, a group, they argue, that is less likely to spend the additional disposable income than to save it. They argue that the Republican plan has put virtually zero funds into the hands of the typical family of four, with annual income of $50,000 or less, wasting it on businesses at a time when they don't need it and won't spend it. Industrial capacity utilization is at the lowest levels in almost 20 years, making it unlikely that companies will add to their investments. These handouts just give companies tax breaks for already planned investmentsnever mind also providing tax refunds for past investments. Republicans counter that the Democratic program caters to a whole host of special interests and political constituencies whose spending programs would have nothing to do with energizing the economy. Now the leadership in both parties is seeking a middle ground of very limited tax cuts and very limited spending programs.
We should look to Congress for measures that give a temporary boost to the economy that needs it while avoiding measures that affect federal budgets for years to come. The critical element should be enhancing consumer spending by helping people who have lost jobs and assisting hard-hit regions. It would be wise to extend unemployment compensation in this period and to share revenues with federal, state, and city governments. New York City, for instance, is suffering catastrophic damage, and the effects of a New York in trouble won't be just a ripple effect. It will be a tidal wave in all those areas where New York is an important capitalfinance, media, advertising, culture and the arts, and tourism.
What we don't need is another fiscal program that would threaten the long-term federal surplus and thus damage the nation's long-term fiscal health. Mitch Daniels, the director of the federal Office of Management and Budget, has projected that the country will run a deficit for the next three years, largely because of the first tax program that was passed. The wrong program will limit the declines in the intermediate and longer-term interest rates, key to corporations' decisions to invest again and to consumers' decisions to buy homes. Losing control over our fiscal affairs over the long term would create a general loss of confidence in the economic management of the country. We have been through that before. We don't need permanent revenue reductions that would produce a fiscal hangover. It is time for Congress to actbut to act