Waiting for the Recovery?

Many scholars and commentators have earned their intellectual reputations arguing that American capitalism is in decline. In the 1950s and 1960s, the American economy was populated with “organizational men” and assembly line workers who had uninteresting jobs that stripped them of their creativity. In response to these “alienating” prospects, the campus countercultural revolution vowed to change the priorities of a country that was obsessed with material possessions.

While it may have taken a while, the college graduates of the 1960s onward found their niches in an economy that was rewarding bachelor’s degrees at a much higher rate than previous decades. The discussion of alienation has retreated to an academic backwater as workers report high levels of satisfaction with their jobs.

In the 1980s, Japan was widely predicted to become the world’s number one economic power on the basis of their superior economic model. Lester Thurow, a leading economist, went further and wrote that a united Europe would also surpass America by the beginning of the 21st century. Others saw the rising governmental and international debt as causing many years of declining standards of living to pay for our profligate ways.

Instead, from 1984 through 2007, the American economy added tens of millions of jobs to our economy and Americans continued to have the highest standard of living among the major industrialized countries. Little noticed here, two separate think tanks in Switzerland rated America as the most competitive economy in the world in 2009.

Now, in the second half of 2009, many are claiming that the financial crisis has demonstrated that American capitalism is too vulnerable to large downturns and it is once again criticized as a dying economic model that should not be followed by other countries. Since we have yet to exit this crisis, the critics have a certain standing of having predicted the crisis (you’ll be proven right eventually if you predict a looming crisis for 35 straight years) and are calling for large structural changes.

The central economic debate now going on concerns the nature of the recovery: will it be V-shaped (sharp recovery), U-shaped (slow recovery), W-shaped (double-dip recession) or L-shaped (stagnation and very slow growth)?

There are three schools of thought:

First, the “structural pessimists” believe that inequality is to blame and hope that a Democratic President and Congress will adopt sweeping changes (a new New Deal) to reverse decades of destructive economic policies under Democratic as well as Republican administrations. To avoid stagnation or a double dip recession, they propose some combination of industrial policy (to restore the unionized manufacturing base), retrenchment on free trade (to avoid the rush to the bottom in terms of wages), expanded social spending (to reverse the abrogation of the old social contract), higher taxes (to pay for the new programs and reverse the effects of wage inequality), new regulations (to stop the old patterns from repeating themselves), and a dedication to undermining the power of the financial oligarchy.

Second, the “cyclical pessimists” base their reading of historical evidence on the assumption that recoveries from large financial crises are weaker and take longer than normal recessions. They do not have the expansive social agenda of the structural pessimists but worry that the federal government will not have the capacity to maintain the right combination of stimulative monetary and fiscal policy. The tendency of the populace to want quick results and the rivalries between and within political parties make it very difficult for large and decisive actions once the threat of total collapse disappears.

Third, the “optimists” base their views on the belief that Americans tend to bounce back from adversity. They see a strong resilience in our entrepreneurial economy and trust the ‘animal spirits’ of consumers and investors. By and large, this group tends to favor less government intervention in terms of regulations, taxes, and even stimulus spending.

With a few prominent exceptions, most economists aren’t structural pessimists and hence do believe that the economy will rebound with time. They are not confident that animal spirits alone will propel the recovery and are looking for the drivers that will set off a positive chain reaction -either in the form of more demand leading to more supply leading to more demand or more supply (requiring more hiring) leading to more demand leading to more supply. The Keynesian presumption is that it is easier to stimulate consumption than it is to convince investors to expand production before the evidence of a recovery is clear. The “cash for clunkers” program, in short.

Everyone is looking at the American consumers and trying to figure out what they are going to do next. Clearly, rising unemployment, the loss in housing equity, and falling stock prices have taken a toll on the financial well-being of many families. The ones hardest hit are those who lost their jobs and those who had little or no equity in their homes; those in the latter group, who can’t wait for home prices to rebound, face the difficult choice of foreclosure or taking a big loss because they are ‘upside-down’ (owing more than the home will bring if sold).

Others mistakenly think that economic distress is spread throughout the populace and cite data on how Americans saved very little over the last 15 years and have accrued debt at record levels. The savings rate data come from the National Income and Product Accounts and are skewed by the treatment of some retiree incomes as ‘dissavings’ and are subtracted from the savings of others. A careful study by the Center for Retirement Research at Boston College shows that the private savings rate of working adults has varied over the past 25 years but was still at 8% of income in 2004 (versus 10% in 1980).

The misconceptions about debt are just as ill-founded; many commentators scare the public by stating that total private debt is greater than disposable income. What these commentators fail to realize is that assets have been also growing and that the asset to income level has grown even more. Even after the huge hit that consumers have taken this year, their net worth is at the level of 2003 and is much higher than it was in the mid-1990s.

Consequently, many of the arguments used by the pessimists, even the cyclical pessimists, are based on an overly negative reading of various economic indicators. In the last government report, real GDP per person was at $46,000, down just 5% from its highest level in the second quarter of 2008. This is still a very wealthy country with powerful economic strengths, and it is easy to see how the green shoots of today will blossom into growth in 2010 and beyond.